For the past few years, a number of companies have been pioneering a relatively new real estate business model. These so-called iBuyers are offering cash and the promise of a quick close to homeowners and then reselling the homes. It might sound a bit like flipping a house but it is quite different, especially when done at the scale that iBuyers are doing it. The biggest difference is that flippers generally upgrade the houses they are flipping in order to sell the house for the highest appreciation. iBuyers, on the other hand, do little to no work to the homes and instead want to profit from being in the middle of a quick transaction. The thought is that many home sellers are also buying another home at the same time and would be willing to take a potentially lower offer that they know can close fast and reliably.
One of the first companies to explore this model was Opendoor. Started in 2014 by seasoned entrepreneurs Keith Rabois and Eric Wu, whose previous startup Movity was acquired by Trulia, the company has grown into a $14 billion dollar enterprise, buying and selling houses by the thousands. In 2018, likely in response to the success of Opendoor, the real estate website Zillow started a line of business doing the same thing. While Opendoor was the first mover, Zillow had a number of important advantages, namely the 173 million monthly users that go on their website to shop for homes or just daydream about where they would move if only they could afford a down payment. This data was to be the secret sauce of Zillow’s iBuying venture, which some thought flew in the face of their original business of helping agents market their listings.
So, it came as a shock to many when Zillow recently announced that they would be suspending their iBuying operations until the end of the year so that they could sell down their existing inventory which has grown by 3,802 homes in the second quarter of the year alone. As soon as the announcement was made, Opendoor’s vocal founder Rabois started opining on Twitter.
Unlike Zillow, Opendoor has plans to increase its inventory, which is already substantially bigger than Zillows, in most of its 44 markets. Zillow’s retreat was seen as a win for Opendoor, with their stock closing over 3 percent higher yesterday. But some think that Zillow’s troubles might be a sign of bigger problems within the business.
“Houses are not a commodity and the information you get about any real estate market lags behind what is actually happening,” said Kevin Clark, commercial real estate broker and adjunct professor of real estate at NYU.
Clark thinks that the thin margins that iBuyers make are not enough to justify the risk of sitting on billions of dollars of inventory. “We have seen one of the longest bull runs in residential real estate history,” he said. “You would think that this would make these companies cash flow positive, but they are not.” Clark thinks that Opendoor, thanks to its venture investors, subsequent SPAC listing, and now $9 billion line of credit are forgoing profit in order to capture the market, much like Uber attempted to do in ride-sharing. “They sell their service as convenience, which is certainly important but in order for the iBuyer model to work they have to find sellers willing to take tens of thousands of dollars less for their property than they would get in a normal transaction,” he explained. “Convenience is only worth so much.”
If Zillow’s main advantage is that they have at least some advanced data on the housing market in the form of searches through their portal, then this announcement might be a defensive play against a possible downturn. Hot markets have already seen a bit of a cooling off in the recent months and many think that the recent inflation numbers will force the Fed to raise interest rates, making homes more costly for most buyers. iBuying can be lucrative, but it is also risky. Zillow might be willing to slow down their buying spree in the face of a downturn to focus more on the advertising aspect of their business, which would likely stand to gain from a softening demand.
One of the red flags that Clark sees in Opendoor’s strategy is their focus on revenue. “Opendoor advertised to investors that they had doubled their revenue and a few financial publications ran with it but having an extra $4 billion of revenue doesn’t sound so great when you think about the fact that they also spent almost $4 billion to acquire it.” While there is nothing wrong with marketing to your strengths Clark thinks the move seems like a way to take eyes off their profitability. Opendoor might be able to succeed in iBuying where Zillow can’t or Zillow is just the first to turn away from the danger that the entire business of buying and selling houses poses in a potential downturn.
