So Zillow was the first of the nationwide iBuyers to blink.
Last week, Zillow announced it is shuttering its iBuying platform –– Zillow Offers –– after nearly 3 years of operation and thousands of homes purchased.
Why did they exit a business they had invested so much time, money and reputation in entering?
Zillow figured out what the other iBuyers have not –– iBuying carries with it a fatal flaw –– and continuing to purchase properties algorithmically simply isn’t profitable.
So what is iBuying you ask?
iBuying, in its simplest form, is when a company (or fund) purchases a home directly from an individual seller, typically with a quick closing, and at a price that reflects the fact that the owner will not be paying a commission or the other costs typically associated with selling.
Most iBuyers use some form of home valuing algorithm (often their own proprietary algorithm) to establish the price they are willing to pay and then apply a formula to back out the typical selling expenses to arrive at the offer. In theory, the offer should represent a market sales price less the typical sales expenses (commission, legal fees, etc.) and less some discount for the convenience of the quick closing in cash.
The Typical iBuyer Offer Formula
iBuyer Offer = Algorithmic Market Value (less) Selling Expenses (less) Estimated Repairs (less) Carry Cost (less) Convenience Discount
The discount is key because any iBuyer will likely have to make repairs, carry the home during the sale process, pay for utilities, etc. and generally experience the costs associated with vacant property –– and did I mention, make a profit?!?
Yes, iBuying is a FOR profit venture and so the discount needs to be deep enough to allow for the iBuyer to make a few dollars for the risk they are assuming.
Provided the iBuyer and seller are able to reach an agreement on price and that the basic contingencies are met, the seller will typically have cash in hand quickly (generally 10-14 days) and the iBuyer becomes the new owner.
Why Use an iBuyer?
iBuying appeals to a seller who either wants –– or needs –– a quick sale and is willing to take a discount to get one.
The most common cases are:
- when the seller cannot buy another house without selling the one they are in
- when the seller does not have the funds to repair the home but needs to sell it
- when the seller does not need the home (think –– heirs / inheritance) and doesn’t want to deal with the process of selling
- when the seller is in financial distress and needs to sell quickly
- when the seller doesn’t want a bevy of strangers traipsing through their home for months on end (think COVID)
As you can see, in theory, iBuying has some legitimate applications –– and is a rapidly growing segment. But it should also be noted that despite its recent growth, iBuying only represents a very small percentage (1 to 2%) of all home sales in the US and Zillow CEO Rich Barton referenced the difficulty in scaling as one of the reasons they pulled the plug.
The Fatal Flaw
So if there are legitimate reasons for iBuying to exist, why did Zillow, in their attempts to dominate each and every facet of real estate, get out?
Zillow, in its announcement that it was shutting down Zillow Offers, claims that the current market is unpredictable and thus projecting pricing with any degree of accuracy going forward makes the purchase of property dangerous –– especially at the scale at which Zillow does anything.
I personally think it is even simpler –– Zillow finally figured out that the public was playing them for a fool.
Wait, what?!? Zillow is the fool?
Why? Because the only sellers who will take Zillow’s offer are the ones who are getting deals from Zillow, not the other way around.
The Public Holds the Option, Not Zillow
Think about it:
- if your house is worth $400,000 and Zillow makes you an offer below what you think it is worth on the open market, then you sell on the open market.
- if Zillow makes an offer above what you think it is worth on the open market, then you sell it to Zillow.
The seller’s option to either accept the offer or list the property gives them leverage that Zillow (or any other iBuyer) cannot compete with.
The economic concept is called ‘Adverse Selection’ and it basically means that one side of the transaction has more information than the other side does –– and can exploit that informational advantage to their benefit.
Apparently, Zillow, despite having access to more housing information than any other entity in history, knows less about the value of a single house than the individual homeowner does.
Initial reports back this up –– several studies show that Zillow is re-selling over 60% of their purchased homes for less than the original purchase price –– and these sales are occurring during a time when housing prices have escalated more than in any other time in history! Nationwide appreciation was nearly 20% in 2021 according to the Case-Shiller Home Price Index.
That is a huge miss.
In summary, Zillow’s iBuyer program bought houses at over-market prices (i.e. bad deals) and they finally figured out that buying things for more than they are worth is a bad business to be in.
Others in the iBuyer Space
Is Zillow the only iBuyer in the US? No.
Others, such as OpenDoor and OfferPad, are still in the game and they have not indicated that they are considering stopping anytime soon. As a matter of fact, OpenDoor’s stock price jumped after Zillow’s announcement.
