Motley Fool Money - WeWork and Reworking Real Estate

Episode Date: November 1, 2023

Housing is expensive, rates are high, but the cut going to agents might be going down.  (00:21) Asit Sharma and Dylan Lewis discuss: - The $1.8B decision hitting The National Association of Realtors and real estate brokerages. - Why real estate might be an industry at a crossroads, and whether it means opportunity or challenges for companies like Redfin. - Three lessons from WeWork’s bankruptcy.  (16:13) Motley Fool Money’s Deidre Woollard caught up with Jean-Manuel Izaret to talk about his book "Game Changer” and the strategies companies use when they set prices. Companies discussed: RDFN, UBER, AAPL, SBUX Host: Dylan Lewis Guests: Asit Sharma, Deidre Woollard, Jean-Manuel Izaret Engineers: Dan Boyd, RIck Engdahl  Learn more about your ad choices. Visit megaphone.fm/adchoices

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Housing is expensive. rates are high, but the cut going to agents might be going down. Motleyful money starts now. Dylan Lewis, and I'm joined over the airwaves by Motley Fool analyst. Asit Sharma. Asit, thanks for joining me. Dylan, thank you for having me. Today, we've got two stories on the state of real estate. Our first one, the National Association of Realtors and several real estate brokerages are facing damages of nearly $2 billion after a jury ruled. They conspired to keep commissions high. Asit, those damage, images could swell and could reach up to $5 billion, but the story to me with this one is, it seems like we may be approaching one of those industry crossroad type moments in real estate.

It has that feeling, Dylan. I wonder if the pressure on homebuyers now with supply being short, interest rates being so high, is not part of the propellant of this movement to break apart, like a rigid structure that's been here for a long time. And I've got some thoughts on this, but you broke down pretty well when we were preparing for the show on the crux of the matter. Maybe if you can explain that for members, I've got some thoughts on it. Yeah, so under NAR rule, a home seller is required to pay commissions to the agent representing the buyer, which sellers in this case have claimed forced them to pay excessive fees.

Those commissions are generally set with NAR, and there's consistency across NAR members. And so there is this thought of the cooperative compensation rule coming into play here. Under the verdict of this, sellers would no longer be required to pay their buyers' agents, and agents would be able to set their own commission rates, which, as you might imagine, could mean rates would go down. I look at this, and a lot of this seems to be what you'd expect when there is, when there is a consolidation of power in an industry. I think so, Dylan.

And it's just weird how this arrangement has arguments on both sides, this sharing of commissions between the seller's agent and the buyer's agent. On one hand, it's provided a really uniform structure of incentive, which has seemed fair for a very long time if you're on the part of the industry, if you're a real estate agent. I think that's helped the US housing market grow, just the uniformity, the structure. But this is a country that favors competition, so it's not the most competitive arrangement in the world. I think if you're a home seller, you have a legit question.

Why do I have to pay the commissions that the buyer is bringing to the buyer's agent? So when we think about how entrepreneurialism in the U.S. is typically structured, you That actually makes zero sense. You have two really good arguments on why maybe you should maintain a commission structure like this and why, on the other hand, it's not constructive. And I think the pressures that we're facing today may have colored the fact this finally got through the court system and has reached the point that it has. Now, whether this will result in a fair system, a more entrepreneurial system,

around the incentives of real estate. I sort of lean to, yeah, it will, but again, for people who've been in this business for a long time. Now, what's the incentive for them to go out and represent buyers and sellers? Does this actually drive cost up more? And that's an open question as well. One of the things that I thought was kind of interesting with this story was we saw Zillow and Redfin both get punished by the market yesterday on this news. I think both were down over 5%. I think Redfin might have been down over 10 percent. at one point during the day. And neither of those companies are named in this suit, and neither

of them really make money from real estate commissions. It's not really part of their business model, and yet they get kind of caught in the wake here. And I look at a company like Redfin and I say, actually, I feel like this is opportunity for Redfin with how they've been positioning themselves in the market for the last five to 10 years. I mean, I think it is long term, because Redfin has been, positioning itself strategically as a place you can go and not have to pay such high fees just to transact a home sale. But, you know, on the other hand, Billy Duberstein, who is a contributor at the Motley Fool, who I really like, I think he's a smart guy. He summed this up yesterday and he said, okay, look, Reds Finn's whole model is to drive down costs.

