It sounds like spin, but web-based brokers ZipRealty and Redfin—as well as property information and service providers like Zillow and Inman—say they’ll not only survive the upcoming U.S. real estate downturn, but actually profit from it. Indeed, when the National Association of Realtors announced that existing home sales fell 11.2 percent in July from July 2005, online players put a happy gloss on the news.

Everything changes, it seems, when real estate becomes a buyer’s market. “Eighty percent of our business comes from buyers,” explains Pat Lashinsky, senior vice president of new product development at online real estate service ZipRealty.

The reality of a softening property market may turn out less rosy than web realtors hope, of course. But the Internet does have the potential to disrupt the way homes are bought and sold, taking a bite out of the $2-trillion U.S. housing market—even if that has yet to happen.

The Internet has transformed the music, retail, advertising, and software industries over the last decade, but real estate’s classic broker-buyer-seller triumvirate remains essentially in place. Buyers may look at photos of houses online, but they still normally hire brokers to show them lists of homes, while sellers hire brokers to list their homes on the Multiple Listing Service (MLS) and camp out at open houses on Sundays. Brokers usually charge the seller about 6 percent of the sales price for their services, then split this commission 50-50 with the buyer’s agent that brings the client to the deal.

But the impending real estate slowdown may finally change things. “Sellers never really migrated to the Internet,” says Brad Inman, founder and publisher of Emeryville, California-based real estate news service Inman News. “But now that they are disadvantaged, they will use the Internet in ways that never happened before.”

Redfin, a startup covering Seattle and the San Francisco Bay Area, hopes to take advantage of that shift with its low-cost brokerage model. Launched in March, the company refunds two-thirds of its commission fee (about 2 percent of the price of a home) to buyers, and charges a $2,000 flat fee for sellers.

Final Frontier

Redfin says sales have been doubling every month since March and the company doesn’t expect to see a slowdown in the business. “There aren’t many large markets left for Internet companies,” says CEO Glenn Kelman. “This is the final frontier for e-commerce.” In more ways than one: Mr. Kelman claims he’s received death threats from real estate agents incensed over Redfin’s cut-rate business practices.

Emeryville, California-based ZipRealty, formed in 1999, was one of the first to challenge the business model, although it doesn’t offer discounts as steep as Redfin’s. It hooks up homebuyers with real-life agents, and gives customers back 20 percent of the typical buyer agent’s commission, usually about 3 percent of the selling price. Sellers, meanwhile, can save up to 25 percent of the sales agent’s commission, which also runs about 3 percent.

ZipRealty has struggled with profitability, but things have been slowly looking up. The company posted a net loss of $200,000 for its quarter ending June 30, 2005—down from a $900,000 loss from the same period a year earlier. Then ZipRealty managed to post profits for its third and fourth quarters last year.

Sites serving up home-buying information are also doing a brisk business. Seattle-based Zillow, which provides free house valuation estimates for nearly 70 million U.S. homes, is already the 11th-most-visited U.S. real estate site, according to Media Metrix—barely six months after it was launched. Backed by $57 million in venture capital funding, Zillow doesn’t currently deal in home sales, but it has real estate agents worried sick about its next move.

Palpable Tension

The tension between traditional realtors and online upstarts is palpable, but modern real estate practice really requires the two sides to cooperate. In the United States, 77 percent of home buyers do online research, and there are hundreds, perhaps thousands, of local real estate sites. And while good real estate agents know how to close deals for their 6 percent commissions, their role as gatekeepers is coming under fire from cut-rate Internet brokers like Redfin.

Web-based players are still a long way from posing much of a threat to traditional agents, of course. For-sale-by-owner listings account for only 13 percent of U.S. listings. Thus, more than 80 percent of U.S. home sales still go through agents.

VCs certainly smell an opportunity.

Online real estate companies have, between them, raised more than $200 million in venture capital in the last two years, according to Dow Jones VentureOne and Red Herring research. As VCs contemplate downstream exits via acquisitions or IPOs, publicly listed real estate technology companies remain few and far between.

As Zillow Chief Financial Officer Spencer Rascoff puts it, “Compared to travel, where there’s $30 billion worth of public companies you can invest in, there’s $2 billion worth of public [real estate] companies.” Choices include LoopNet, online brokerage ZipRealty, lead generator HouseValues, U.S. portal Move.com, U.K. portal Rightmove, Australian portal realestate.com.au, and Realogy.

Weathering a Downturn

As worries about an impending real estate slump have grown in the last six months, share prices have slipped at these firms. But content-focused companies like Zillow and Google—with mapping and market information making up the bulk of their offerings—argue that they can weather a downturn because they depend not on transaction commissions, but on selling ads. And in a tougher market, sellers and agents will be forced to do more advertising to get homes sold.

