JEROME M. COLE : Prudential’s Piece of the Rock : Realty Wing Wants a Share in the Land of the Tough Sell
They are the battleships of the residential real estate industry: Century 21, based in Irvine; Denver’s RE/MAX, the only national broker in the top three not based in the county; and Coldwell Banker, based in Newport Beach.
Jerome M. Cole of Corona del Mar has worked for Coldwell Banker and Century 21. Now he is trying to strike pay dirt again, this time based in Costa Mesa and backed by the gigantic Prudential Insurance Co. of America.
Prudential joins other giants--Metropolitan Life, which owns Century 21, and Sears, which owns Coldwell Banker--in selling franchises to local brokers. Not only is there the potential to make a lot of money in franchise and service fees, but the franchisers can also use their network of local brokers to sell home buyers other merchandise, from furniture to insurance.
Cole, 54, didn’t get into real estate until he was 29. He joined a San Fernando Valley company, which was bought by Coldwell Banker in the late 1960s. The firm became the base for Coldwell Banker’s leap into residential real estate.
Other acquaintances left the firm and set up in Santa Ana to sell franchises to brokers nationwide. They called the new company Century 21.
Until 1987, Cole ran Coldwell Banker’s franchising operation, which he had started and which existed alongside the company’s own network of residential brokers.
While still at Coldwell, Cole said, he talked Prudential, the insurance giant based in Newark, N.J., into starting its own franchising program.
Prudential unveiled its new subsidiary, Prudential Real Estate Affiliates Inc., in 1987, with Cole as president.
But it is a tough market, and other franchisers have already swept up the easy pickings, leaving many brokerages that will be tough sells. And franchised brokerages’ share of the real estate business is shrinking, from a 21% peak in 1981 to 15% last year.
Cole talked recently with Times Staff Writer Michael Flagg about 1988--the company’s first full year of operation--and the outlook for 1989. Q. Let’s start with nuts and bolts. How does Prudential’s franchising program work?
A. There’s a franchise fee at the front end (charged a local brokerage). We have a sliding scale, with the main office the most expensive at $22,000 and decreasing for branch offices, down to a low of $8,000. As part of the deal, they must have our computer system, which we give them, and they must use it. They also get training, help in recruiting and advertising. There’s also a sliding scale for the ongoing service fee they pay us, which starts at 6% and--depending on how much business the broker does--can work its way down to 3%.
Q. Is that competitive with other franchises?
A. To my knowledge, only we and Coldwell Banker--which did it to be competitive with us--have a sliding scale. That makes it more feasible for a large, highly successful brokerage to justify joining a franchise program. And we give them about $10,000 worth of computer software and hardware.
Q. How has the first year gone?
A. We brought aboard our first franchisees in May. We’re currently at 209 offices, which is probably as successful a start as anybody’s ever had, if not the most successful.
Q. Isn’t that quite a bit less than you predicted you would have?
A. The goal was to have 300 at the end of our first fiscal year (which ends March 30). We’re probably a touch behind schedule, not because we couldn’t sell franchises but because we spend so much time qualifying people, getting financial statements and doing background checks, and it’s a slower process than we had anticipated. We’ve probably received checks and applications from two or three times as many brokers as we have on board, but our direction is to maintain a high quality.
Q. What happens this year?
A. This year is the more critical year. I think we got off to a very respectable start last year. This thing is the largest undertaking that’s ever been done in this business from scratch. The question isn’t whether we’re going to succeed. The question is how long it’s going to take us. The goal is 5 years. It might take 6 or 7 years.
Q. What happens in 5 years? Are you still planning to be be first or second in the industry in revenues and have 3,500 offices, as you said last year? Or is that not a realistic goal anymore?
A. I really try to avoid the 3,500 number. I feel 3,000 in that period is a realistic number. I think 3,500 is possible, but maybe not in 5 years. It may take longer because of the quality factor, and there’s another reason too: In a really hot real estate market, a lot of the bigger, better brokers don’t feel they need a franchise. It’s been proven time and time again that in a bad market, franchise sales are much better.
Q. When do you turn a profit?
A. Probably in another year. It usually takes a couple of years to turn it around. This is a major investment. Prudential pulled out the stops. They put aside $40 million to get this program off the ground. Considering we started the Coldwell Banker program at $2 million, you can see the degree of the commitment.
Q. Why does it take so long to decide who you want in the franchise program? How do you qualify them?
A. We get 3 years’ financials on them that the accountants have to fill out. We get personal income tax returns from them. They must be among the leading firms in their area, both in market share and in reputation. They must be financially stable.
Q. Are there many out there that are not stable?
A. You’d be amazed at the number of real estate companies that appear to be very successful, but underneath it all they’re really just hanging on. It’s a business that’s been forced to get more aggressive in commission splits as companies try to keep their top sales people. The sales population is fairly fickle; they get a better deal down the street and they’re gone. As a result, there’s a commission war, not publicly but in house.
It’s caused a lot of brokers to be operating without enough revenues to sustain themselves. That’s another reason why they need these strong franchise relationships; it’ll help them recruit and maintain top people. If all a broker has to offer is a better commission split, he’s going to go down the drain. With so many of them--it’s incredible--they’ve been driven to give a greater percentage than they can afford to give away. A lot of them are losing money. This is what we’re running into out there.
Q. Given that the housing market has been pretty hot the last few years, surely things can’t be all that tough?
A. What the companies really need is a more realistic split with their salespeople. That’s the prime problem most of them have today. Theoretically, the perfect split is 50-50. But 60-40, with 60% going to the salesman, has become more of a normal split. In the more aggressive, competitive markets, brokers have gone to a 70-30 split. All this happened in the last 5 years. That kind of a split can be disastrous, because the bills for the owner often amount to 30% of what the company takes in. A lot of this is due to the RE/MAX concept, where the owner is like a landlord, and the broker pays him a fixed number of bucks and keeps the rest.
