Mini mergers: Smaller firms unite
Faced with the same tough market realities as their big counterparts, small and mid-sized firms are increasingly joining forces
Residential sales have slowed, the cost of running a brokerage has climbed, and tech is becoming more of a threat by the minute.
While there has been plenty of coverage of all of those issues, most of the headlines have focused on how New York City’s bigger players — the Douglas Ellimans and Corcoran Groups of the world — are handling it all. The small and midsized firms, which grind out deals in the less sexy corners of the New York market, have, however, gotten overshadowed.
But those companies are living with the same market realities. And they tend to have fewer resources to cope with them. As a result, they are more often facing do-or-die situations.
Lately, their answer to the perfect storm of market forces has been to merge with — or get acquired by — another firm.
The deals, sources say, allow companies to consolidate their overhead costs while adding to their agent headcount and locking up more deals.
“It’s a much tougher marketplace for small to medium-sized firms than it ever has been before,” said Steve Murray, owner of the Colorado-based consultancy Real Trends.
In the last five years, average gross margins across all types of brokerages nationally have dropped by about one-third, according to studies conducted by Real Trends.
Murray said his company is handling 25 or more valuations per month. While not every one of those companies is for sale, seeking a valuation is often the beginning of a broader conversation that starts like this: “What are we supposed to do now?”
Murray cited one company he’s worked for that’s been in operation for 30-plus years and has a headcount of about 80. In 2015, the company had about $10 million in gross revenue and about $1.2 million in earnings before interest, tax, depreciation and amortization. Now, the firm’s EBITDA has dropped to about $380,000 to $400,000, Murray said.
And that firm is just one of many.
“It’s like somebody flipped a switch 18 months ago,” said Murray.
“What about us?”
None of this is happening in a vacuum, of course.
M&A activity among all kinds of real estate firms hit $524.7 billion last year — nearly 25 percent more than the 2007 record of $424.5 billion, according to figures from Thomson Reuters.
And the brokerage world is filled with examples of these deals.
For instance, last year, in a move that sent ripples through the brokerage world, Berkshire Hathaway’s HomeServices of America acquired Virginia-based Long & Foster, which had 11,000 agents and $29 billion in 2016 sales plus affiliated mortgage, insurance and property management businesses. That transaction spurred a lot of questions for smaller brokerages, Murray said. He explained that other firms wondered what would become of them if the leadership of a much larger company felt they needed to get bought.
Meanwhile, Compass bought the California-based Pacific Union International Realty, the fifth-largest firm in the country, last month.
And Berkshire and Compass are not the only bigger players shopping for firms to absorb. Elliman, which has been on its own expansion tear, picking up firms in Los Angeles and Boston, announced last month that it was also snapping up the Manhattan townhouse brokerage Vandenberg.
The firm was founded in 1990 by a husband-and-wife team — Dexter Guerrieri and Jane van den Berg Ordway — and was one of the few remaining independent brokerages in the city. The founders (along with their eight agents) will become a new townhouse team at Elliman, bringing 16 exclusives asking a combined $150 million.
Meanwhile, Realogy — the conglomerate that owns Corcoran, Citi Habitats, Sotheby’s International Realty and Coldwell Banker — is chasing growth by doubling down on recruiting and expanding its franchise business.
The housing market has undoubtedly been difficult both in New York and nationally.
Seattle-based discount brokerage Redfin lowered its third-quarter forecasts and warned of “volatility” and a “significant slowdown.” And Zillow Group’s shares took a beating after the company cut its 2018 revenue outlook.
And this year’s second quarter saw the third consecutive decline in Manhattan residential sales volume — with the median price falling 7.5 percent. Meanwhile, resale apartments sold for the highest discounts off asking prices in over five years.
All of that adds up to less money coming in for firms. At the same time, firms are also being forced to spend more money on everything from commissions (to lure in more agents) to tech to compete with venture-backed startups that are encroaching on their space.
Industry veteran Andrew Heiberger cited all of those issues (plus others) when he announced that he was shuttering his firm, Town Residential, back in April.
Other smaller firms are now seemingly trying to avoid that fate.
Last year, Oxford Property Group, which was founded in 2010, merged with Titan Real Estate Group, owner of the Hecht Group brokerage. The combined firm — which has about 500 agents and offers them high commission splits in exchange for fixed monthly fees — is located at Oxford’s existing 5,000-square-foot office at 286 Fifth Avenue. Oxford co-founder Adam Mahfouda said the company is in the market for a 10,000-square-foot headquarters and a satellite office in the Financial District.
“The economies of scale will be a win-win for everyone,” company Vice President Oded Hecht said in a statement at the time the two companies joined forces.
