Quick Reaction to Zillow News: Not Surprised

I’m still in recovery mode from thyroid surgery on Friday (it went great, thank you to all who have messaged me) but wanted to throw out a quick reaction to the news coming out of Zillow in its Q2 earnings report. Rest assured, I’ll be covering this in some depth at some point, probably.

For those who may have been living under a rock, the news is:

• Zillow acquires a mortgage lender (Mortgage Lenders of America)
• Zillow expands its Homes division (called Zillow Offers), gets brokerage license in AZ.
• Zillow does cool shit in the rentals space.

I think I can say that the Q2 announcements prove that Spencer Rascoff and Co. are among the smartest people in real estate, if not the smartest. Wall Street downgraded Zillow stock, and the stock price took a hit (about 15% as of this writing), which makes me think that Wall Street simply doesn’t understand real estate. Which is not news.

My biggest takeaway at this early, haven’t-thought-about-it stage, is that those who have read the June Red Dot on Zillow, Redfin, and Realogy’s Q1 results are not surprised in the least. They probably can (or should be able to) understand these moves. After all, the report was subtitled, “The Shape of Things to Come.”

Everyone else is probably puzzled and going, “What the hell is Zillow doing?”

So rather go too much into things, especially since I’m supposed to go ice my throat and watch TV, let me just copy and paste from the relevant part of the June Red Dot. Think of it as a free sample or something.

From the June Report

The following comes from the section on Zillow. I won’t blockquote it because of length.

[BEGIN EXCERPT FROM JUNE REPORT]

Turns out, Zillow’s iBuyer program is far more than just an iBuyer program. It is an elegant construct of interlocking and interdependent strategic elements that has the potential of massively disrupting and transforming the real estate industry as we know it.

The Wall Street analysts who focus on “execution risk” are missing the forest for the trees. The industry that focuses on commissions and bashing Zillow isn’t even in the same zip code as the forest.

Zillow Homes Is Not Just iBuyer

The first thing to point out is that Zillow is not like any other iBuyer. Redfin comes the closest, but we’ll talk about that under the Redfin section.

Opendoor, Offerpad, and others like them who have been extremely successful in raising financing and have a lead on execution (i.e., actually improving the house, maintaining it, and then ultimately flipping it) might welcome Zillow to the fray. Zillow’s entrance, after, all, provides major validation to the entire concept of the iBuyer.

But they too are missing some important connections.

Zillow’s Data Advantage

Everyone recognizes that what sets Zillow apart from other iBuyers is that Zillow has more traffic: 175.5 million average monthly unique users. Well, duh!

What fewer people recognize is the data advantage that Zillow has from all this website traffic. Thankfully, Spencer Rascoff, Zillow’s CEO, lays it all out for us:

So, I guess the way that we will benefit from the demand side of the funnel is by selling these homes quickly and at a high price or higher price than if we didn’t have access to the demand. We will also benefit from having the demand side of the marketplace by being a smarter bidder on the homes that we are buying. [Emphasis added]

Elsewhere in the earnings call, Rascoff talks about the buy-side demand of the first home that Zillow has purchased:

But for example, on the first home that we’ll be buying, or the first home that we signed a purchase/sale agreement last week, there are about 100,000 home shoppers on Zillow and Trulia every day looking at homes in that ZIP code and the surrounding ZIP codes. So, 100,000 home shoppers that might be interested in this home that we are going to own in short order.

There are about 5,000 people that have specifically asked us to notify of them when homes that match this type of criteria, that square footage, ZIP code, et cetera, those 5,000 people are waiting for an e-mail or a push notification that a home like this has come on the market. And there are about 18 homes that are currently on the market that look like this home that we’ll be buying.

So, if you are one of those 5,000 home shoppers who has already looked at those 18 homes that are already in the market or you’re one of those 100,00 home shoppers that are looking but aren’t receiving notifications from us just yet, you are very interested in this home that Zillow is going to own and then bring back on the market just a couple of weeks later.

So, I think the lowest hanging fruit is to try to bring down that days on market by marketing and pre-marketing homes that we own and will own and also using that demand signal to make us a much smarter bidder on the front end, because we know what homes are likely to sell, because we know what buyer demand looks like, because we operate the largest marketplaces on the buy side. So, that demand signal is very important, a very important input to us on the bidding side. {Emphasis added}

This is a longwinded way of saying that Zillow has a massive data advantage over every other iBuyer in terms of knowing how much to bid on a property.

Redfin, with roughly 15% of Zillow’s traffic, might have enough buyer demand data to be statistically significant. The others? Not a chance.

They would have to acquire that buy-side demand data either from Zillow (fat chance), or from the “real estate industry” overall, which means hundreds of MLSs, thousands of brokerages, and millions of REALTORS – none of whom are all that excited about sharing data of any kind with anybody who isn’t paying them. In many cases, the MLSs are not sharing data even with people who are paying them dues as Participant Brokerages.

