PAA Research says that recent cuts to featured listings for premier agents suggest that Zillow’s (Z) advertising inventory problems could be escalating as brokers exert leverage.

Contrarian investor Andrew Left, head of The Citron Report, is making a presentation Tuesday that will make similar points at the Value in Investing Congress in New York.

Zillow did not respond to a request for comment by publication time at 6 p.m ET, but HousingWire will publish their response when it available.

Citron has been highly critical of Zillow and its proposed acquisition of Trulia (TRLA).

Housingwire reported in July on the firebomb critique leveled at the deal by Left. Left, a short-seller, has been a longtime critic of Zillow, as noted in other business trade media. This stands to reason as Zillow is one of the most shorted stocks out there.

Others have sounded off about what they see as problems with Zillow’s valuation and operations.

In the report by PAA Research, an independent investment research firm, the company says it “made three critical conclusions about Zillow’s advertising ecosystem, which as far as we can tell still have not become a central component of the investment dialogue surrounding the company (or Trulia’s for that matter).”

Those conclusions related specifically to listings and ad inventory were:

  1. Large brokers increasingly dominate the Zillow ecosystem, which sounds like a good thing, but actually is not.
  2. Available ad inventory on Zillow is actually shrinking, which will make it almost impossible for the company to achieve the kind of growth in premier agents bulls are expecting.
  3. Lead quality (which is already viewed as poor) could deteriorate further as more and more leads originated from the Zillow ecosystem come from homes that are not for sale. More than half of Zillow’s traffic (excluding rentals) comes on homes that are not for sale.

“In our original report we argued that there was an element of circular logic in the bull case for Zillow as it relates to the company’s advertising solutions for agents in the purchase market. In short: the more premier agents the company adds, the less available advertising inventory Zillow will have,” PAA Research says.

Premier agents get ‘featured listings’ through which they can block other agents from advertising next to their listings.

“In our view, we estimate that 10-20% of available ad inventory for homes for sale on Zillow could already be blocked from existing premier agents. In addition, we identified that both Coldwell Banker and Keller Williams were preventing any third party agent ads from being placed next to their listings. That suggests that an additional 20-25% of ad inventory could effectively be blocked from third party advertising from Keller Williams and Coldwell Banker alone,” the firm says. “Over the past few weeks, we have been reviewing listing activity on Zillow more closely and as it turns out Keller Williams and Coldwell Banker are not the only firms blocking third party agent advertising on their listings.”

PAA Research says that based on that review of recent listings, it appears that an additional five of the top 10 brokerage firms are blocking third party agent ads in some fashion on their listings. These claims could not be immediately corroborated. 

The firm makes the following allegations:

“Here are the firms that are blocking third party agent ads from being served to some degree:

Century 21

Sotheby’s

Weichert

Howard Hanna

Long & Foster

“These firms account for approximately 10% of listings on Zillow based on our analysis. This implies that approximately 45-55% of available third party agent ad inventory could be blocked from featured listings from premier agents and brokerage firms protecting their listings,” PAA Research says.

This development could have hugely negative implications for Zillow, including:

  1. Deteriorating lead quality, which is already at low levels
  2. Declining impressions – agents now pay for when their contact information is displayed. If there’s no ad inventory how can impressions be delivered
  3. The remaining large brokerage firms could ask for similar arrangements, further reducing ad inventory
  4. Premier agent additions could collapse due to the absence of available ad inventory
  5. ARPU could come under pressure as a result of lower impression levels and Zillow’s decision to reduce the number of featured listings per agent (more on this later)

The monetization of the Zillow ecosystem could be far less than previously thought as brokers continue to block available ad inventory at rates that are a fraction of the average premier agent ARPU. Make no mistake, at some point in the past 6-12 months it appears the large brokerage firms made a “power play” on Zillow.

There’s some debate among investors and industry participants as to who has the most leverage between the brokerage firms and Zillow/Trulia. Based on what has transpired, at this stage the brokerage firms have demonstrated that they continue to hold the keys to the real estate lead generation ecosystem, PAA Research argues.

“As we have said several times in the past, if Realogy pulled all of their listings from Zillow, which company would survive? As a result, the brokerage firms can continue to protect their listings on incredibly favorable terms. You might be wondering: how will Zillow offset this decline in available ad inventory?” PAA Research says. “Well, at some point in the past few months, the company elected to reduce the number of featured listings available to platinum premier agents. Now, platinum premier agents only receive 10 featured listings per profile, down from 25 at the start of the year (in case you’re wondering TRLA appears to have done the same thing). Additionally, premier agents can no longer purchase additional featured listings as they could as recently as 1H14.

“Is there any greater sign that Zillow management is concerned about advertising inventory available on its ecosystem? It will be interesting to see how premier agents respond to these changes. While there are plenty of agents that use Zillow as a platform for buyside leads, many also advertise on Zillow to “protect” their listings. Might increased churn and slower agent additions result from these changes to the platinum premier agent program? We think so,” the researchers conclude.

PAA Research says that in an attempt to grow its available advertising inventory, Zillow has restructured its platinum premier agent program such that subscribers no get significantly less featured listings.

“Ask yourself, who’s operating from a position of strength Zillow or the brokerage firms?” analysts ask. “If our understanding of the bull case is correct, Zillow investors think the company has the potential to reach more than 100,000 premier agents (bulls might think much more than that) at an ARPU more than twice current levels. We’ve already established one fatal flaw in the bull case – less than 15% of agents can afford that price point. However, after reviewing the listings data another fundamental problem for the bull case has become quite clear – Zillow simply does not have the advertising inventory to support more than 100,000 premier agents.”

PAA Research says that based on the 52 markets reviewed, “featured listings” represented roughly 20% of total available listings of homes for sale. Other agents cannot advertise on featured listings.

Many of the larger brokers have forged advertising relationships with Zillow that prevent agents from other firms from advertising on their listings.

PAA Research’s full report can be obtained here