The firm — not to be confused with the much larger Toronto-based real estate investor Oxford Properties Group — has, however, faced challenges recently.
In June, it was cut off from the Real Estate Board of New York’s syndicated listing feed, known as the RLS. It also dropped its REBNY membership, and New York’s Department of State confirmed to The Real Deal that it was investigating complaints against the company.
At the time, Mahfouda said the RLS issue was sparked by a decision by some of his agents to drop their REBNY memberships — either because they work part-time or for other reasons.
“Since REBNY requires 100 percent participation to participate in the RLS, we are at this time not party to the RLS,” Mahfouda said. “We are working with our agents and with REBNY to resolve this matter.”
DOS said last month that there was no update on the case, and REBNY declined to comment.
Nonetheless, Mahfouda hasn’t let those problems deter him. He said he’s currently on the lookout for more M&A opportunities.
“There’s a lot of repetitive work done by different companies in New York,” he said. “A lot of times, a company will say they’re differentiating, but the product is very similar and the business structure is very similar.”
Two small firms, for example, will have their own accounting departments and administrative staff. But combined, they can shrink those expenses.
Many of the smaller companies aren’t venture-backed, so they need to turn actual profits rather than just show growth that may lead to profits in the future, Mahfouda said. “You can’t just keep raising and spending money.”
Finding a sandbox
For smaller companies, merging can offer a path to survival, while for stronger companies those deals can offer more security, said one real estate attorney.
Last year, the Manhattan-based firm City Connections Realty merged with DSA Realty in a deal that boosted agent count and presence in the rental market. The combined firm, which operates under the CCR name, also gained some sales brokers.
DSA brought 128 exclusive rental buildings to CCR, which itself represented 130-plus buildings.
Prior to the deal, CCR had about 95 agents, and DSA added another 35.
CCR also bought Aventana Real Estate, a five-person firm with 40 rental exclusives, in June.
The approach appears to be paying off.
David Schlamm, founder and CEO of City Connections, said 2017 and 2018 have been the best two years in the company’s history.
The firm hasn’t yet expanded its office space, but Schlamm is now considering it. It currently has about 6,300 square feet on West 23rd Street and is mulling taking another 7,700 square feet in the same building or at another location. But Schlamm said he wants to boost business before growing the office footprint.
“I want to be secured with some people,” he said. “I don’t want to do an expensive buildout and wait for people to come.”
One challenge for companies is putting a dollar value on an M&A deal.
And for a brokerage, that can be tricky because the value of the company often boils down to the agents who work there, said Mark Brenner, a partner at the Manhattan-based law firm Gallet Dreyer & Berkey. But he noted that some companies also have operations, like property management services, that can add zeros to their bottom-line value.
As Brenner put it, merging with another firm allows a company to diversify into different areas of the industry. “It’s an expansion of a skill set,” he said.
But when agents are the main asset, deals can be more complicated. Conflicts can arise, for example, if compensation structures are changed, said Charles Damato, a partner at the law firm Windels Marx.
“Retaining agents, that’s a big part of it,” he said. “It’s going to be talent-driven at the end of the day. You need really good people.”
Either way, those selling firms tend to have rosy (read: unrealistic) expectations for what their valuations should be, brokerage executives and attorneys said.
That makes for some tough conversations, Real Trends’ Murray said.
“We see a fair amount of that,” he said, adding that it’s important for sellers to understand that buyers need to evaluate a company in the same way a bank evaluates a loan.
But in addition to the financial hurdles, there are psychological hurdles for sellers to confront. Brokerage owners generally like having top billing and calling the shots. In that sense, an acquisition can be hard to stomach, sources noted.
For his part, Schlamm said he knows he’s not competing against the city’s brokerage heavyweights. But he said he’s successfully carved out a middle-market niche — mainly in the $500,000-to-$3-million range.
“I can’t play in the same sandbox, and that’s fine,” he said. “I understand my niche.”
City Connection may not attract the star brokers who specialize in high-end listings, but the firm is looking for agents with experience.
Oxford’s Mahfouda, meanwhile, is casting his net wide, engaging in talks with both firms and individual agents.
He said the owners he’s looking to talk to should want — or need — to sell, whether to retire, take on less responsibility or for some other reason. He’s also not interested in talking to sellers asking a “ridiculous price” or imposing very specific conditions.
Schlamm said he’s open to merging with firms as small as five people or larger ones with around 100. But he’s looking for an amicable process — with firms that realize merging is in the best interest of everyone involved.
“I want them to know that, yeah, I hope to make money from merging, but they will do better, too,” he said.