Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Onthemarket.com (OTM)
Investment Case
OTM faces headwinds from reluctant vendors and low levels of audience traction, despite a strong start with 6,500 agencies signed up since launch in January 2015.
The market however continues to be an attractive investment proposition that offers £19-35m a year in structural growth and where the leading players Rightmove and Zoopla enjoy 50%+ margins.
Yet for OTM, comparatively low returns on marketing spend, especially in terms of leads; remain a key concern. Unless it can at least double its inventory of listings from current levels of 240,000 and increase marketing spend to build audience reach comparable to the incumbents, its long term sustainability across the UK will remain doubtful. Another key test is whether the business can continue to raise enough capital from its members to fund its growth.
We expect OTM to become an acquisition target.
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Executive Summary
In this report, we analysed OTM as a challenger in the digital classified property advertising marketplace. We started with a model to estimate the total addressable market size. We then looked at key factors that impact the market. This is followed by a study of the market structure and an in- depth analysis of OTM (based on information available). Finally, we concluded with a forecast that forms the basis of the investment case.
Total Addressable Market Size
We used a three stage top down model to estimate the total addressable market size for digital classified residential property advertising in the UK. First, we used transactions (sales and lettings), degree of estate agency intermediation, and average commission rate to arrive at the total estate agency market size.
Next, using public data and primary research, we estimated total marketing spend as a % of estate agency’s revenue from intermediation, and the share of digital marketing.
And finally, using estate agency market size, marketing spend as a % of estate agency revenue and digital as a % of total marketing, we estimate the total addressable market size (as illustrated in figure 1 below).
Figure 1: Model to estimate total addressable market for digital classified residential property advertising (UK)
Finally, we examined factors that are likely to impact the total addressable market size over the forecast period (2016-18).
UK residential property sales market size
ONS estimated 1.22m properties transactions (4.4% of total housing stock) were completed in the UK in 2014 with aggregate value of £303bn. The number of completed property transactions in 2015 was 1.23m. As ONS hasn’t released the aggregate value data for 2015 yet, we use house price increase
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
data as a proxy instead to calculate the aggregate value. Average house price increase for the year was 6.7%. Therefore, we estimate aggregate value of property transactions in the UK was £324bn for 2015.
Figure 2: UK Residential Property Transactions, 2006-2015
Source: ONS
Majority of property transactions are intermediated. We use consensus of 90% in our calculations. Estate agencies charge a commission for facilitating a transaction which is applied on the sale price of the property. The commission rate varies depending on a number of factors. Typically, it is between 1- 2%, but in reality the range is wider (0.75-3% + VAT). According to Which?, the national average was 1.8% + VAT in 2015.
Using aggregate value of property transactions, degree of intermediation, commission level, we estimate total estate agent market from property sales intermediation in the UK to be £5.2bn in 2015.
UK residential property lettings market size
According to the 2011 census data (figure 3), out of the 23.4 million households in England and Wales, 15 million (64%) were owner occupied and 8.3 million (36%) were rented, half of which were rented privately (4.2 million).
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Figure 3: Home ownership and renting in England and Wales, 2011
Source: ONS
Most rented properties are small dwellings, flats and small houses majority of which are two or three bedroom properties. Research published by Kent Reliance1 indicates that total rent from private rental sector in 2015 in Great Britain was £56.7bn. In this section, we used Great Britain as a proxy for the UK, and also limited our definition of the lettings market to be that of the privately rented sector.
The private rental sector is a dynamic market. Our research indicates that ~60% of the market is intermediated. According to the Association of Residential Lettings Agents, the average tenancy in the UK is 19 months. Letting agencies have a number of different operating models right from completely managing a property to simply acting as a commission agent. Our research indicates that commission income is by far the most common model for letting agencies. Commission rate is calculated on the annual rent of property. The range (7-17%) varies depending on the level of service, competition and location. For the purposes of calculating the total addressable lettings market size, we are taken 10% of the annual rent to represent average letting agency commission rate.
Using total rent from private sector residential lettings, degree of intermediation and average commission rate, we estimate total estate agent market from property letting intermediation in the UK to be £2.5bn in 2015.
