The FTSE's hidden property gems

One of the biggest listed real estate companies in the UK is not a real estate investment trust (Reit), nor is it a housebuilder. The FTSE 100 business does not own any buildings, has never built any buildings, and is worth just shy of £4bn. It is, of course, Rightmove (RMV), and it is one of many UK-listed property services companies. These businesses are not directly engaged in real estate transactions but still benefit from them.

The sub-sector's collective market cap is around £23.4bn. It represents a big chunk of the UK-listed property world, and competition among the major players is fierce. Rightmove had been the second-largest UK-listed property company until it lost around £1bn in value last month after its much smaller rival OnTheMarket (OTM) revealed it had accepted a £100mn takeover offer from property data company CoStar (US:CSGP). OTM’s move is an audacious bid to become the UK’s biggest online property portal, and as such it is specifically targeting Rightmove. 

The pair are not the only ones profiting from property services. There are multi-service agencies such as Savills (SVS), agency franchises such as LSL Property Services (LSL), and companies such as IWG (IWG) and InterContinental Hotels Group (IHG) which provide services to occupiers of a building. The business models vary, but what they share in common is a dependence on activity in the property market despite not owning or building any properties.

As a result of their diversity, their performance in the property downturn has been mixed. So, too, is the outlook for their futures.

Right moves

For its part, Rightmove has managed to excel (operationally speaking at least) despite the slump in the housing market. The reasoning for this is counterintuitive. Although its business model depends on housing market activity, the real burden is on its estate agent customers. They pay Rightmove to host their listings on its website. With higher borrowing costs meaning fewer people willing to buy or sell homes, estate agencies are more eager than ever to advertise the stock they have for sale. As such, many are upping their packages with Rightmove, which helped it post its fastest rate of revenue growth since 2018 in its results for the half-year to 30 June.

In this sense, Rightmove has the whip hand over agencies. Its operating margin easily trumps all the other listed property services companies – including the agencies who are its customers – in both the UK and the US (see table).

But while Rightmove’s operating margin might make it attractive to investors, there is also a sense in which it leaves it exposed – particularly to OnTheMarket. Where the former charges agents enough that it can post a margin of over 70 per cent, the latter has plenty of room to undercut its competitor by charging much less while still increasing its operating margin from a lowly 6 per cent.

Certain estate agents, therefore, are unsurprisingly supportive of the challenger. “If CoStar can remove a little bit of the monopoly Rightmove has amassed over the past 10 years, I think that will be good for all of the users and all of their clients,” Guy Gittins, chief executive of Foxtons (FOXT), told Investors’ Chronicle.

“There’s definitely room for things to be cheaper and for more competition. A lot of the smaller independent [estate agencies] spread across the country have had their profits decimated because of what they have to spend just to be in the race."

Others may not mind too much either way. Belvoir (BLV) and The Property Franchise Group (TPFG) have hundreds of small independent estate agencies operating under their franchise. They both make the same point: that the money its franchises spend on Rightmove, Zoopla, or OnTheMarket equates to the amount they would have spent advertising in local newspapers two decades ago. In that sense, costs have not changed all that much.

And despite their thinner margins and the money spent at Rightmove and other property portals, the agencies are not necessarily struggling. In a trading update for the nine months to 30 September, Foxtons posted a 5 per cent increase in revenue because, while rising rates have hit house sales, residential rents are increasing at the fastest pace on record thanks to a combination of landlords passing on the costs of high interest rates, a lack of stock available, and immigration. 

This means lettings business is booming. Belvoir and TPFG also posted positive results over the same half-year period because they too had offset low sales revenue with increased lettings revenue.

Gittins said Foxtons had intentionally shifted its business towards lettings from sales because, while it sees the latter as cyclical, it describes the former as “super reliable and super sticky income”. However, he insists any agency needs the two services because they complement each other: if a landlord can’t rent their property, they may want to sell; if they can’t sell it, they may want to rent it out.

For Belvoir, diversification is the name of the game. Alongside lettings and sales, the company also offers financial services, namely mortgage and remortgage services. Like lettings, these services are not cyclical, as homeowners must remortgage when their term runs out, regardless of the macroeconomic picture.

