Question: Can you share your thoughts on the latest news about Zillow’s issues with their home-buying program?
Answer: I don’t usually comment on real estate news, but the recent issues reported with Zillow’s home buying/selling program are interesting and worth discussing.
Catch Me Up
Zillow entered the i-buying game in April 2018 (launched in Phoenix) with a home-buying program called Zillow Offers in which they’d quickly purchase homes using their pricing algorithm (Zestimates) directly from homeowners for cash. The incentive structure is simple: fast, cash, reliable, and no list prep. I wrote a column on this type of “i-Buying” in 2019 and discussed the approach, pros, and cons.
Since 2018, Zillow Offers has expanded to over 20 markets around the country (mostly in the south and out west) and bought thousands of homes (maybe tens of thousands, but I couldn’t find a good source). Two weeks ago, news broke that Zillow was freezing home buying through 2021 as they work to offload ~7,000 homes.
Yesterday, news broke that an analyst at KeyBanc, Edward Yruma, studied a sample of 650 homes Zillow is currently selling (about 20% of their total inventory) and found that 2/3 are selling for less than their purchase price at an average discount of 4.5%.
What Does it Mean for the Market?
Does this signal a falling/collapsing real estate market?
People, especially news outlets, love looking for signs of a market or business collapse and will certainly play up this angle. However, I think it’s a lot of nothing at this point.
First, Zillow’s i-Buying program doesn’t represent the housing market, so I don’t buy that it’s an early indicator of a downturn. It’s a new technology-driven business model for buying and selling homes and even if you expect i-Buying to find long-term success, you expect bumps along the way as algorithms and processes evolve through different market cycles.
Zillow relies on its Zestimate home valuation algorithm to determine their offer price and they have a published median error rate of 6.9% for off-market sales, which is essentially what a Zillow Offers home purchase is. Zestimates is within 10% of the final sold price on an off-market deal just 63.8% of the time.
Their published, and more visible, 1.9% error rate for on-market sales is misleading because the Zestimate algorithm adjusts to asking prices and days on market data once a listing is posted, which brings Zestimate accuracy for on-market sales (majority of sales) much closer to the sold price.
Combine Zillow’s 6.9% error rate for off-market sales with the difficulty in tweaking their pricing algorithms in a rapidly appreciating market (they’ve had to adjust values higher on the fly for their offers to have a chance of being accepted) and it's easy to understand how they ended up with too much inventory worth less than what they paid.
This isn’t a housing market issue, but the growing pains of a new business model and technology.
What Does it Mean for Zillow?
Did Zillow reach too far from its core business and get itself in trouble?
Business Insider reported that if Zillow sold everything at the current list price in Phoenix (Zillow Offer’s second largest market), they’d lose about $6.3M. Let’s say they take even more losses on these homes and take similar losses in the rest of their markets, we’re probably looking at losses of ~$50M-$100M against a market cap of approximately $22B and ~$3.7B cash on hand as of today. Far from trouble and probably losses they’re willing to accept in return for the lessons learned/experience.
These losses are also offset by the financial gains Zillow gets in the other businesses they have that benefit from their home purchase/sale transactions. Zillow bought a mortgage company in 2018 and markets their loans to buyers of their homes and likely converts quite a few home sellers via Zillow Offers into Zillow Home Loans borrowers on their next purchase. Zillow also has its own title and escrow business, Zillow Closings, a notably profitable business. The transaction activity also strengthens their very lucrative revenue stream from real estate agents who purchase leads from, and pay referral fees to, Zillow.
Not only is this news about underwater inventory unlikely to materially impact Zillow’s business, but it’s hard to even call it an embarrassing misstep at this point given the valuable information/lessons learned they likely picked up along the way.
Does Zillow Offer to Operate Here?
Zillow Offers does not operate in the DC area the closest market to us that they operate in is Raleigh NC. I believe we don’t see Zillow Offers here because our housing inventory is more diverse and older than most/all of their current markets.
A diverse housing supply makes it more difficult for algorithms to predict values compared to markets Zillow Offers operates in that have huge developments of homes with a very similar inventory. An older housing supply is likely considered too risky for a hands-off buyer like Zillow making it hard for them to make competitive offers that account for the added risk factor.
Looking Forward
I’m very interested in when Zillow restarts their i-Buying program and if they make significant adjustments to the markets they operate in, their fee structure (fees are already high for homeowners), or process. There’s so much potential in i-Buying for a company like Zillow because of all the different ways they can create revenue/profits, even if they take some losses on the actual sale, that it’s hard to imagine they don’t come back better and stronger than before.
On the flip side, they could decide that i-buying creates too much risk/distraction for their core business(es) and find revenue elsewhere, leaving i-buying to companies that specialize in it like Opendoor.
If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at [email protected].