They charge like a percent to a percent a half for a listing fee. well, if the courts are going to break up this buyer-seller fee arrangement and there's going to be competition for traditional brokerages to now they have to go out and really compete on fees, that's going to drive down cost in the industry as a whole. So all of a sudden, the brokerages that weren't competitive with Redfin, now that spread has diminished. So suddenly Redfin, at least in the near term, may have more competition, which I thought was pretty interesting.

It sounds like you might be describing a race to the bottom there, Asset. I hope not. At least for all those young homebuyers, I mean, luckily, we bought our home years and years ago, so I'm not in the market, but man, I have empathy for anyone in this day and age who is faced with this commission structure, which seemed less onerous when interest rates were, what, three, four, five percent lower than what they are today if you're out there trying to get a 30-year mortgage. All right, Asset. over to our second real estate story today, from homes to offices.

Following a botched IPO process, years of operating losses, and now a tougher environment with hybrid and work from home, we are seeing reports this week that WeWork will likely be filing for bankruptcy, having issues, getting payments over to creditors. And, Asset, there's been so much coverage of WeWork's demise. It is well-worn territory at this point. And so I think rather than zoom in on the individual details here, I think maybe we can take a step back and look at some of the investing lessons here and things that investors maybe can kind of take away from this story and from this multi-year saga.

And one of the ones that jumps out to me most is how important it is for business model and financial statements to sync up. And when you have things that are out of step with that, it is probably going to lead to a calamity. And that's kind of what we saw with WeWork. That's such a great way to put it. Dylan. It brings to my mind something that I've developed just for my own analysis called the three bees. And I think of this in terms of debt. Are you bridging? Are you building

or are you bailing? So you can use debt for three purposes. And the interrelation of the financial statements of WeWork, even after 2020, when they sort of restructured after Adam Newman left the scene, really what you saw was a picture where there was liquidity. So there was bridging money there on the balance sheet, but the income statement, the statement of cash flows told you that long term, what was going on was a lot of bailing among the financial statements. So there was no solvency, which is like, can you repay your debts? That's what solvency is.

But there was liquidity, meaning can you live to fight another day? Yeah, I mean, they were until, I don't know, TechCrunch says that the bankruptcy is going to maybe go down as soon as today. So they lived to fight a few more days. Yeah, it's incredible to see. And I love that bridging versus building idea or bailing idea. I think with WeWork, there was this idea that maybe the business model would change over time, and ultimately we didn't see anything that gave us that sign. And at core, this was a leasing business. And they never were able to get away from the leasing business economics, which would have helped change the financial picture for them.

And you can trace this right to the balance sheet, Dylan. what's the biggest asset on the books of We Work Today? It's actually just their lease assets, their right of use on the leases. On those, they've got on the bottom side of the balance sheet, the liability against those. They have to keep paying the lease expense. And then we flip over to what the financials look like. They did improve a bit from 2020.

The top line stabilized a bit. And even the operating expenses per day. location, they managed to bring a little bit under control, but this model just wasn't built to work. There was no way to have enough pricing power, enough utility of the buildings, the right type of membership subscription to make that dollar of revenue, be able to withstand all the expenses that it got battered with from the restructuring cost they had to go through to all the ongoing pre-location cost to, you know, just keep it. the type of environment that folks want to work in in such a shape as that they could keep

the subscriptions. So there's a lot of maintenance. Even if you own the operating asset of the lease, you're responsible for certain things in that lease, for the upkeep, and also for all the coffee and fun that goes on in those we work locations. So the model itself, even after restructuring, just wasn't built right. And I think you've got something here. that is so fun to look at. Dylan, sometimes we look at a set of financial statements, and we just don't know, right? Like, how this idea could work out? I mean, I think it could have some legs. But this was that rare case where you could be even a novice investor and just see like nothing was adding up for the last two to three years. And I think that's sort of

where your eye was going when we were talking about this earlier. Yeah, there's just a fragility to that financial position that. if everything goes right, you're fine, but if you wind up with any hiccup along the way, those losses mean that you're drawing on cash to maintain operations. If you have a heavy debt load, that gets more and more expensive over time. And I think we just kind of saw that unravel here. And I think it's a great example to study if you want to look at the interplay between financial statements and just kind of learn about these things.