Digital Classified Property Advertising Market Size
Estate agency commission market from residential property intermediation in the UK was £7.4bn (property sales - £5.2bn, lettings - £2.1bn) in 2015. We estimate that marketing spend on classified advertisement is 7% of the revenue from intermediation and digital advertising is 55% of marketing.
We estimate that the total digital classified residential property advertising market size in the UK is £285m.
------1 Kent Reliance is one the largest buy-to-let mortgage provider and part of OneSavings Bank plc
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Factors that impact the market
There are three factors that impact the addressable market. These are categorised into cyclical and structural changes. Coincidentally, all of these factors have a continued positive impact on the market over the forecast period which underpins our analysis that this sector remains an attractive investment proposition.
Cyclical recovery of the market
Activity in the housing market is on the rise although it still remains below average. We identify the increase in transactions as cyclical recovery which started in 2013 and is expected to continue over the forecast period, which is supported by a) increase in supply of new properties in the market. 144,970 new houses were completed in 2014. We estimate 160,000 houses were completed in 2015. New house building completion levels remain at 15 year low (figure 4) although the situation has been marginally improving over the last two years. There is significant political pressure to build more homes to meet the market demand. However, restrictive planning permissions and unavailability of enough land in areas where demand is the greatest remain roadblocks. Despite the roadblocks, we believe that over the forecast period, 150 – 180,000 new houses will be completed each year. b) continued increase in house prices that has brought more properties on the market. c) changing demographics, mainly increase in retiring age population
Figure 4: New house building completed in the UK (2000-2014)
Source: ONS
Cyclical recovery of the residential property market in the UK helps in the growth in revenue for the estate agents. In turn, a strong estate agent market benefits property portals through an improved pricing environment and additional estate agency formation.
Despite the recovery in housing activity, number of property transactions remains comparatively low. Our analysis indicates that across the economic cycle, in a given year an average of 5% of the total housing stock changes hands. In the past two years, total transactions were only 4.4% of the total housing stock.
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Structural growth opportunity
We identify two separate structural forces impacting the market. First, a growing private rented sector is changing the dynamics of the estate agency market and increasing the addressable market size for both the estate agents and property portals. The second is the continued migration to digital led primarily by audience. We explore both in detail
(a) Continued growth in the private rental sector: Increasing house prices, rising affordability gaps and increased migration to London and the South East has led to a robust and sustained growth in the private rental sector. There were 5.6 million households renting privately at the end of 2015, according to research by Kent Reliance1. 400,000 households are expected to be added in 2016. The property rental market provide estate agents with low but more frequent commission income which over the lifetime of the property on average is more attractive2 than sales transactions. We estimate an addition3 of £9-14m a year to the market size over the forecast period.
(b) Continued digital migration: Near universal smartphone usage along with ‘always on’ mobile Internet has led to sustained growth in online property searches so much so that it is believed 90% of property searches starts online these days. Our survey corroborates further by showing that property portals account for more than 70% of leads to an average estate agency. On the supply side, anecdotal evidence indicates that when vendors engage estate agents, access to property portal is an important consideration along with asking price and commission fee.
Share of digital classified advertisement lags behind at 55% of total classified marketing spend. This is partly due to slow churn from legacy print and traditional methods, but a key reason is greater effectiveness of the digital proposition. We will explore the benefits and return on investment from digital classifieds in the advertising marketplace section. Nonetheless, a catch up is now overdue. This underpins our reasoning that the pricing power of the industry is here to stay for some time. We expect that share of digital as a percentage of total marketing spend to continue to increase by 2-4 percent a year over the forecast period, adding £10-21m to the addressable market size.
Structural changes in the property market will increase the total addressable market by £19-35m a year over the forecast period. Cyclical recovery is expected to add £13-28m a year to the market size.
Market Structure
The demand and supply sides of the property market is highly fragmented consisting mainly of millions of individuals/households. Transactions are generally intermediated. There are 21,500 estate and letting agency branches and approximately 3,000 new home developers that act as intermediaries.
Estate agency market consists of large chains as well as independents. Some estate agencies specialise in an area but mostly they offer multi-products. The market is fragmented, top 10 chains account for 14 percent of all agency branches. Most agencies are independent small businesses with less than two branches on average.
The home developer market on the other hand is relatively concentrated. The top 25 constitute 70% of new home development sites. New homes form a small proportion of the overall market (12% in 2014 and 13% in 2015).
