Let’s talk about Zillow. The headlines are everywhere: Zillow Offers is dead, and 25% of their workforce will be cut. So, what went so terribly wrong despite a strong housing market? As we dive in, let’s first establish what Zillow Offers was to begin with, and how its goal to reshape the industry collapsed.
The concept was that Zillow would buy your house in cash, offering sellers a quick close and convenience of not having to have potential buyers traipse through the home, streamlining the process considerably. This was especially relevant throughout the height of the pandemic as weary sellers did not want buyers in their homes.
Zillow will then handle any repairs or quick renovations and sell the house themselves. This was not an entirely original idea. Competing real estate firm Redfin has an equivalent program, and there are entire companies dedicated to this business, like Opendoor and Offerpad.
While Zillow’s program worked well when it was first tested in 2017, problems began to mount soon after. Its Homes segment had an operating loss of $312 million in 2019 and $320 million in 2020, and its shortfall was $539 million through the first nine months of 2021. Just last month, the company informed investors it would stop buying houses, citing construction, renovation, and closing labor shortages across the country. Bloomberg went on to speculate the problems may be deeper: Zillow was selling most of the homes it purchased at a loss.
An Insider analysis of homes in five markets (Atlanta, Dallas, Houston, Minneapolis, Phoenix) found 64% of the homes Zillow purchased were listed for sale for less than they paid for them, with a median difference of $16,000.
Part of the loss could certainly be attributed to the pandemic: labor shortages and unstable material prices undoubtedly slowed repairs of purchased properties, increasing costs, and likely contributed to its backlog of pending property sales. But still, it is not the whole picture. As of now, the company is aiming to sell 7,000 homes for $2.8 billion, likely in batches to larger, institutional investors.
This speaks to the broader risks associated with some iBuying models. Without on-the-ground brokers who have the experience and understanding of individual neighborhoods, communities, and traditional velocity, it becomes incredibly difficult to gauge future values, and therefore profits, by algorithms alone.
While there were some homeowners who undoubtedly capitalized on this by selling their homes to the real estate giant for more than a typical buyer would pay, there is speculation that iBuyers are artificially driving up home values to strengthen their bottom line. When they relist the home, they could use their higher-than-average purchase prices as comps to justify their list price.
However, the volatility has proved to be too much for Zillow. As CEO Rich Barton recently stated, “We’ve determined the unpredictability in forecasting home prices far exceeds what we anticipated, and continuing to scale Zillow Offers would result in too much earnings and balance-sheet volatility.”
According to research by DelPrete, the profit margins in this industry are slim at best. This past quarter, Opendoor and Zillow were posting net losses of $144 million and $59 million, respectively. Even though Offerpad posted a profitable quarter of $9 million, DelPrete believes most profits are coming from record home price appreciation, which is temporary, and appears to be slowing.
What About The Zestimate?
This begs the broader question of using Zillow’s widely popular Zestimate tool as a reliable indicator of value. It launched in 2006 and played a role in Zillow’s home-buying operations. “We leveraged the Zestimate in our Zillow Offers operations the same way we encourage the public to use it: as a starting point,” Zillow spokesperson Viet Shelton told MarketWatch.
Despite this, Zillow had more ambitious plans to merge its Zestimate model with its iBuying program. In February, Zillow stated its Zestimate would represent “an initial cash offer” for eligible homes across 20 cities. While this sped up the process, it ultimately proved unsuccessful at such a large scale.
From this, it has become clear brokerages have better access to real-time data, as they are involved with transactions prior to when the closing price is officially filed. There is a general lag in MLS data becoming available. In markets like New York City, where there is no MLS, the numbers can be even more murky.
While buying turned out to be a no-go for Zillow, it does not allude to broader uncertainty in the housing market. Inventory is low compared to demand, and the largest generation of millennials is beginning to enter their first-time homebuying years. All signs point to a healthy market throughout the rest of the year and into 2022.
Ultimately, Zillow shuttering its Offers program may be a broader indicator of things to come for similar firms. Real estate is a people business. While algorithms and the Zestimate tool can be fun to use, iBuying is a difficult business model and will continue to be.