Q. But, after all, you are in the business of selling franchises. Why not just take a chance on anybody who wants one?
A. We don’t make money on the up-front franchise fees, they cost us money. We make money down the line with the service fees, depending on how much business the franchisee does. And we don’t want companies--I don’t care how great they look or how great their reputations--if the first time we have an economic downturn or another real estate down cycle, they go belly up on us.
Q. Are there any good companies left? Or have they all been snapped up by your competitors?
A. There has been a very strong consolidation of real estate companies. Where there used to be a three-tiered market--the big guys, middle guys and the little guys--the middle guys are disappearing fast. The big guys are the Coldwell Bankers and the big local brokers--the three or four local companies that are huge, with as many as 200 offices. They’re the reason the other guys join franchises: to compete.
The middle guy is the hardest hit. The little guy can still make it as kind of a boutique guy. He’s got his own little niche. He’s got his own little neighborhood where he knows everybody and he does okay, he makes a living. It’s the middle guy who’s neither fish nor fowl. He’s big enough to have a massive overhead, a lot of sales people, and he’s got to try and compete against the big guys. He’s got to advertise, train people, all the things the big guy does, just in order to maintain his 10 offices.
The bottom line is that the middle tier is getting thinner and thinner. They’re still there, but there are not as many as there used to be. And they’re really our market. Somebody who’s got 200 offices isn’t going to join a franchise.
Q. Does this trend toward consolidation worry you at all? What about the possibility that it might make the industry a lot less competitive and mean the consumer could get shortchanged down the line?
A. It’s not just our business. Consolidation is happening in every industry. But in real estate it’s highly illegal for one real estate company to even talk to another company about what they’re going to charge home buyers. You can go to jail for that. So the commission is set by what the market will bear. 6% is kind of the going rate. The reality of it is, if you charge less than that you’re probably going to go out of business. It takes that kind of a commission just to pay the bills and pay salespeople and do all the things you have to do.
If somebody tries to go to 7%, people who are selling their homes probably won’t want to list with them. Everybody would have to go to 7% together, and the minute that happens Uncle Sam is going to be all over the place trying to find out why. So that isn’t likely. Actually, in order to become more profitable and viable, the companies almost need a 7% commission.
Q. Speaking of commissions, are you finding a lot of competition from the discount brokers and sell-your-own-home folks?
A. None of them have been successful. They’ve happened before, they’ll happen again. I see them as a flash-in-the-pan thing. They make a little noise and then they disappear. None of them has ever been a serious threat.
Q. How do you find franchisees and get them to come aboard?
A. There are two secrets to this business that give you an edge: One is you don’t have to worry about selling a franchise in order to pay the bills. Whenever your sole source of income is selling franchises, you lose your ability to go after the top guy in a market and stick to your guns until you get him. Because the pressure of making payroll comes looming up on you, and there comes a point when you say: “I can’t get No. 1, I can’t get No. 2, and the payroll’s due. I’ll take No. 8 because we have to pay some bills.” And once you take No. 8, you can’t get No. 1, because he won’t join a program that’s got No. 8 in it.
The other thing is that when you come into the business without any credibility, you’re just a concept. That’s a hard sell. But when you’re somebody like Coldwell Banker, and you already have hundreds of offices, you’re renowned. You can say: “Hey, we want to franchise you, we can give you programs that will make you more profitable.” That’s saleable.
Q. What was behind Prudential’s decision to start a franchise network from scratch rather than just buy one? Were they turned off by their experience with trying to buy Century 21, when they were outbid by Metropolitan Life?
A. Prudential--among many others--made offers to buy Century 21. It kindled their interest in getting into the real estate business. They looked around the market to see what else might be available, and there was nothing else that they felt made sense economically or quality-wise or whatever--I wasn’t party to it. So they just shut the door and walked away.
One of the possibilities was to go out and start buying individual companies in a major acquisition program, similar to Merrill Lynch or Coldwell Banker, which are the two prime examples of companies built primarily through acquisition. If you look at both those companies, what you see is the expenditure of millions of dollars and to date not a particularly outstanding return on those investments. And so that approach has not proven to be a real strong way of getting into the real estate business.
Q. Because you have to put up so much money up front?
A. You have to do two things: You have to put up enormous amounts of money, and it takes forever. It’s a long, slow process. It creates enormous management problems, because you’re buying all these entrepreneurial types of people, and the strength of what you’re buying is that they were successful entrepreneurs, and you try to incorporate them into some big national thing. And they don’t fit real well. They’re difficult folks to handle.
Q. So these companies have tended to have problems?
A. Merrill Lynch apparently didn’t do a very good job, because the top management they bought ended up leaving them within a short period of time. They tried to impose very strict regulations on these entrepreneurial people, and those people said “adios.”
Coldwell Banker, on the other hand, worked out some attractive earn-out opportunities for these folks, and in almost all cases they stuck around for many years. Despite that, neither company has shown any great profitability.
Q. So you talked Prudential into a franchise operation instead of acquiring brokerages?
A. Franchising is a much more successful way of entering the business, of expanding rapidly, and of getting the market share that you’re looking to get. Look at Century 21; in a relatively few short years, they got up to 10% or 11% of the national market starting from scratch, even though they were tremendously underfinanced. It was not a company built on millions of dollars. It was a company built on dreams. I was one of the original vice presidents of Century 21, so I know the whole story.