No listed UK agency does diversification better than Savills. Alongside residential lettings and house sales, the company offers commercial real estate agency services, planning consultancy, sustainability consultancy, land promotion, auctions, financial services, data services, valuations and property management. It also operates globally, meaning only a fraction of its residential sales and lettings revenue comes from the UK. Other large agencies, such as CBRE (US:CBRE), JLL (US:JLL), and Cushman & Wakefield (US:CWK), also offer a similar array of services, but Savills is the only UK-listed company to do so.

However, while all of this protects it from the sales downturn in the UK, it does expose it to the global residential and commercial property downturn – which presents other problems for its revenue streams. In this sense, Savills begins to look overdiversified. Its US rivals look shaky for the same reason.

Thriving franchises

Aside from the services they offer, what also differentiates UK-listed agency companies is whether or not they are franchises. Savills and Foxtons are not; Belvoir and TPFG are, while LSL Property Services converted to a franchise model earlier this year.

According to Belvoir and TPFG, the benefit of franchising is that a business can capitalise on the fragmented nature of property services business across the UK. While big homegrown players such as Savills and international giants such as CBRE and JLL pick up a lot of business, the bulk of the market is still made up of local, independent players. This gives franchises a lot of space to grow.

The other reason Belvoir and TPFG believe franchising makes their businesses better is the mindset of their franchisees. Belvoir’s chief executive, Dorian Gonsalves, said the reason it had “outperformed the market” in terms of sales and lettings is that “our agents are self-employed and when their income is threatened they tend to work harder and work smarter”. Or, as TPFG’s chief executive, Gareth Samples, puts it, independent franchisees always have to find a way to make a deal to have an income. “Whereas if you’re an employee at a corporate agent, you take a wage every month,” he said.

Agency franchises also tend to have a higher operating margin than agencies (see table). As the franchise group owner, they take a cut of the revenue while their costs are limited to investing in the franchises. But they don’t need to spend money on the day-to-day running of the business or wages, which have increased significantly due to inflation, in the way non-franchise agency companies do.

The franchise model is far from perfect, however. For one, there is the possibility of conflicting interests between shareholders wanting dividends and franchisees wanting investment in the business. TPFG’s Samples concedes this can happen and stresses the importance of managing both parties’ expectations. “But the dynamic is that you have to keep investing in the franchisees to grow the business which benefits the shareholders,” he added.

Foxtons’ Gittins says it is difficult to make a franchise business profitable at first because of the scale needed. “We are entirely dedicated to being wholly owned,” he said. “It takes a long, long time to turn the franchise model into something that makes money.”

‘Hotelification’

The final category of property services companies initially looks disconnected from the rest. These are occupier services businesses which operate by leasing a building and then subleasing it. This is how the hotel business works for the likes of InterContinental Hotels Group and Whitbread (WTB), and it is also how flexible office operators such as IWG (IWG) and WeWork (US:WE), which filed for bankruptcy this week, have been run. It's no coincidence the flexible office operator model looks so much like the hotel operator model. Indeed, many describe what flexible office operators offer as the ‘hotelification’ of office space.

And while this model is distant from Foxtons’ business, larger agencies are getting in on the action. In Savills' case, this is through its flexible office brokerage service Workthere, an online portal for would-be occupiers of flexible offices. Savills also offers property management services for blocks of offices and flats, akin to the occupier services provided by the hotel and flexible office operators but without lease risk. 'Flex' by JLL takes things one step further. The business arm is a flexible office operator which occasionally uses the same lease and sublease model as IWG and WeWork.

Whatever the precise nature of the business, Covid-19 upended the fortunes of all ‘space as a service’ companies. Hotel businesses and flexible office operators suddenly had no customers. IWG has had some success at encouraging those customers to return, having recently posted record revenues. But it has still not returned to pre-tax profit and remains saddled by debt, albeit not as much as its US rival WeWork.

Hotel operators seem to be faring better, with Whitbread and IHG posting leaps in pre-tax profit in their most recent results as leisure travel roars back to life post-pandemic. However, as with flexible operators, lease debt remains high.

The difference between flexible office operators' and hotel operators' fortunes underscores how varied the performances of property services companies can be. While some struggle to make real estate services work post-Covid and amid a property downturn, others thrive. There is an opportunity for investors here, providing they know where to look.