I do, I said, want to talk a little bit about the soft bank side of the WeWork story, because this was an investor for them that fueled their rise to a $48 billion valuation. It has been in the mix as an investor and a provider of capital to where the company is now, below an $100 million valuation. We talk often about wanting to water flowers and not water weeds. Do you feel like SoftBank might have stuck around a little too long with the story? It's easy to say this in retrospect. We know my associate son and SoftBank in general, his investment company, are patient investors,

and sometimes crazy patient investors, and sometimes it seems just crazy investors. At the same time, my associate son has pumped billions into other companies and been very patient as they've sustained billions in losses, and then those models turn around and work. Kupang is a great example of that, the South Korean e-commerce company, that spent, by my estimation, somewhere between 8 and 10 billion between losses and capital investments to basically take over the logistics space in South Korea and be a first mover. So that's the ethos of SoftBank, but I feel that there is also an element of maybe throwing good money after bad here. SoftBank put the big dollars in at the beginning through the Adam Neumann cycle,

And then they provided essentially that liquidity as time went on. And I think there was still some hope that the model would prove itself out with more time. But it just on paper was never a strong proposition. And finally, this is even too much for SoftBank. They're going to let this one go. But like any great investment firm or venture capital firm, this is not their only bet. They have bets spread out among a number of different investors. I've hit some rough times lately, but I'm sure they're feeling some relief to call this

one the end and to move on. You know, you mentioning their investing style reminds me, we were just in New York together, and Molly Full co-founder and CEO, Tom Gardner, interviewed Michael Lewis, and they were talking through the incentives and the approaches of private investors. And they were talking a little bit about how, given even everything that happened with FTCS and everything we have seen, seen, it's not entirely clear that given the chance to redo everything, a lot of those private investors would have changed anything because the model is look for big upside ideas and invest, and you are almost punished from missing those ideas.

And coupling that with what we were just talking about with SoftBank, I do feel like there's a cautionary tale here. And maybe it doesn't always make sense to follow the stories that are being brought public by some of these private investors, just because their approach might be a little different. In some cases, they are actually rolling the dice with a very talented founder or a really great idea. And why this can work for these entities, Dylan, is because they've got capital. And this also goes back to walking into your favorite casino. If you like to gamble on vacation, you get this intuitively.

There's a certain amount that you come in with. If you got a little bit of an edge, you can play a little bit longer into the evening. And with great venture capital firms and even mediocre ones as well, the more the capital, the more the bets can be spread. And the more you can say, yeah, you know, I take those chances again. I know it sounds crazy. But look, we only have all these funds today because we took these chances when we were smaller. And now we have greater capital that we've got to allocate and the system works. Now, of course, they'll pride themselves on their ability to identify which are the better business models.

and also to assess founders to see what kind of person is on the other end of the table. And look, Sam Bankman-Fried, Adam Newman, they turned out not to be great bets if you're betting on a person. But for every one of these gentlemen, there are many luminous CEO founders who go on to establish great companies that often have a payoff in the public market. So it is a game of numbers in some ways and a fascinating one for those who have the money. And for the rest of us, you know, we can learn a bit by studying what they do, seeing what works and what doesn't. Awesome. Appreciate being on the other side of the table for you for this conversation.

Thanks so much for joining me today. Thanks so much, Dylan. It was really fun. Some of the best lessons don't come from a classroom. They come from experience. On The Power of Advice, a new podcast series from Capital Group, you'll hear from CEOs, investors, and founders about how they built careers, took risks, and reinvented themselves. If you're starting your own journey, this is the kind of advice you won't want to miss. Available wherever you get your podcast, published by Capital Client Group, Inc.

Coming up, the price you pay for streaming services, airline tickets, or your next Uber ride is probably something your investing brain should be paying attention to. John Manuel Isare heads up the marketing sales. sales and pricing practice for the Boston Consulting Group in North America and Motley Fool Money's Deidre Willard caught up with his array to talk about his book, Game Changer, and the strategies companies use when they set prices. I think most of us have this kind of simplistic view of pricing, fair market value that you just price as much as the market will bear. Your book shows that it's a lot more complicated.

So why is pricing more than just like trying to get to the most of consumer will pay without going over what they're going to pay? So there is that element, no doubt. But each time you set a price, there's two things that you tend to forgot. You set a price for something, whatever is the offer. And you set a price in a unit. And it seems like the unit is assumed if I'm buying a car, well, I'm buying a car, like I'm paying for the car. But you can actually buy a car by the month, and that's called leasing.

Or you can buy a car by the day, and that's called rental. Or you can buy a car by all the mile and the time, and that's a cab. And recently you had a new business that sprang up 15 years ago, which is buying a car by the ride. And so the unit that you choose is actually much more important than people imagine, because it tends to create entirely new business for almost the same thing. And as we got into products that are more digital, the units by which you pay something is something that varies a lot more because you have more choices by which to go. Let me give you an example.

