Zillow quits I buying says it model doesn't work. 18k houses to sell

Real-estate firm Zillow Group Inc. is exiting from the home-flipping business, saying Tuesday that its algorithmic+ model to buy and sell homes rapidly doesn’t work as planned. Zillow has about 18 thousand houses it will be looking to sell. What does this mean for the real estate market? Has Zillow predicted the peak?

Why did Zillow really quit buying houses

A few weeks ago, Zillow announced they were “pausing” I buying as they worked through supply constraints. Fast forward two weeks and as I predicted, the real reason for the pause was drastically different than what they had said. In a statement Tuesday, Chief Executive Rich Barton said Zillow had failed to predict the pace of home-price appreciation accurately, marking an end to a venture the company once said could generate $20 billion a year.

Zillow, which released earnings Tuesday, said its home-flipping business, Zillow Offers, lost $381 million last quarter, as measured by adjusted earnings before interest, taxes, depreciation and amortization. That resulted in a combined adjusted Ebitda loss of $169 million across all of Zillow.

A wider look at Zillow’s national performance by analysts at KeyBanc Capital Markets found it had listed 66% of homes at prices below what it had paid for them, with an average discount of 4.5%.

Zillow has an inventory of about 9,800 homes across the United States that it is currently shopping to investors. Additionally, there are another 8,200 homes in contract it has agreed to buy. The company expects to lose somewhere between 5% and 7% on these homes, the company said.

Why did Zillow strike out in the home buying business?

Zillow had an interesting strategy. They would buy your home based on the Zestimate and then resell it with minimal improvements at a small profit. Their strategy was with enough volume they could operate on the lower margins.

Zestimate inflated/overpaying for homes: I have been saying for years that the Zestimate is not fully accurate in many cases. Zillow found out the hard way as they were overpaying for houses by 5-10%. This is not surprising as if you look at a house listed on Zillow, more often than not, the Zestimate is extremely close to the list price. I’m doubtful that almost every house listed is priced correctly, unfortunately Zillow has an incentive to “stretch” on the Zestimate to not upset realtors who pay to advertise on their site. Unfortunately, this came back to bite Zillow as they bought houses based on an inflated Zestimate.
Too little margin on each transaction: Along with overpaying, Zillow put too little margin into each transaction. After factoring in fix up costs, hold times, etc… there was not enough margin to make the venture profitable.
Extremely difficult to scale: It is difficult to buy and sell this quantity of houses. As Zillow began acquiring more houses, the processes broke down and they relied on automation that ultimately failed during this experiment.
Miss timed the market: Zillow really began buying most of the houses in the last 18 months or so. This was the peak of real estate prices in many markets and sales are now slowing considerably. The ibuying process is predicated on an appreciating market that is moving quickly. Unfortunately, both of these factors have slowed considerably which makes the I buying model very difficult.

What does this mean for other competitors (Opendoor, Redfin, etc…)?

Zillow has demonstrated with their sudden exit from the ibuying marketplace that there is considerable risk as companies scale up their purchases in markets throughout the country. Zillow’s failure should be a cautionary tale for OpenDoor and Redfin. Ibuying is going to be very difficult to profitably scale especially in a slowing real estate market.

What does this mean for real estate prices going forward?

Zillow is a stark warning that the real estate market will not appreciate forever. We are already seeing substantial slow downs in markets like Denver and the rest of the country should begin seeing a similar slowdown in the next quarter or so as mortgage rates rise considerably and the nesting phase of the covid crisis comes to an end.

Summary

I have said this a few times that we are at or near a peak in real estate and the only way from here is best case flat, likely case is down. Other ibuyers like Opendoor and Redfin are continuing to buy which will ultimately not end good. Zillow is a friendly reminder to other ibuyers and anyone in real estate of the downside risks.

Additional reading/resources

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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