Maybe that buy-side demand data is not meaningful. Maybe the sophisticated data analytics and AVM engines of Opendoor and others do not require buy-side demand data.

I find that very hard to believe since no data scientist I have ever met or spoke to ever wants less data. In that world, more data is always better, more granular data is better still, and they live with the constant worry that maybe there’s some piece of data out there that they don’t have that would wreck their models.

Zillow’s Distribution Advantage

That domination of buy-side is not just an advantage in data, but an obvious advantage in distribution.

As Rascoff points out, if Zillow knows that 100,000 consumers are interested in exactly the kind of home that it will buy, and that 5,000 of them have asked to be alerted the minute a home like that comes on the market, that house is as good as flipped.

That’s obvious. Less obvious is that their distribution channel may be a profit center for Zillow. How?

Zillow has made it clear that they will use Premier Agents to sell their properties. Rascoff said during the Q1/2018 earnings call, “The commissions that we’ll be paying are pretty standard for what other investor buyers would pay, those that are at scale in a given city.” In other words, the commissions Zillow would pay might be closer to 1% instead of 3%.

But Zillow would only pay agents who are paying them via Premier Agent. We don’t know the precise numbers, obviously, but it seems intuitive that Zillow’s spending on distribution will be offset by the distributor (i.e., the agent) paying Zillow to be a Premier Agent. It does have the feeling of paying the agent (in part) with her own money.

Zillow also has a distribution advantage in terms of making offers for houses. And I don’t mean just the massive traffic advantage.

In the Inman video interview where he announced Homes, Zillow’s Chief Industry Development Officer Errol Samuelson said:

We’re actually testing a concept… where we’re going to work with these brokerages so that when their agents go do their listing presentations with their CMAs, they can also ask us for an Instant Offer, so the agent and the brokerage can come in and offer the consumer the transparency of the two approaches. In either event, the agent can take the listing and earn a commission, or they can have the Instant offer be taken and earn a commission. So really what we’re doing here is trying to help the brokerage community compete with the iBuyers in their marketplace.

We know that Opendoor tried this, and we know that Redfin also does this dual-option approach – that is, offering the homeowner the option of listing the property (more money, but more time and more risk) or taking the investor offer (less money, but certainty).

But Redfin has about 1,300 “lead agents” at the end of Q1/2018. Zillow has tens of thousands of Premier Agents, and potentially hundreds of thousands of agents if Zillow partners up with some large brokerages or franchisors, who will gladly offer the consumer the option of selling right now to Zillow.

Quantity has a quality all its own.

Once Zillow gets out of its tests and goes wide with Zillow Homes, can we really doubt that it will be able to put its offers in front of many, many, many more homeowners than its competitors can?

Advantage, Zillow.

Listing Leads

That Wall Street thinks Zillow is taking a big risk by becoming a direct buyer simply proves that Wall Street doesn’t understand real estate.

Fact is, Zillow’s Homes segment (which is what they’re calling their iBuyer program) is going to make a fortune just from listing leads.

Here’s Spencer from the earnings call, once again:

Eventually this we believe will become a large listing lead generation business, which will benefit IMT on the Premier Agent side. We aren’t ready to announce how to actually monetize that. Whether it will be through the seller boost ad products where we are already selling ad product that generate listing leads on not-for-sale homes, whether it will be a brand new products, whether it would be sold at auction, through the agents, through brokerages, et cetera, there are a lot of ways that we can monetize this.

But if you just look at the data that we have on our funnel of how much consumer demand there is for instant offers, we know that we can build a big business that generates listing lead opportunities for agents and brokers from Instant Offers.

That Homes would become a ginormous waterfall of cash from the sale of listing leads should be obvious to anyone who understands the real estate industry.

In the video announcement referenced above, Errol Samuelson says that out of everyone who submits a request for an Instant Offer, 1/3 sell their house within 90 days. That’s about as highly qualified as listing lead as one can get.

He then says that 90% of them choose to list with the Premier Agent who sent them a CMA.

If you can think of a more powerful web-based listing lead generation source, I would like to hear about it.

In fact, I would hazard a guess that there’s a very good chance that Zillow could lose money on Homes year after year, and more than make that back from monetizing listing leads.

Zillow: The Market Maker

Let’s get a bit more speculative, but pull the disparate threads together.

In his call, Spencer mentions something rather interesting about the Homes program:

One of the other interesting and exciting things about this is that by injecting liquidity into the real estate marketplace, we think we actually can create new transactions and kind of un-stick people from their homes. One of the reasons people don’t sell is because they are afraid that there’s nothing to buy. And if we come in and create more liquidity in the marketplace, we think we can help unstuck people from their homes

That term “liquidity” caught my interest.

I have long maintained that Opendoor is the most interesting company in real estate, because I thought what they were doing was not a real estate play, but a mortgage play. I thought what Opendoor wanted to do was to create a system in which housing can trade much like stocks and bonds and commodities.