------1 Kent Reliance is one the largest buy-to-let mortgage provider and part of OneSavings Bank plc 2 On an average 5% of the housing stock is sold each year compared to average tenancy of 19 months. Rental yield on average is 4.5% in the UK. Agency commission is 0.75-3% for sales and 7-17% for lettings. 3 from additional households and rise in rents (assumed up to 5% per year)
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Most estate agencies and almost all home developers have a physical presence; however there are a growing number of online only estate agencies (200 in 2015). These agencies aim to exploit the opportunities presented by digital migration. Their cost base is small and that gets reflected in their pricing.
Digital classified residential property advertising marketplace
The digital classified property advertising marketplace is primarily served by three players. The largest, Rightmove commands 62% share of the market by revenue, followed by Zoopla with 24%. The new entrant and a challenger, OTM reported 6m visits per month (4% of the market). However, we believe that OTM will have 5-7% share of the market by revenue (£15-20m) by the end of 2016. Figure 5 is a brief comparison of the three players.
Figure 5: Key metrics of the top players (UK)
Advertisers ARPA/month Inventory Visits/month Leads (2015) Rightmove 19,752 £754 0.9m 100m 49.8m Zoopla 15,408 £342 0.7m 45m 25m Onthemarket 6,500 n/a 0.2m 6m n/a
All three players have a subscription based model. Rightmove and Zoopla offers tiered pricing – a basic service to list properties and premium tiered services to attract more eyeballs, feature on top of the list, market research tools etc.
Advertising on property portals is extremely crucial for estate and letting agencies. We believe that 90% of consumers use Internet to begin their property search. Nearly 70% of all leads to estate and letting agencies come from property portals, thus giving portals significant pricing power.
It is often misunderstood that the property portals only generate leads for estate agencies. It is important to realise the ancillary benefits which include a) market research: Both Rightmove and Zoopla provide tools that estate agencies can use for local market research which include number of leads on competitors properties, volume of searches in a particular area etc. b) Improved marketing effectiveness: The levels of high quality leads reduces the need for spending on alternate channels c) employee productivity benefits: Both Rightmove and Zoopla’s tools integrate with most software products used by estate agents, thereby reducing the need for data entry and other manual tasks. It should be noted however that there is a long road ahead before maximising productivity benefits.
Portals develop strong and defensible market positions by exploiting network effects. As illustrated in figure 6, these effects work like a perpetual motion machine constantly gathering pace. Estate agencies and the audience migrate to the same platform reinforcing each other in a cycle creating network effects. Availability of better inventory of properties attracts more audience and increases number of visits and leads. More traffic and leads attract more estate agencies to join the portal thereby increase the inventory. Strong network effects drive scale in the marketplace and also helps create barriers to entry.
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
Figure 6: Network effects in a property portal market
Onthemarket.com (OTM)
Agents Mutual, a mutual consisting of estate agents, launched a property portal onthemarket.com on January 26, 2015. Early backers included many of who in the past had backed similar agent controlled property portal PrimeLocation4 which was later sold to Digital Property Group, now part of Zoopla Property Group.
OTM is primarily aimed at disrupting the dominance and pricing power of Rightmove and Zoopla who between them have 86% of the market by revenue and over 90% of the market by visits. Through OTM, estate agents aim to gain control over the advertising ecosystem and eventually offer cheaper alternative to Rightmove and Zoopla.
Agents Mutual believes that there is room for a third player in the market, where the top two enjoy in excess of 50% margins. In the first 15 months, OTM has signed c.6,500 agencies as its members who have listed ~240,000 properties on the portal. OTM is gaining audience traction with 6m visits a month (4% of the market) in January 2016. We believe that OTM will have 5-7% share of the market by revenue (£15-20m) by the end of 2016.
But the key question is - is there room for a third player in the market today? To address it, we look at the market and its history to take some lessons.
High margins attracts competition: A market where the top two players generate margins in excess of 50% will attract competition. Yet for the incumbent, Rightmove, there hasn’t been any that has challenged its pricing power or dominance (except Zoopla). For Zoopla, timely acquisitions helped it grow in size and challenge the dominance of Rightmove, yet these acquired businesses with their individual rate cards and differential pricing has shackled Zoopla to effectively challenge the pricing power Rightmove.
