Realtor verdict, poor revenue guidance send Zillow stock plunging

Shares of Zillow Group Inc. NASDAQ: ZG were trading about 9% lower for the week of October 30 after a federal jury in Missouri ruled that the National Association of Realtors and some large real estate brokerages conspired to inflate realtor commissions.

Like Zillow, Redfin Corp. NASDAQ: RDFN was not named in the suit, but its stock initially fell before rallying on November 1 and 2. Zillow had yet to regain any upside traction.

After the market closed on November 1, Zillow reported earnings that beat analysts' views, but the stock tumbled 4% on a weak revenue outlook.  

While you might think of Zillow as that place to scout for new real estate that's come on the market, the company derives the bulk of its revenue from its Premier Agent business unit. That business consists of revenue from buyers' agents.

Shift to products for sellers' agents?

If buyer agent revenue dries, Zillow may shift to more offerings aimed at sellers' agents, which would likely slow growth. 

Analysts expect Zillow's earnings to decline by a massive 64% this year to 51 cents a share. Next year, the company is expected to report a loss of 31 cents a share. Both of those forecasts were revised lower recently.

The realtors’ association and brokerages must pay about $1.8 billion, but those damages may be raised.

The verdict has the potential to lower the costs of realtor commissions. 

Other real-estate-related securities such as low-priced Compass Inc. NYSE: COMP, Opendoor Technologies Inc. NASDAQ: OPEN and Douglas Elliman Inc. NYSE: DOUG also tumbled on the news. 

Shares of Re/Max Holdings NYSE: RMAX and Anywhere Real Estate Inc. NYSE: HOUS, both of which were initially defendants in the lawsuit but settled before the trial, also rebounded after trading lower on the news.

Will brokers leave the industry?

The fear about brokerages is that realtors will leave the industry, which, combined with lower fees, will result in lower revenue for these companies.

However, residential real estate stocks had already traded lower as interest rates rose. For example, the Anywhere Real Estate chart illustrates the phenomenon best: The stock began turning lower in February 2022, just before the Federal Reserve began its series of interest rate hikes. 

The reason the verdict was hitting real estate stocks so hard is that home sellers are currently required to pay a commission to buyers’ agents. Sellers claimed that forced them to pay excessive agent fees, and the jury agreed. 

Sellers alleged that brokerages and the National Association of Realtors joined forces to implement the cooperative compensation rule. 

Sellers no longer required to pay buyers' agents

However, the verdict specifies that sellers are no longer required to pay buyers' agents, who can now determine their commission rates. While you might think they have the freedom to raise rates, that's unlikely to happen; market forces are more likely to push commissions down. 

That's why Zillow was trading lower; it's easy to see how that ruling could have a significant impact on the company's earnings. 

In the Zillow earnings release, CEO Rich Barton said, "We have strong momentum across the board," although the company reduced its revenue forecast, seemingly undercutting his statement. 

New guidance below Wall Street views

Zillow now expects revenue between $430 million and $455 million in the current quarter, down from earlier guidance of a range between $458 million and $486 million. That's significant because the high end of the new forecast is lower than the lower end of the previous guidance. In other words, a lot has changed since the earlier forecast.

The new forecast is also below analysts' expectations of $457 million.

In a letter to shareholders that accompanied the earnings release, Barton addressed the Missouri verdict, saying it "will likely be tied up in court for years."

Barton reminded investors that Zillow was not a party to the lawsuit and that it expects industry changes to come from the suit or others like it.