The residential real estate industry is reaping the benefits of prevailing low interest rates and the rising popularity of remote working. Two of the fastest growing companies in this space — Zillow (ZG) and Redfin (RDFN) — have delivered triple-digit gains so far this year. With a unique business model and better quarterly results, the question is will ZG outperform RDFN? 

The residential real estate industry has been one of the biggest beneficiaries of the COVID-19 pandemic. Historically low interest rates combined with the normalization of remote working worldwide has led to a widespread flight by people from crowded cities and metropolitan areas to the suburbs.

A second wave of the pandemic is now plaguing the U.S., while a new strain of the virus is reactivating lockdowns in European countries. This should fuel the demand for residential real estate further, as people quarantine in their houses.

Permanent remote working is expected to double in 2021 owing to increased productivity levels, according to a survey conducted by Enterprise technology Research. This bodes well for this industry.

Companies such as Zillow Group, Inc. and Redfin Corporation have revolutionized the housing sector by launching technology-backed services to make the home purchase and rental process more streamlined and efficient. Both companies are riding a residential real estate boom, with high holdings turnover. In fact, low inventories amid surging demand have become a real concern for both the companies, which is pushing prices up even further.

Both companies have generated significant returns over the past three years. Zillow has gained 246.7% over this period, while Redfin returned 190.3%. However, in terms of past-year performance, RDFN is the clear winner with 264.9% gains versus Zillow’s 230.9% returns. Also, RDFN has gained 72.4% over the past month, outperforming ZG, which gained 25.4% over this period.

But which stock is a better buy now? Let’s find out.

Latest Developments

In October, ZG launched four tiered ‘Rent Connect’ packages, to provide advertising solutions and streamline purchase impressions for multifamily professionals. Further, with Gen Z young adults now graduating from college and joining the workforce, the residential housing market is witnessing demand from a new demographic. However, under the work-from-home conditions, most people are moving from cities to the suburbs for more space. This has led to record low in rental prices in major metropolitan areas like New York.

Earlier this month, RDFN launched its iBuying service, Redfin Now, in Seattle, San Francisco, and the Bay Area. These areas serve as the nation’s technology. As such, real estate demand from in these locations should drive RDFN’s revenues. RDFN expanded its business operations to Sacramento on October 9.

RDFN has raised $575 million through an offering of senior notes to institutional buyers in mid-October.

Recent Financial Results

ZG’s revenues from the mortgage segment increased 114% year-over-year to $55.20 million in the third quarter ended September 2020. Total revenue from the Internet, Mortgage and Technology segment rose 24% from the prior-year quarter to $415.39 million. Net income rose substantially from the negative year-ago value to $39.57 million, while total adjusted EBITDA increased 860.6% from the same period last year to $152.18 million.

RDFN’s revenue from the Services segment increased 37.1% year-over-year to $217.28 million in the third quarter ended September 2020. Gross profit rose 74.4% from the same period last year to $93.07 million, while net income grew 403.8% from the year-ago value to $34.17 million. EPS increased 328.6% from the prior-year quarter to $0.30.

Past and Expected Financial Performance

ZG’s revenue and tangible book value have increased at CAGRs of 50.7% and 106.5%, respectively, over the past three years. In comparison, RDFN’s revenue and tangible book value increased at CAGRs of 36.9% and 20.8%, respectively, over this period.

However, RDFN’s total assets increased at a CAGR of 38.2% over the past three years, while ZG’s total assets increased at a CAGR of 27% over the same period.

Analysts expect ZG’s EPS to rise 200% in the current quarter, 140.7% in the current year, and 59.1% next year. Consensus revenue estimates indicate a 19.7% improvement in the current year, and 44.6% rise next year.

RDFN’s EPS, in contrast, is expected to increase by 137.5% in the ongoing quarter, 60.2% in the current year, and 82.9% next year. Analysts expect the company’s revenue to rise 11.4% in the current year, and 43.4% next year.

Moreover, both ZG and RDFN have impressive earnings surprise histories, as they beat the Street EPS estimates in each of the trailing four quarters.

Profitability

ZG’s trailing 12-month revenue is almost four times RDFN’s. ZG is also more profitable with a gross margin of 41.4% compared to RDFN’s 21.9%.

Furthermore, ZG’s leveraged free-cash-flow margin of 23.5% compares favorably with RDFN’s 8%.

Valuation

In terms of trailing 12-month Price/Sales, ZG is currently trading at 9.06x, 5.2% more expensive than RDFN, which is currently trading at 8.61x. ZG is also more expensive in terms of trailing 12-month EV/Sales (9.07x versus 8.92x).

However, RDFN’s trailing 12-month Price/Cash ratio of 104.77x is 149.4% higher than ZG’s 42.01x.

POWR Ratings

Both ZG and RDFN are rated “Strong Buy” in our proprietary POWR Ratings system. Here are how the four components of overall POWR Rating are graded for both these stocks:

ZG has an “A” for Trade Grade, Buy & Hold Grade, Peer Grade, and Industry Rank. It is currently ranked #7 of 61 stocks in the Internet industry.

RDFN has an “A” for Trade Grade, Buy Hold Grade and Peer Grade, and “C” Industry Rank. It is currently ranked #2 of 46 stocks in the Real Estate Services industry.

The Winner

ZG’s unique business model allows it to showcase a larger variety of properties, such as direct listings by owner, new constructions, rentals, and foreclosures and pre-foreclosures. RDFN, in contrast as a full-service real estate brokerage services company, does not have access to these properties. Also, a sale through RDFN takes a longer time on average to be completed compared to ZG.

Thus, ZG’s efficiency rates have allowed it to grow substantially over the past couple of years. Even though slightly more expensive, ZG’s growth potential compensates for its marginally higher valuation, we think, and hence, it is a better buy here.

ZG shares were trading at $143.86 per share on Thursday afternoon, down $2.08 (-1.43%). Year-to-date, ZG has gained 214.52%, versus a 16.80% rise in the benchmark S&P 500 index during the same period.