REA Group (ASX:REA) reported third-quarter results with EBITDA before associates and excluding mergers and acquisitions of $220 million, up 16% on the prior year, on an 11% increase in revenue and a 5% increase in operating costs.

Why it matters: The residential segment, which contributes most of group revenue and EBITDA, accelerated from the first half, increasing revenue by 12% during the period, compared with 7% in the first half. Listing volumes drove the acceleration and were up 1% on the prior year, compared with a 6% decline in the first half.

  • We believe listing volumes are increasing due to deteriorating investor sentiment. Investors have historically driven procyclical changes in supply, holding on to dwellings when prices are rising and becoming more interested in selling when prices stop rising or begin to fall.
  • We believe another rate hiking cycle and the likely introduction of tax changes for real estate investors at the May budget are a catalyst for continued deterioration of investor sentiment and will therefore boost near-term listing volumes as marginally more investors choose to lock in gains.

The bottom line: We increase our fair value estimate for narrow-moat REA Group by 2% to $129 per share, reflecting the time value of money. At current prices, REA Group shares screen as materially overvalued.

  • We believe REA Group is overearning this year. In April, listing volumes shot up around 20% from the prior year, reaching 5% above the five-year average. Moreover, this five-year average itself was already well above trend, as it included the elevated period of 2021-22.
  • Longer-term, we expect listing volumes to normalize and REA Group to become more constrained in raising listing fees due to competition from CoStar-backed Domain, regulatory intervention, and possible property price declines.

Investors now in the driver’s seat of the property market

We expect REA Group’s near-term challenges to center on navigating significant regulatory and competitive tension. REA Group has come under increasing regulatory scrutiny for anticompetitive behavior, which we find understandable, given the dominant position it holds and the steep price hikes it puts through every year, both from direct price hikes on existing tiers and through the introduction of new listing tiers, which we consider price hikes by a different name. The acquisition of competitor Domain by CoStar, and its intention to increase competition, adds to near-term challenges, although mitigates regulatory scrutiny.

In the long term, we expect a gradual decline in listings due to friction in the housing market caused by ongoing increases in transaction costs in the form of stamp duty, and to a lesser extent, REA Group’s own listing fees. Total dwelling transactions in the Australian housing market declined for nearly two decades until the onset of the pandemic, despite the number of dwellings increasing around 1.7% per year over the period. We attribute this falling liquidity principally to rising stamp duty, which has increased around fivefold in the past two decades. We do not forecast a significant reduction in stamp duties, despite some state governments undertaking initiatives to replace the upfront stamp duty with an ongoing land tax. We do not believe any Australian state is in a sufficiently financially healthy position to be able to afford this transition, as evidenced by their deteriorating credit ratings and as evidenced by recent state governments’ decisions to raise property taxes and remove previously introduced land taxes. We therefore forecast a continuing decline in housing stock liquidity.

We expect REA Group’s long-term growth to be primarily driven by growth in yield, or listing fees, within its residential division. We see limits to these price hikes from societal friction and regulatory tension. In the long term, we don’t believe competitive pressure pose a significant limitation on the company’s pricing power.

Bulls say

  • REA Group and Domain effectively operate a duopoly in residential real estate listings in Australia, and REA Group is the dominant platform of the two.
  • REA Group has demonstrated its ability to defend its competitive lead over Domain where it matters most, in audience size, revenue, and margins.
  • REA Group’s deep relationship with corporate parent News Corp provides it with access to some of Australia’s most popular newspapers, websites, and television channels.

Bears say

  • REA Group’s earnings are affected by the housing market, which is highly cyclical.
  • AI-curated shortlists based on user prompts can diminish the value of REA Group’s list-based search and tiered pricing model.
  • REA Group is attracting increasing regulatory scrutiny and is under active investigation.

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