We all are talking about generative AI and all these models. Are they going to replace us or not? Well, there's a simple view. If Gen AI is priced by user is going to enhance users, and if it's priced by the task, it's going to replace users. So when you see Gen. I models that are just sold as a subscription per user, for instance, with Microsoft, it's basically a tool that will make people smarter

and summarize emails and all. of the good things that you can have. It's not going to replace people. But if you in a call center have a Gen. AI model that can answer the phone instead of humans, and it's priced by phone calls that are answered, then suddenly it will replace humans. So the unit by which you price has a fundamental impact on the business that you create and even potentially on society. You talk about a lot in the book, and that I think so many of us are experiencing, which is the bundling and unbundling and re-bundling of things. In the book you talk about, sell carriers when they made the switch to bundled plans from

unbundled. We have airlines going the other way, unbundling, like now you have to pay for your bill, you have to pay for your bags. And right now we're dealing with cable and streaming. And it seems like we're halfway between the bundle and the unbundle. What types of inputs are driving these decisions that the companies are making? Many different inputs. You have some businesses where it is possible to bundle and others where it's not possible to bundle. But in the consumer space, when you have several products, considering about where they are not to bundle, is usually a good idea.

There's a simple rule of thumb, which is when you are at the beginning of the markets and there's an expansion of the offers and you have a high growth that is coming towards you, companies tend to have an advantage in bundling things together. So at the beginning of when the airlines are coming together, saying that you're going to have the newspaper and a great meal and it's all going to be nice and a lot of amenities are bundled into the offer. You attract more customers and you round up your service that allows you to pad the margins on top of just paying for the fuel and for the plane. You carry that for 35 years or 40 years and competition. comes in and low-cost providers like EasyJet and Southwest come in with no frills offers. And your bundled offer seems bloated. There's too much in there and too much that is not really needed. And so therefore the airlines went to unbundling.

So therefore, you have a cycle of growing, to grow at the beginning, you need a really good product. When you have a good product that has a lot of traction, you tend to bundle a lot with it in order to make as much money as possible, then people are saying, well, do we We need all these things together. And so then unbundling starts to happen, and the market cycle starts over again. The telco industries and the cable companies have had several cycles like this, which is why they had cycles of bundling and unbundling.

Each time there is something new that is coming. They're trying to bundle it with the old thing they had in order to make the old thing almost new. So that was true for bundling cell phones with regular phones, and then cable with TV. and with streaming services, each time you add new things, there is this tension that happens. Well, you sort of hinted about a company that does dynamic pricing earlier, which is Uber. Dynamic pricing is something I think that we know exists. We don't always like it.

As a consumer, we don't like to pay more for the same thing. But what factors go into a company's ability to use dynamic pricing? That's an excellent question. There's a number of factors. Moving into dynamic pricing can be advantageous if you have a fixed inventory, a fixed capacity that you need to fill in, and a number of people are willing to pay a very different amount for that fixed capacity. It also could be a good idea if you have a fluctuating demand that is hard to predict.

And so it's hard to predict what would be the right price. So two good examples of this are airlines. concert tickets. For airlines, you don't exactly know always what is going to be the demand at any point in time. And what people are willing to pay can be very different depending on business travelers versus tourists and last-bedded people and students and all that. People have different willingness to pay for almost the same seat. And so getting to a dynamic pricing model was quite advantages for many of the airlines. Similarly for tickets, You're going to set up a concert hall.

You can have many people that could come. The demand might fluctuate depending on what happens, and everybody might be willing to pay different prices. And so there's the tendency to say, I could vary the prices in order to offer different prices with different people might not be a bad idea. Where it becomes a really terrible idea is when the actual prices tend to vary by an order of magnitude

that people are not used to. For instance, if on Uber, it takes 30 bucks for you to go back home from where you work. And then on an evening, because there was a concert of search, there was a surge pricing, and now you need to pay $250 for the same ride. Like, you feel really terrible. It's more than almost 10xas. Like, why is a driver, it's a car? Why am I paying because of scarcity?

And it's the same feeling that if you're in the desert and you're really thirsty, and someone offers a bottle of water and says, you need to give me all your life-saving? You're like, no, even if I die, I'm like, you're going to feel really terrible. So people taking advantage of extreme situation of supply and demands really illicit feelings that it's unfair to get the prices to go to the extremes that they could go.

