Zillow will borrow money to buy the homes, which means that (a) the clock will start ticking the instant each new home is purchased, and (b) this endeavor can be profitable only if proceeds from resales/rentals are sufficiently high to cover cumulative debt service costs -- in addition to all property taxes and ongoing maintenance expenditures associated with home ownership.
Why would a heretofore capital-light SaaS business like Zillow want to do this?
The only sensible explanation I can think of is that Zillow's current business is no longer growing quickly, i.e., Zillow is now a boring, mature company.
The stock dropped 7% on the news last Friday.
The question becomes if there are enough opportunities like that to move the needle for them.
If I had to guess, I would have guessed moving into Lending Tree's matchmaking area would be easier and have a better ROI.
Question I have is if whatever "pie" Opendoor is grabbing is actually sustainable in a recession/down market...seems like the worse case scenario is that they are left holding a bunch of illiquid inventory of declining value they can't get rid of.
1. buy at a discount (essentially a fee for the service of selling your house with a click)
2. sell at a markup (we're talking a small one in most cases, but the fact is in a good market you can reliably print small amounts of money with some paint, some minimal landscaping, and new kitchen appliances. Zillow will not be using a high-interest loan for the purchase or repair, so they will not be sweating like your typical flipper on TV.)
Assume for the sake of argument that Zillow has data to decide where these bets are safest based on comparables and key economic indicators. And they will say no to sellers as often as the data suggests they should.
I don't think this has much to do with finding super-profitable deals with data, but with reliably shaving points off a large pipeline of deals.
If it doesn't work in a healthy economy, they stand to lose the difference between the discounted price they paid for a house and the market value they can sell it for. In a recession, they can probably stay afloat by renting properties they can't sell at a decent price.
Zillow wins by buying an asset it has more information on the true market value of, then providing an easier, economies of scale on the associated services (inspection, legal, repair, etc), then being able to offer a standardized product to home buyers.
Buyers win from taking a lot of the uncertainty out of a transaction. And from possibly lower fees if Zillow decides to rebate a portion.
Let's not forget there's a standard 6% commission in US real estate transactions... most retail would kill to start with a 3% margin.
If Zillow has high confidence a home is underpriced, it makes sense to time arb that into profit when it can match with a buyer.
I wonder how this will impact disclosure rules versus sales advertising? Existing model to use, or adopt another industry's? Will this cause fears of LIBOR-style manipulation?
This will be interesting to watch...
edit: p.s. Maybe another chance to make a Carfax-like system for homes? In the US market, I find there is not a lot of opacity, especially when one gets into larger/commercial deals.
What info would be available that you could not see via Zillow or the MLS listing?
They must be making a lot of money from this if they're going it alone. The 7% drop is probably not because of riks here but because it signals lack of growth.
[0]: Very rough estimate, may be market-specific.
That being said, I wouldn't say 10% is a super high overestimation. On my street are two identical houses and one sold for $150k while the other sold for $180k, even though they're literally identical other than the color of the siding.
The number that really matters is the appraised value. Zillow had my house at $110k when I bought it and the buyers were asking $140k. It was a surprise when the appraisal came back at $145k. If Zillow was right, the bank would never have given a loan for $30k over the value of the house. But there was no way for Zillow to know the amount of work the previous owners put into the interior of the house.
Ethically, it seems a bit fuzzy for me given that one of Zillow's big features is there zEstimate. How can they demonstrably prove they aren't tweaking that somehow for their own gain?
See also: Amazon
I wouldn't be surprised if they make a bunch of money and then make a big mistake and lose a much bigger bunch of money.
The key advantage here is that they can make these low offers to a much bigger audience than anyone else can do. This should allow them to be either be more profitable per house than anyone else, do more volume than anyone else, or hit any mix of these two better than anyone else.
Of course, they can shoot themselves in the foot pretty well if they:
- Try to go for volume over profitability, and then catch a downturn. - Do a bad job of running repairs. - Don't do a good job of catching houses that are much worse than they appear.
However, there's no physical reason this can't be extremely profitable. They have the data to see their current home investors making money. If they feel they can identify the most profitable attributes of these flips, then they can route all the extra profitable ones to themselves. The only losers here are the existing people in Zillows home flipping program. They are almost guaranteed to now be getting the second best homes, once Zillow has skimmed off the profitable ones.
Maybe that's not a big part of the cost?
It'd be pretty inconsistent to put in a lowball offer when your company publishes an estimated value for every home in the market.
Sometimes people just want sell now.
Unless Zillow has some new efficiency that no one else has (super contractors that can fix up cheaper than other investors, low cost capital) I don’t know how they will be able to outbid the market consistently as there aren’t enough dumb sellers with dumb agents out there.
But maybe I’m missing a way how they could use analysis to identify “bargains” without the seller getting clued in and upping their price.
I have been studying this part of the business quite a lot lately. A few considerations:
1) It seems to me that Opendoor, Unison, etc, and now Zillow, are trying to capture "pre-foreclosure" opportunities before they hit the market. Think about this: why would you want to sell your house quickly, and leaving money on the table, if not because you're short on cash and you know you will soon lose your house?
2) Secondarily, especially in the case of Opendoor, some homeowners might want to simply avoid the complex and time-consuming task of "changing homes" (fixing small details, picking the agent and listing it, staging it, handling the delicate balance between selling the current one and securing the next one, etc). Opendoor promises to vastly simplify this part, which I think is good.
3) I believe that some of these assumptions are specific of the current market situation, where in most "hot" real estate areas (SF, LA, Seattle, NY, Honolulu) prices are wild, the appetite for real estate has never been stronger, and at the same time there's still many opportunities to make a quick buck by flipping, accessing certain information earlier, etc.
I am not completely sure what will happen when/if the market corrects (might also depend on the size of the correction).
4) In the US the whole process of buying homes, financing them, and potentially use LLCs/Trusts/etc to handle various real estate properties as investment is still very fragmented, and still very dependent on which State you live in and in which State the property resides. There are essentially thousands of different combinations and configurations, and the optimal answer to each can also vary over the years, following updates to the legal code or to tax rules.
All in all, I think that Zillow is trying to carve out another piece of the market, and not necessarily because their current market is showing signs of slowing down (even if that has discussed just recently [0]). Heck, it might even be that Opendoor's outstanding fundraising results might have triggered the decision to go against them.
5) Long term, I think most real estate assets will become fully digital, and handled exactly like a small piece of software - that is, for everything that pertains property and ownership, taxation, transactions, etc. Of course, fixing a leaking pipe will still require a physical intervention :)
For background: I'm co-founder/CEO of a startup which will provide a software platform to digitize real estate assets, and legally transact on properties using APIs. We leverage the Ethereum Blockchain as a global land registry where these transactions are recorded. (I don't intend to use this comment to publicize it, hence no link).
