Burning down the house

Homestore, an online property-listing company, has been one of the few dot-com success stories. But the real estate agents who are its main customers are growing restless.

Published July 27, 2001 8:00AM (EDT)

Homestore.com CEO Stuart Wolff, like a lot of people tracking the tech industry these days, is a fan of the evolution metaphor.

"If you put deer on an island and give them food," he told BusinessWeek Online in March, "the population of deer explodes. When winter comes, there's a crash, and only the strongest survive. The Internet isn't revolutionary, it's evolutionary."

Darwin-speak works well for Wolff. While other dot-coms drop like flies -- at least 555 since January 2000, according to one estimate -- analysts and the trade media are trumpeting Homestore as one of the few dot-coms with a serious, working business model.

Homestore, a real estate dot-com that offers home listings and other services, has far outgrown its competitors, including MSN's Home Advisor, which features fewer than half of Homestore's property listings and attracts less traffic. Homestore has delighted Wall Street by forming high-profile partnerships with giant corporations such as AOL and Cendant, and recently shook off a Department of Justice antitrust inquiry. While other dot-coms are declaring bankruptcy or losing their NASDAQ listings (including former Homestore competitor Homeseeker.com), Homestore stock is currently selling for $28.50 -- down from a high of $55 last September.

After the company released quarterly earnings reports Wednesday, it stock rose 10 percent -- not bad for a company that lost $72 million over the last quarter. But by using "pro forma" accounting measures, which exclude restructuring charges, charges for stock options and various other expenses, Homestore was able to report that it had actually made $14.5 million. Even if by standard accounting measures the company still isn't profitable, Homestore is at least making a stab at proving how a business can make money online. It is, as the econo-Darwinists say, a survivor.

Homestore executives say the company is successful because it chose not to repeat the mistakes of the past. In contrast to failed dot-coms like Pets.com and Webvan that sought to re-create an entire industry online, Homestore looked for a niche that complemented, rather than threatened, the established realty business. Wolff took advantage of something the Net is good at: distributing information, to change the way people look for homes. Home buyers go to Homestore not to buy a house online but to find a house they like and a real estate agent to help them buy it. Realtors who list themselves with Homestore are the company's primary customers, providing 65 percent of its revenue.

But some of the very partnerships that are titillating Wall Street may end up alienating agents. Many are less than thrilled with the terms of the agreements that bind them to Homestore, and may not be inclined to renew them. The agreement with AOL gives Homestore a huge audience, but could be devastating if Homestore stock falters. Most problematic of all, the deal that launched Homestore, a partnership with the National Association of Realtors, has some inherent contradictions that call into question whom Homestore is most loyal to, its customers or its shareholders.

Meanwhile, Wolff and his family trust are also busy selling stock, and lots of it. In the first five months of 2001, they've sold over 550,000 Homestore shares for roughly $16 million. A Homestore spokesperson says the stock dump is a "systematic" move, but it does call into question Wolff's own faith in his company and the future of its stock price.

Homestore may well represent the survival of the fittest after the dot-com boom and bust. But if the problems bubbling beneath the surface end up defeating the company, the answers to some very basic questions about how to succeed commercially online will become even harder to find. If replacing an entire industry on the Internet, as Webvan tried to do, doesn't work, and if making Homestore-style online/offline partnerships creates insuperable contradictions, then how does one build an online business? Will anyone survive Internet evolution?

From the beginning, Homestore was designed to keep real estate agents in business.

In 1994, at the cusp of the dot-com boom, the National Association of Realtors sniffed danger online. Like stockbrokers and travel agents, agents were, in part, dispensers of information. They controlled the MLS, or multiple listing service, which lists available properties.

"If you were a home buyer and you wanted to look at the listings in your market, you had to go to a Realtor and sit in his or her office and watch him or her call it up on a screen," says NAR spokesman Steve Cook. "Only Realtors could put listings on. Only Realtors could access listings."

The Internet offered home buyers another way to get that same information. If the MLS went online, home buyers could find a house they liked without ever setting foot in a real estate office. If agents were left out of that stage, how much more of the home-buying transaction would move online? Would they become obsolete?

In a bid to adapt to the Web before it swallowed the realty profession whole, the NAR launched Realtor.com, which provided property listings, agent profiles and home-buying advice. Realtor.com gave out the MLS listings, or some of them, then passed potential home buyers back to the agents. But what worked for the NAR turned out to be a bust financially. By the time Wolff, a 32-year-old budding entrepreneur, came along, the NAR was ready to hand over the enterprise.

In 1996, Wolff took over the operations of Realtor.com and made the site part of a larger company he founded: Homestore. In exchange for the site, the NAR received 4 percent of Homestore and engaged in a complicated agreement that ensured, effectively, that Homestore could only move a specified amount of the home-buying transactions online. Homestore, by contract with the NAR, could augment the realty business, make it more efficient, but not replace it.

At least initially, the arrangement worked out well for the NAR. Last February, on the eve of a major NASDAQ dive, the real estate agents association cashed in some of its stock, realizing about $35 million. But the deal between Homestore and the NAR has kinks. "We have our differences," says Cook. "There are times when our missions are not always aligned."