Online brokers also aim to profit from everyone’s thirst for richer information. Zip Realty, besides basic listings, now provides property sales histories, information on price reductions, and local school and neighborhood data. It also invites customers to comment on houses they’ve visited. Most of the other online real estate companies, as well as sites run by local agents, are rushing to include the same kind of informational services.

Online real estate upstarts do not have access to national MLS listings for now, although that could change if the U.S. Department of Justice wins a pending antitrust suit against the National Association of Realtors. In the meantime, startups like Redfin, Trulia, PropSmart, and PropertyShark work around the gaps in information by combining things like public records, neighborhood information, and sales data, building “mashups” of the combined information on an interactive online map. They also have been able to build their own listings outside of their local areas by going from area to area.

“These Web 2.0 sites [are] popping up like mushrooms after a monsoon,” says Peter Conti, an analyst with research firm Borrell Associates. “Six months ago there weren’t any.”

Turf Protection

But the web site backed by the National Association of Realtors isn’t about to sit back and let newcomers invade its turf without a fight. Move.com, the most popular real estate site, has a special advantage, at least for now. Previously known as Homestore, the site has virtually exclusive access to national MLS home listings. Thanks to a 10-year-old deal to operate Realtor.com, Move.com gets access to 900 regional multiple listing services from the NAR.

Predictably, Move.com is unenthused by sites like Redfin that allow buyers and sellers to do business almost exclusively online. “We do not buy into the belief that disintermediation of Realtors is inevitable,” says Move.com CEO Mike Long. “Homes are not commodities; market understanding cannot be extracted from tax records and recent sales.”

Ads Aplenty

How the Internet impacts brick-and-mortar real estate agents remains to be seen, but there’s no doubt that real estate advertising, long the domain of newspaper classifieds, is moving to the web.

Borrell actually predicts that real estate advertising spending as a whole will decline for the rest of the decade, down to $9.6 billion in 2010 from $11.7 billion in 2005. But that’s because advertising will become more efficient as it moves to the Internet, Mr. Conti reckons. That said, a surprising number of agents have yet to appreciate the drift of things—61 percent of them still don’t advertise on the Internet. But as trends deepen, Borrell sees online spending nearly doubling from $1.7 billion to $3.1 billion by 2010, while newspaper spending drops from $4.7 billion to $2.9 billion.

A large portion of current spending goes to the big web portals like MSN, AOL, and Yahoo. Yet the companies have only begun to do original site development, mostly using listings from partners thus far. AOL in August launched a “major overhaul” that involved channeling visitors into different syndicated content (from Move.com and others) based on what role they were playing in the property process, such as first-time home buyer, renter, or vacation property owner.

Yahoo just announced its overhaul (see “Yahoo Revamps Real Estate,” RedHerring.com, August 29, 2006). Visitors will be able to save their searches, look up local information, and make use of other people’s advice via Yahoo Answers.

But all eyes are on Google. The company doesn’t yet have a real estate service, even if it’s thoroughly immersed itself into the online real estate ecosystem. A Google search for “San Francisco homes,” for example, will bring up user-contributed listings from the company’s online database, Google Base. Agents also buy search keywords by the truckload and register with Google’s local business center, while many real estate sites use Google Maps as part of their offering. (Taking things a step further, Zillow uses Microsoft’s competing mapping technology which uses images shot from low-flying planes to give viewers a bird’s eye view of a street.)

Cautious Consumers

“Years ago I used to say one magical business model will transform real estate, but that has not happened at all,” says publisher Brad Inman, who has followed real estate as a reporter, conference coordinator, and entrepreneur for two decades. Consumers are cautious about making such a huge purchase without an expert at their side, and rightfully so, he says.

But with the rise of information sites like Zillow, real estate agents may need to shift their focus away from marketing (which is really all listings are) and instead focus on acting as midwives for the huge life event of buying or selling a house.

But one thing neither traditional agents nor web-based property companies can control is the real estate market. No one is really sure what will occur if prices continue to fall for years to come, but a shakeout of real estate firms—both traditional and online—is likely.

“The softness in the housing market is going to challenge online sites because they are relying on customer demand to drive advertising revenue,” says Greg Sterling, founder of Sterling Market Intelligence. His company predicts that many of the newest sites will collapse—only the ones that have the highest traffic and good backing, such as Move.com, Zillow, ZipRealty, and AOL Real Estate, will survive the downturn.

Contact the writer: Editorial@RedHerring.com