Real Estate Giant Compass Is Facing an ‘Existential’ Cash Burn Problem

Not too long ago, the real estate company Compass looked poised to dominate the industry for years to come. With a promise to combine the best of the technology and real estate sectors, it had raised an eye-popping $1.5 billion in funding from investors that included SoftBank, poached or acquired many of the top agents in the business, developed a deep bench of engineers, and made its logo an almost omnipresent feature of high-end neighborhoods. 

By CEO Robert Reffkin’s own admission, earning a profit was not top of mind. “Short-term profitability is something that many of the more modern companies are not as focused on,” he told the Wall Street Journal in 2019. Instead, Compass kept aggressively spending to grow. By last year, Compass, which focuses on selling luxury homes in high-end markets with the help of a sleek app, was working with thousands of agents and selling more residential real estate by sales volume than any other brokerage.

Now, Compass looks like something more akin to the WeWork of the residential real estate market—a company that raised and spent money like a tech firm but made money like a brokerage. “What they’re doing, it doesn’t make sense,” one rival CEO recently told Bloomberg. Like a lot of high-growth tech darlings, Compass has still never made an annual profit, but when the housing market started to cool down and the tech industry came back to earth this year, the lack of even a clear path toward profitability was laid bare. 

In mid-May, one analyst, Mike DelPrete, published a short analysis of the company to his website saying Compass had a severe “cash burn problem” and was at a “a critical juncture” where it would need to raise money or cut costs after years of operating “more unprofitably than any of its publicly-listed peers.” One month later, the company announced it was laying off 10 percent of its workforce. Then, in August, Compass announced an additional $320 million “cost-reduction program.” Soon after, DelPrete wrote that the move made sense, considering the company needed to “significantly reduce expenses to remain solvent.”

DelPrete, a scholar-in-residence at the University of Colorado Boulder—and an investor in real estate companies, including Compass competitor Side—has become one of the most closely-watched thinkers in the online real estate space, thanks to his evidence-based and often prescient analysis of companies like Compass and Zillow. 

He spoke to Motherboard on the phone last week about the rise of Compass, where it went wrong, and where they could go from here. We lightly edited the interview for clarity. 

Motherboard: Let's just start here: When Compass announced these job cuts and this cost-cutting strategy, were you surprised?
Mike DelPrete: No, not at all. 

And why was that?
Because they have a cash burn problem. Fundamentally, Compass is a business that spends more money than it makes. And it's been spending more money than it makes for years now, since inception, so perhaps a decade, and it's doing it at a scale unprecedented in the real estate space. Compass is the world's most unprofitable brokerage ever.

What are they spending their money on that other companies aren’t?
They're spending their money to aggressively grow. So over time, that's been recruiting. They're acquiring brokerages. They're acquiring agents. So aggressive, aggressive recruiting tactics. Also, technology. They say they've spent $900 million—just say it again, $900 million—building their technology platform.

And what does their technology platform do?
The technology platform is like a back office or an operating system for a real estate agent. So it's designed to help an agent do everything they need to do in business: handling and managing leads, sending out mailers, prospecting for new customers—anything that an agent needs to do to run their business.

You've compared the company's strategy to the New York Yankees’ strategy. Can you elaborate on that?
There's a couple famous sports teams, the New York Yankees and Real Madrid in Spanish soccer, that have tons of money and they go out and they buy the superstars. And that's their competitive advantage. They have so much money, they can go out and buy the best players and try to build the all-star team. Compass had a similar approach. They had so much money, they would go out and target the most productive agents. If you get a list in terms of how many houses agents sell in a given area, they would just start at the top and go through the list and call those agents and they wouldn't hang up until they've thrown enough money or incentives at those agents to convince them to come on Compass. So their strategy was to effectively try to build an all-star team. And when it got too cumbersome to pick up the phone and call them one at a time, they would go out and just acquire the brokerages.

The entire brokerage?
Yeah, just acquire the brokerage. They were paying top, top dollar. They didn't care. They just wanted to acquire market share to get as many top-producing agents as they possibly could.

(“We are working to be the best place in the industry for agents to come and be successful and grow their businesses,” Compass spokesperson Joshua Friedlander said in response to a Motherboard request for comment. “The size of the residential real estate opportunity is massive, and there is lots of upside for the company that becomes truly excellent at empowering agents to succeed.”)

So is it fair to say compensation was high there compared to competitors consequently?
Yeah, and agents don't get a salary. An agent gets compensated based on a commission split, where when they sell a home, they get to keep a percentage of the commission they earn and they pay a percentage of the commission to the brokerage they work for. So Compass’ share of that commission was very, very, very low, meaning the agent got to keep most of that money. Compass would also incentivize agents with sign-on bonuses and stock options. So those kinds of all added up to make it financially a really lucrative proposition for an agent.

Just to back up, how was Compass able to raise all this money? They raised over $1 billion, including from SoftBank. What made them the company that could raise so much compared to their competitors?
I don't know. How does anybody raise money? It's a great compelling narrative, coupled with a charismatic founding team. They told a great story of a huge industry—real estate—that kind of operates the same way it always has, coupled with technology. Real estate and technology, put them together, and we're gonna make a lot of money.

The CEO said a couple years back that short-term profitability is something that many of the more modern companies are not as focused on, is it safe to say profit was not a point of emphasis early on? 
It was definitely not an emphasis, nor shouldn't have been. If you have a billion dollars in the bank, the worst thing you can do is let it sit in the bank. You need to spend it to grow. That's what these high-growth companies are supposed to do. They're supposed to spend money in an unprofitable manner to reach escape velocity, to get really, really big. So they were going according to plan. 