So companies who implement dynamic pricing need to be really careful at not letting the algorithms run completely wild and have price differences that are 10x, 20x, 30x, because they elicit feelings of anger from customers, and it's never a good idea to anger your customers. Very true. One of the things I found really interesting in the book was you talked about this study with cappachin monkeys and how they were given. So this is really interesting to me because it's about psychology.

So these monkeys were rewarded for giving a stone to the researchers, and if they, if they got a cucumber piece. But then the researchers started giving, as I understand, some of them got grapes. And then the monkeys that saw the other monkeys get the grapes, they got a little, they got mad because they saw, like, wait a second, I'm doing the same thing, but I'm getting a lesser reward. So it's really fascinating, psychology, how psychology plays into pricing. That's right. So the sense of what is fair and not fair is very much ingrained. into our brain very deep. I'm not sure if it's the people that allow us somewhere. But monkeys have the same sense of fairness that we have, which is basically against discrimination. For the same

reasons, people should be treated the same way. And discriminating is usually not a good idea. That applies to pricing. But now, if you ask people whether they think that the seniors should get a discount for a number of products, you can attend to find agreements across the world that people, oh yes, sure, seniors should get discounts. And if you ask them, well, if seniors get discounts, should young people get discounts? And then you have half of the people who think that seniors get discount, think that students and younger people should get discounts. You don't have the same agreement.

So what's the fair price and how should it vary is also a societal norm that depends on the conditions. And you find like in societies like the US and India, people tend to want to give discounts to seniors because the retirement systems are not as robust as other countries like Japan and France, where people are more favorable to giving discounts to students, but not to senior people. So the sense of what is fair price and small variations really depends on the social contacts and what people get used to. To come back to my airline example, there was a lot of pushback at the beginning when airlines started to price things differently, but we understand today that because everybody pays a different price, more people can travel. And we think it's a good thing that more people can travel.

And we have ways to make this travel very affordable for people that otherwise wouldn't have been able to travel while business people who can afford to pay more, actually pay more. Society at this stage has accepted this as it's okay to have such price variations. So the lesson for company is that it's okay to differentiate your prices, but you always need to be able to justify that to the public. You always need to be able to say, we're doing this for a reason. And for instance, if the reason is because these customers are more loyal to us than others, you could also become a loyal customer and you would get the loyalty discount.

That's perfectly fine and very well acceptable. If I am giving a discount with no reason just because I like you better than the other, that's really not acceptable, and that's what happened with the monkeys. I want to move on to one of your games that you talk about, which is the choice game, and Starbucks as an example of this, which makes sense because any of us who have ever gone to a Starbucks, you know you can spend a ton on a drink with extras, but you can also get a relatively cheap coffee. So what are some of the pros and cons of the choice game? And how does that play out across different industries?

So the choice game is the one that takes the most advantage of what you mentioned earlier, psychology and some psychological biases that we have. If you sell only one single product and you have a number of, competitors. If you don't price your product right, your customers are going to go to your competitors, and that's really not good. But you think about Starbucks if once you walk into a Starbucks, the price of one of the items is slightly more expensive than you're willing to pay. Well, you have a few other choices that you're going to have. You are within the Starbucks. Starbucks is not going to lose a customer. So what's the advantage of a company playing with the

choice model is you're going to have less price sensitivity, if you wish. And you're going to be able to guide your customers to what is the best choice to them. And there are some biases that customers have and that are quite well-known and well-documented for the past 40 years, which is customers, when you offer them three choices at three different prices, high, medium, low, will always tend to prefer the one in the middle. On average, there's very few people that are saying, oh, I deserve the best and others, like, I can't afford, I need to be very careful. Some will be there, but people tend to choose the middle option, which is,

why many companies have adopted a choice model by offering what's called good, better, best lineups. Starbucks has pushed this to an extreme. You don't have just three options. You have 50s and more options and different variations that you could have. But it's always the same ideas. I'm giving you choices. And if you pay more, it's because you want it to. And I'm always giving you a pretext something good that you could pay more for. And some people take that offers and others want. and overall, the balance of power in the market will be fairly rewarded. So that's why many companies go to the choice game. As always, people on the program may own stocks mentioned,

and the Mali Fool may have four more recommendations for or against. So don't buy or sell anything based solely on what you hear. I'm Dylan Lewis. Thanks for listening. We'll be back tomorrow.