------4 Primelocation was set up in 2001, owned by 500 shareholders representing more than 200 estate agents which included Savills (14%), Knight Frank (10%) and Hampton International (10%). The business was acquired by Daily Mail & General Trust in 2005 for £48m. According to Financial Times (9 Dec 2005), in the first nine months of 2005, Primelocation had revenues of £4.1m compared with £4.7m for full year 2004. The business made £0.5m pre-tax profit in 2004. At the time of the acquisition, it was reported that primelocation.com had 850,000 visits a month compared to 7m visits a month to rightmove.com (revenue £18.2m, pre-tax profit £8.8m).
Digital Property Group, part of Daily Mail & General Trust. Digital Property Group which operated primelocation.com merged with Zoopla in 2011.
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
A number of large players including Tesco and Google entered the market attracted by profitability, but subsequently either left the market or got acquired.
Market opportunity: Cyclical recovery of the property market in an environment where house prices continue to increase is a positive sign for OTM. However the pace of structural growth opportunity is on a decline. On balance we believe that the market will grow by £32-63m a year. To remain relevant, OTM will need to grow by £8m in revenue each year over the forecast period. This will mean adding 2,200 net additional agency branches each year.
Funding growth: Property advertising is a two sided market – develop a large audience and complete inventory. OTM has far lower levels of inventory as well as brand recognition compared to Rightmove or Zoopla which means that to get the same amount of leads; it will have to spend considerably more on marketing.
Using Zoopla as a base case, we believe that OTM will continue to require funding until it doubles its agency members as well as inventory levels. At the core of the model is the argument that in 2016 OTM will be spending 6x in marketing to get the same number of leads as Zoopla. We estimate that OTM will spend £15-18m in marketing in 2016.
Network effects create barriers to entry: Rightmove and Zoopla’s dominance and pricing power is derived out of network effects (figure 6) that helps build scale, create entry barriers and where “winner takes all”. Sellers migrate to the same platform as buyers and vice versa in a reinforcing cycle. In this market, better inventory attracts more audience and increases number of visits and leads. More traffic and leads attract more estate agencies to join the portal thereby increase the inventory. Strong network effects drive scale in the marketplace. Scale increases return on marketing spend and thereby profitability.
In order to carve out a market position, Agents Mutual member contracts stipulates that its members can list on only one other marketplace for a period of 5 years. Thus far, nearly 90% of members have chosen to keep Rightmove and leave Zoopla. We believe that this is a key benefit to OTM. Success for the business in a large part will be determined by (a) whether OTM can implement the restriction until it doubles in size, (b) sign on new members on the same terms.
Vendor reluctance: It is common knowledge that when vendors engage estate agents, there are three main areas of negotiation (a) asking price of the property, (2) fee level (typically 1-2%) and (3) access to property portals. Our survey indicates that vendors are reluctant to list on OTM primarily due to lower brand awareness. We aren’t certain to the extent this is impacting estate agency appointments.
On balance we believe that it is entirely possible for OTM to create a niche, however it is questionable if the business will have optimal size to enjoy network effects. We believe that OTM won’t change the fundamental industry dynamic of strong pricing power with significant opportunity for further structural growth.
Conclusion
The size of the digital classified property advertising marketplace in the UK is £285m in 2015. It is expected to grow by £32-63m each year over the next three years (2016-2018). The growth will be driven by (a) cyclical recovery, and (b) structural shifts in the market.
The marketplace is dominated by Rightmove (62% share), followed by Zoopla (24% share). They enjoy the pricing power that has underpinned their robust growth. Onthemarket.com was launched in 2015 to challenge the duopoly and their pricing power. It has successfully ramped up agency signings to 6,500 and its policy to restrict its members to list in only one other portal has dented Zoopla’s revenue and market positioning. However, the business faces strong headwinds from a two sided market - (a) lack of audience traction, (b) challenges with inventory availability including reluctance from vendors.
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Shomik Banerjee, CFA Poulami Bhattacharya Director [email protected] +44(0) 7800 922132
The structural limitations to the business will have strong impact on the long term viability. Without comparable inventory, it is unlikely that OTM will be a success. We expect OTM to become an acquisition target.
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