That said, their business models differ from Zillow’s in that they only buy and sell properties (Zillow sells leads to Realtors among other things) and if they stop buying, it means they would cease to exist as a company.
Why are they still operating? Perhaps their estimate is superior? Or perhaps they have better processes in place? Or maybe they are also about to implode? I’m not sure, but one would think the same flaw that caused Zillow’s failure would apply to everyone in the segment.
Time will tell.
It should also be noted that BlackRock Investments, one of the nation’s largest investment funds, is investing heavily in ‘build to rent’ –– which means buying new housing and renting it out versus trying to resell immediately it at a profit. Obviously, BlackRock recognizes that housing scarcity is one of the main drivers of price escalation and they are making a bet that owning housing (not flipping) will yield far more in the long run, especially when adjusted for risk.
I happen to agree. Show me any patient landlord and I will show you a wealthy one.
On the lending side, there are numerous mortgage companies that are in a parallel space. Companies such as Flyhomes or Knock have programs that will make a debt-based borrower into a cash buyer for a fee. The fee is steep, but the benefit of winning a bidding war as a cash buyer can justify the cost of the service.
And did I mention that they can secure the buyer a mortgage after they win the bidding war? Not a terrible idea.
So the good news is that the consumer still has options –– it’s just that Zillow will no longer be one of them.
Zillow’s exit from the iBuyer market tells me several things, most of which are positive for the real estate agent.
One, Zillow’s algorithm is exactly what we thought it was –– an approximation of value, not actual value. Zillow has always downplayed the (lack of) accuracy of its estimates and perhaps they finally figured out what most agents already knew –– Zillow is nowhere near as accurate as they would have you believe. When they finally put their money where their mouth is, they lost millions.
(A quick sidebar –– I cannot tell you how happy this makes every Realtor who has ever been told by a client ‘Well Zillow says…’ only to realize after the fact that their agent was correct and had made far better recommendations than a computer in Seattle. But I digress…)
Two, it begs the question –– how much, if at all, was Zillow manipulating the estimates to their own benefit? Were they inflating the post purchase values on the homes they were selling in order to protect their investments? Remember, Zillow is publicly traded and thus their primary responsibilities are to their shareholders –– not to the public and definitely not the Realtor.
If the choice is between losing 40% of your stock price and laying off 25% of your workforce or inflating the estimates of the homes you own, what would you do? The conspiracy theorists are already chirping loudly.
Three, algorithmic home purchasing is just not a viable long term strategy.
Consumers are savvier than the tech barons give them credit for and the ability for a seller to only sell when the algorithm overestimates the value means a losing proposition –– over any time frame and at any scale.
In the same way that casinos have odds tilted just enough in their favor so that the the longer the gambler plays, the more likely they are to lose, Zillow finally figured they were playing a game where their information was suspect AND their opponent had the option to play only when it suited them.
I don’t care how good you are, when your opponent can see your cards AND their own, winning is near impossible.
And lastly, there is tail risk in iBuying that Zillow should want no part of — especially with such thin margins. I don’t care how many disclaimers or disclosures Zillow can get the buyer or seller to sign, one angry client and a shrewd attorney can erase years of profits.
Imagine the press if Zillow is seen as taking advantage of someone’s grandmother or some other sympathetic character? In a sale between two individuals, most courts will support the sale as legitimate provided there was not intentional fraud by either seller or agent. But when Zillow jams someone’s Memaw, even if unintentionally, not only will the settlement likely have several commas, the PR would be a nightmare.
So in a fit of rationality, Zillow swallowed its pride, demonstrated self-awareness, and got out –– kudos to them. The world is littered with hubris-based falls from grace by CEOs who thought market dynamics didn’t apply to their company. Rich Barton did not make that mistake.
Remember, Zillow did not achieve their place in the market by being dumb. They are data driven and well funded, and they remain a dominant player in a huge market despite their announcement. If they exited iBuying, they did so because they did not see a future in it –– what does that say about the segment?
The bottom line is that being a Realtor, investor, contractor, and/or property manager is a lot harder than it looks and none of those gigs scale easily –– if scaling was easy, someone would have done so already.
Don’t believe me? Then just ask any homebuilder who jumps into a new market and proceeds to overpay for lots –– and then builds the wrong houses on them. Most builders who enter a new market call it the ‘stupid tax’ and IT. HAPPENS. ALL. THE. TIME.
So even a group like Zillow, with all of the technological and intellectual capital they have at their disposal, could not overcome the fact that not only is an individual homeowner is a lot smarter than they thought, but the homeowner knows when Zillow is wrong a lot better than Zillow does.