In 2017, I wrote a post about Opendoor called “Understanding Opendoor’s Mortgage Brokerage Move” in which I outlined my speculations about a “market maker system” of real estate.

In my sci-fi vision of the market maker system, every property would have a Bid and Ask price, and the seller can sell his house to a market maker (like Opendoor… or Zillow) by accepting the Bid price for his property. Conversely, a buyer simply places an order for a house by agreeing to the Ask price.

As a mortgage broker, Opendoor could legally write an unlimited number of owner-financing deals with whatever underwriting standards it wants for its own properties using its own money.

Well, Zillow has been doing mortgage operations for years now. Spencer talked about how it’s been weak during the Q1/2018 call and what they’re doing about it.

Now that Zillow is in the iBuyer game, there’s no reason why only Opendoor or Offerpad can pioneer the market maker model of real estate. Zillow can do the exact same thing, but probably at far larger scale, with far more advantages.

After all, the function of a market maker in any marketplace is to provide liquidity. And here’s Spencer talking about injecting liquidity.

Keep in mind that Spencer also just spoke about knowing 5,000 people who want to be alerted when a home that meets their criteria comes on the market.

In a very real way, in inventory-constrained markets, Zillow may be able to do “insta-flips” in which they do absolutely nothing to the house. They just purchase it via Instant Offers, and then immediately sell it to an interested buyer (via a Premier Agent, of course).

That is classic market maker behavior: buy at the Bid, sell at the Ask. Make a small spread.

No doubt, this is pure speculation. But with everything that Zillow already has in place, it seems like we have taken a fairly significant step towards making that reality.

The missing piece today is a seller-financed mortgage product. It would be fun to watch for that innovation in the months and years ahead.

[QUICK ASIDE: Does the Mortgage Lenders of America acquisition make more sense in light of this? Seems significant to me that MLOA is not a mortgage broker but a mortgage lender.]

Takeaways from Zillow’s iBuyer Strategy

So, there are three major takeaways from Zillow’s approach to iBuyer:

1. They’re going to make a fortune on listing leads
2. They’re going to make a fortune on buying and selling homes, because of their access to buy-side data
3. They’re going to make a fortune on the listing merchandising product.

Most analysts are completely missing the forest for the trees.

There is also the tantalizing hint that what we may be seeing here is the birth of the transformation of real estate from a labor-intensive, time-consuming, and entirely inefficient “custom” buy-and-sell process into a market maker system with Zillow serving as the provider of liquidity.

[SKIPPING AHEAD]

A Brief Aside: Real Estate’s Game of Thrones—The Platform

Before we continue to the Recommendations, I have to take a moment and point out what’s actually at stake here.

What is actually at stake here is nothing short of the real estate industry’s version of the Iron Throne: who will be the platform for real estate?

What do we mean by “platform”? Let me quote from this 2017 New York Times Magazine article:

Uber, like so many other successful tech companies in 2017, is a “platform business,” one built around matchmaking between vendors and customers. If successful, a platform creates its own marketplace; if extremely successful, it ends up controlling something closer to an entire economy.

Harvard Business Review says in a 2017 article called Finding the Platform in Your Product:

Five of the ten most valuable companies in the world today—Apple, Alphabet, Amazon, Facebook, and Microsoft—derive much of their worth from their multisided platforms (MSPs), which facilitate interactions or transactions between parties. Many MSPs are more valuable than companies in the same industries that provide only products or services: For instance, Airbnb is now worth more than Marriott, the world’s largest hotel chain.

As of this writing, there is not one company that can be said to have won the Iron Throne: becoming the real estate platform. Zillow is the closest, but it has not won yet.

As of now, one could say that there are 700-plus “platforms” for real estate in the 700-plus MLSs in the U.S. At the local level, there is no doubt that the MLS still remains central to the “matchmaking between vendors and customers,” at least through the customer’s own vendors (the buyer agents).

But the MLS platform has always been and remains a platform mostly for active listings. That data is now widely available, as the real estate industry has pointed out time and again to people like the Federal Trade Commission and the Department of Justice.

The rest of the real estate process, from initial dreaming to closed transaction, has been completely decentralized in tens of thousands of brokerages and millions of real estate agents.

What we are looking at, then, are the initial forays into centralizing and consolidating the rest of the real estate experience outside of seeing what’s for sale. Redfin has been at that game for ten years. Zillow is now entering that game with Zillow 5.0.

And over the horizon, across the narrow sea, there be dragons.

Realogy and the rest of the brokerage industry is still playing the recruit and retain game, while the Game of Thrones is underway.

The big picture subtext of this entire paper is that question: Who will be the dominant platform for real estate transactions? Who will win and keep the Iron Throne?

[END EXCERPT]

For Red Dot Subscribers

The August Report on iBuyers, which went out to active subscribers last week, should provide even more guidance. Read that in light of recent events.

-rsh