Why Zillow, Redfin and other real-estate stocks tanked after a jury ruling

Shares of real-estate names plunged Tuesday following a jury ruling that has the potential to shake up the way people purchase homes.

A Missouri jury earlier Tuesday deemed that the National Association of Realtors, HomeServices of America and Keller Williams colluded to inflate or maintain high commission rates. Jefferies analyst John Conaltuoni said in a note to clients that a judge could issue an injunction preventing commission sharing on MLSs, or multiple listing services, which would hurt the buyer-agent business.

See more: A Missouri jury goes after the real-estate industry’s commission structure. Here’s what that could mean for homeowners.

Shares of Opendoor Technologies Inc.
OPEN,
-9.09%

plunged 9% on Tuesday, while shares of Zillow Group Inc.
ZG,
-6.87%

Z,
-6.98%

fell 7%, shares of Redfin Corp.
RDFN,
-5.67%

dropped 6% and shares of RE/MAX Holdings Inc.
RMAX,
-4.36%

declined 4%.

Conaltuoni thinks the recent ruling could bring big changes to the Participation Rule, which is an NAR requirement for seller agents to disclose the compensation being offered to buyer agents when they list through an MLS. The Participation Rule could soon get banned or turn optional, in his view.

Such a ban “would cause negotiations about buyer agent commissions to occur when an offer is presented, since there would no longer be an avenue to communicate splits up front,” he wrote. “This would eliminate the seller’s incentive to compensate buyer agents, which would force them to seek compensation directly. Shifting the burden of payment to buyers would likely meaningfully reduce their use of agents given most already struggle to cover closing costs.”

Conaltuoni further commented that were the rule to become optional, the “status quo” likely would continue.

Read: Why aren’t homeowners selling their homes? It’s not just the ‘lock-in effect’

What would these developments mean for Zillow, which reports earnings Wednesday afternoon? He flagged that nearly two-thirds of the company’s revenue comes from its Premier Agent business, which itself is primarily made up of revenue from buyer agents. “[A] reduction in their usage would force [Zillow] to pivot to offering products for seller agents and create near-term headwinds to revenue,” he wrote, while cutting his price target on Zillow’s stock to $48 from $60.

Bernstein’s Nikhil Devnani wrote that Zillow “is NOT part of this case and not directly impacted by the ruling,” but there’s the potential for repercussions down the line.

“Premier Agent is built around buyer commissions,” Devnani said. “And a reduction to commission rates (which could happen if cooperative compensation were outright banned in the worst case scenario) would create challenges for industry revenue growth, in our view. Maintaining the current structure with more transparency would have less impact we believe. It would need a stronger decoupling of who pays for buyer and seller agents.”

While Redfin shares dropped Tuesday along with other names, Chief Executive Glenn Kelman put out a blog post titled: “Change Comes to the Real Estate Industry.”

“The judge may take days or weeks to decide what structural changes the jury’s verdict will entail,” he wrote, and appeals could take years.

But traditional brokers “will undoubtedly now train their agents to welcome conversations about fees, just as Redfin has been doing for years, especially when advising a seller on what fee to offer to buyers’ agents,” he continued. “Rather than saying that a fee for the buyers’ agent of 2% or 3% is customary or recommended, agents will say that a buyers’ agent fee, if one is offered at all, is entirely up to the seller. This is as it should be.”

RBC Capital Markets analyst Brad Erickson wrote after the ruling that just over half of Redfin transactions come from the buyside. Its stock and Zillow’s “partially reflected these risks coming in,” in his view.

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