Homestore, beholden to its shareholders, is eager to charge as much for its services and software as it can, and be the only company to offer those services. But the association owns 4 percent of Homestore, so the greater Homestore's monopoly and the higher its prices, the better it stands to do as Homestore's stock price appreciates. But individual NAR members, who are the purchasers of Homestore's services, would like to see lower prices. "We would much rather have the marketplace set these prices or spur innovation," says Cook.

Plus, the more comprehensive the Homestore site becomes -- and the fewer competitors it has -- the more obligated agents are to sign on to the costly Homestore directory.

"It becomes almost a 'given' that a listing agent has to sign up with Realtor.com -- to make sure that their personal information gets in front of the Web visitor viewing the listing," writes Terry Light, operator of the consumer site The ABC's of Real Estate on a Realty Times forum. "This requires an expenditure of approximately $500 a year or more and creates a captive market for Homestore.com. Is the real goal to keep the realtor 'central' to the real estate transaction, or to make more money off NAR members?"

Once they've become Homestore members, some agents say that they feel obligated to spend money for enhanced listings, personal Web pages and other Homestore products -- or be lost in the crowd.

On Realty Times, real estate agent Jim Lee complained that some Homestore products can, in some instances, "virtually force agents with a Realtor.com home page to buy them or risk becoming invisible to consumers."

Then there's the thorny issue of exclusive listings. Under its controversial "Gold Alliance" deals, Homestore signed renewable agreements with many MLS companies, paying them for exclusive rights to their listings. This worked out well for Homestore, but some agents complain that exclusivity deals ultimately harm the industry by effectively making agents dependent on the dot-com. If Homestore has all the listings, then Homestore sets the industry's price for all related products.

Homestore's response is that the company is simply helping agents, and that Gold Alliance deals are part of its program to make the realty industry more efficient. "The average time to buy a house has gone from eight weeks to four weeks," says Homestore spokesman Gary Gerdemann. Prospective home buyers are "showing up at the professionals' door saying, 'I want to see these three houses.' Professionals like that kind of shrinkage of time. Consumers like it."

Last February, Homestore announced that it had completed a deal to acquire Move.com, until then Homestore's biggest competitor, from Cendant. In exchange for Move.com, Cendant received 26.3 million Homestore shares -- about 19 percent of the company. The deal, which attracted the scrutiny of the Department of Justice, is another source of concern for some agents and others following the company.

Among other things, the Cendant deal gave Homestore exclusive, 40-year access to listings put out by megabrokers Coldwell Banker, ERA and Century 21. The deal also specified that Cendant would buy Homestore products. Once again, a Homestore deal had turned customers into owners. With 65 percent of its business coming from agents, Homestore now had an even more significant chunk of its ownership made up of people who would buy the products.

Bringing on board a company like Cendant, whose brokers are considered competition by many real estate agents, has "alienated a lot of Realtors," says Nick Karris at Gomez Advisors. As a result, the NAR, which has already persuaded Homestore to share its listings on other sites, may lean even harder on the company. Says Karris, "Realtors don't want Cendant to benefit from that relationship."

Gerdemann says that deals like the one with Cendant are part of the company's move to make the realty industry move smoother. "At the end of the day," Gerdemann says, Homestore is "making it easier for individuals and professionals to buy and sell homes."

To Homestore's relief, the feds have dropped their antitrust inquiry. But some stock analysts worry that the Cendant/Homestore arrangement still spells trouble. "You have a company whose biggest customer is also its biggest shareholder," says Lanny Baker of Salomon Smith Barney (one of two firms, along with Merrill Lynch, to recently downgrade its rating of Homestore). "That's OK, but I don't think I totally understand how that customer and shareholder [relationship] works."

Then there's AOL. In May 2000, Homestore signed onto an expensive arrangement with the portal: For the price of $20 million in cash, plus 3.9 million shares of Homestore common stock, AOL agreed to let Homestore be the exclusive provider of home and moving services to AOL customers. With AOL quickly assembling sites such as Monster.com, Travelocity and WebMD in an effort to build an empire capable of a face-off against the Microsoft Network, the Homestore deal made sense. But for Homestore, the stakes are amazingly high: In exchange for the AOL audience, Homestore guaranteed AOL that 60 percent of those shares would jump to $68.50 a share by the third year of the deal. If the shares failed to do so, Homestore would owe AOL the difference.

Even analysts enthusiastic about Homestore call the deal expensive. "It was cut in a different time period," says WIT Soundview's Shawn Milne. "That deal was signed at the top of the market." Gerdemann points out that the company set aside $90 million in restricted cash as insurance for the AOL deal, and that if AOL draws $40 million from that account, then the deal can be cancelled or renegotiated. But if Homestore stock takes a significant dip, it's clear that keeping to the contract will be painful for Homestore.

Some worry that Homestore stock is simply overvalued. In a Merrill Lynch bulletin dated July 9, analyst Henry Blodget wondered how much bigger Homestore can really get, "now that several customer 'elephants' have been bagged (i.e. Cendant, et al.)."

Homestore stresses that its products are much broader than listings for available properties. It has mortgage calculators and moving help, home improvement advice and dozens of other services. But, in the long run, what are the limitations on a technology company that, by agreement with its biggest partners, can't take the place of human industry? Until the real estate agents find a way to make peace with the dot-com, Homestore thrives, but delicately.

This story has been corrected.

By Amy Standen

Amy Standen is a writer living in Oakland, Calif.

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