But I think the idea of having a viable path to profitability was always uncertain. There was no clear path to profitability. Everybody knew this couldn't last forever. And there were vague notions of what would need to happen to reach profitability—either it would have to get to enormous scale in the U.S. or they would have to deliver on the promise of technology reducing costs and making people more efficient. Or, We're gonna get into mortgage and title insurance and we'll make money there. But that's where things got really hazy. It's like a magician waving their hands and the misdirection [that comes with that]. There was no real set in stone path of: This is how we're going to be profitable one day.

(“This is not really true. Of course we had plans to build a profitable business,” Friedlander said. The company had planned to “profitability naturally” by scaling to such a level that revenues overtook costs, Friedlander added, but recent “market dynamics have necessitated a different approach to the same outcome where we will make cuts more quickly.”)

So maybe a year ago before the housing downturn, before people were talking about inflation very much, where would you say Compass was then? Had the cash-burn issue not become apparent yet because funding was still so plentiful?
A year ago, nobody was paying attention, myself included. They had a lot of money in the bank. They were spending a lot, but that's what they've been doing for years. So there was nothing new. There was nothing different. What really happened is that in 2022—I don't know what happened; I don't know what meeting I missed or what memo I didn't get—but suddenly the investment community decided: Actually, profitability is really important. We need and want all companies to be profitable or have a path to profitability. 

So the stock market got hammered. Suddenly, Compass’ ability to replenish its coffers, to raise more money was gone or severely handicapped. And that's when the pressure is on, right? It's like if you're driving your car across the country, everything's fine until you run out of gas. But when your next gas station is in 350 miles, you have an Oh shit moment. Like, Oh my God, can I make it?

And that's when they started layoffs and other cost cutting. Can you give me a sense of what costs they're reducing? And where do you expect them to cut costs moving forward?
Earlier this year, they cut 10 percent of the workforce—450 employees. And now they just announced a much larger $320 million cost reduction program. And they alluded to two areas.

The most important area is tech. They're basically saying, Hey, our tech platform is almost done. And we're gonna be able to reduce our expenses there. It's a little weird, because a tech platform’s never done. It’s like saying, We’re finished, we're done. All of the technology has been built, we're gonna fire 80 percent of our engineering team. Or Google being like, We're done. We finished the search engine. We are totally set. That's not how tech works. But I think that's code that they'll be cutting their tech team in a pretty aggressive way. Their software development team has 1,000 people, which is mind-boggling for a real estate brokerage. I think they're on track to spend around $360 million on tech this year. So there's a huge cost there. 

(“Mike is right, but it is true that building an end-to-end platform takes a big investment to ‘build from scratch’ and it's completely possible to maintain and deliver further new innovations and features with a smaller team than what it took to start from scratch,” Friedlander said in response. “We will still have a tech team to run the platform and continue to add new capabilities based on what agents and the employees who serve them need, but we can do that with a smaller team than we have had to date.”)

The CEO of a rival brokerage told Bloomberg recently that Compass is not a technology company. They're a real estate brokerage company. That's been a constant question: How much are they really a tech company? Do you feel like all of this is an admission: Maybe we really are just a very snazzy real estate brokerage at the end of the day?
We could have a philosophical argument about that for hours. I don't know. I don't know if they're a brokerage or a tech company, and I would assert that it doesn't really matter. They make money as a real estate brokerage. They have 1,000 software engineers. They pitch themselves as a technology company. I mean, they’re both. They've clearly been valued as a technology company in the past. And today, and always, they make money as a real estate brokerage. The interesting irony here is they could be profitable tomorrow if they fired all of their tech people. So it's a Catch-22.

It does sort of remind me of WeWork. There were lots of co-working space companies, but WeWork was the company that raised a lot of money because they were the ones that said, We're not just a co-working space company. We have a technology element as well. Do you think that's possibly part of it?
Yeah, it's impossible not to draw parallels between those businesses. But just because there's similarities doesn't mean they're the same.

(“While we are similar in that both are founder-driven companies, we'd look at each founder individually – that’s where you’ll see the difference (diligence vs excess),” Friedlander said.)

Where do you see this problem heading over the next six months or so?
Compass is not going to run out of money. But Compass does have a cash-burn problem. They're spending a lot of money, and they have a rapidly diminishing bank account. So they need to make really significant cuts. And the question is, can they do that while still retaining their agents? How does a company cut $320 million of expenses and still offer the same level of service to its customers?

It's one thing to say, Oh, we're gonna cut some enormous chunk of the company and then the balance sheet will look a bit better. It's a bit different so come out the other side with a sustainable operation and not one that’s really injured.
The other interesting angle here is looking at the competitive set. So you've got Compass who's cash flow negative and needs to cut $320 million. Who are its peers? Who is it competing against? eXp. Anywhere Real Estate, which is Coldwell Banker and Sotheby's. Douglas Elliman. These are companies that are cash-flow positive. They're making money. They're not laying off people. They're not having to cut hundreds of millions of dollars of expense. It's important to think about it from a competitive standpoint.

You have a company like Compass that needs to shed hundreds of millions of dollars of costs. And they’ve said we're stopping growing, we're not going into new markets, we’re not going to offer new incentives to new agents to join us. Many of these other companies that are actually cash flow positive, they're making money. They can afford to invest. They can afford to grow. 

So I think that's an existential risk here for Compass. They're taking a much-needed pause. But what's the long-term implication of that going to be relative to who they're competing with in the market?

This post has been updated to include that Mike DelPrete has invested in real estate companies in the past, including Side, a Compass competitor.