(Pardon me a moment while I go put on my asbestos suit for the inevitable flames coming my way.)
The Zillow Group Q4/2018 earnings call yesterday was a shocker in many ways. What most people immediately focused on was the change at CEO from Spencer Rascoff to Rich Barton. I gather from social media this morning that the news was met with fairly typical stuff from some in the ranks of individuals who swear to a Code of Ethics. I’m still processing a lot of what I saw and heard, but….
Missing in all of the drama was an incredible piece of data that Zillow released in its Supplemental Financial Tables for Q4.
Unless I’m missing something, or making an incredibly obvious calculation error, it appears that homeowners actually net more money from selling to Zillow than they do by selling with a REALTOR in the open market.
If this is true, then the case I made previously about how iBuyers could come to be the default way that people sell homes is not only proven out, but it’s proven out way before any of the really speculative stuff I wrote about in that post.
Thing is, if you’re a real estate agent, you can relax. You’ll still get paid, no worries. But if you’re a real estate investor? Time to worry.
Let’s get into it.
The following is taken straight from Zillow’s Supplemental Financial Tables, from the tab “Homes Non-GAAP Measure”. I have manipulated the numbers a bit to illustrate the point, but the data all comes from Zillow itself.
|Zillow's Numbers||Per Home|
|Service Fee (7%) to Seller||$18,489||7% of Home Acquisition Cost|
|Actual Sale Price of Home||$274,752|
|Home acquisition costs||264,134|
|Selling costs||13,043||4.75% of Actual Sales Price of Home|
|Total operating costs||288,887|
|Return on homes sold after interest expense||$1,723|
A few things to note here.
First, that 7% service fee to the seller comes from Zillow’s press release. I didn’t make it up.
Second, I’m assuming that the Selling costs line consists of REALTOR commissions (probably 1% to the listing agent and 3% to the buyer agent, which would be completely normal for institutional clients) and 0.75% in closing costs like title and escrow.
Third, holding costs according to Zillow includes “utilities, taxes and maintenance.” This could be important.
Given the above, Zillow paid $264,134 to buy a home that it sold in Q4. That homeowner who accepted Zillow’s offer paid Zillow a 7% Service Fee, which comes to $18,489. Zillow then sold the home for the Actual Sale Price of $274,752 in Q4 of 2018, which gets us the total Homes revenue line of $293,241.
The homeowner who took Zillow’s offer received $264,134 less the $18,489 in Service Fee, which means that her net from the sale was $245,645.
Selling With a REALTOR
If that same homeowner chose not to accept Zillow’s offer, and listed it with a REALTOR instead, then her expected net looks like this:
|Actual Sale Price of Home||274,752|
|REALTOR Commission||16,485||6% of Actual Sale Price of Home|
Some reasoning here is necessary.
- Sale price. There is absolutely no logical reason to think that she would get more in the open market than Zillow would, since both are represented by a REALTOR. Zillow has said from the very inception of Zillow Homes (then Instant Offers) that they, unlike competitors, will use a REALTOR to list and sell the homes in their inventory. I realize someone is going to claim that they would have sold that house for $300K; all I can say is, give Zillow a call, because they sure would like to list their homes with you.
- Renovation and holding costs. Similarly, I see no logical reason to think that an individual would somehow spend less on renovation and holding costs than Zillow would. In fact, an individual’s holding cost might be higher than Zillow’s, since Zillow doesn’t have to pay a mortgage every month; its interest costs are calculated into the unit economics above. I’m willing to bet good money that Zillow gets a better interest rate on its corporate bonds and credit facilities than an individual homeowner would on a mortgage.
- REALTOR commissions at 6%: I know some would argue that prevailing commissions are lower, but I’ve actually looked for information on what the average commission in Phoenix (the ground zero of iBuyer activity) is… and I’m finding 6%. If you know differently, please let me know.
Yeah, that’s right. Her expected net selling with a REALTOR is $244,496 vs. $245,645 selling to Zillow.
She makes less money, with more effort, more uncertainty, and more work, by listing her home with a REALTOR and going into the open market.
[Note that even if we change the REALTOR commission to 5%, her net only goes to $247,243. So she went through the dain bramage of the home selling experience for an additional $1,598? I’ll gladly pay that to avoid the hassle and the delay and the uncertainty of selling my home on the open market. YMMV.]
If that’s not a gobsmacker, a gamechanger, a paradigm shift, insert-other-hyperbolic-buzzword-here, then I don’t know what is.
Now Layer On Mortgage and Title and…
In my previous post where I made the case for iBuyer becoming the default, I wrote:
Assume that Zillow Offers improves to a point where it’s only 2% over using a REALTOR. On a house that ultimately sells for $250K, selling with a REALTOR the traditional way would cost the homeowner 6%, or $15K. Selling it to Zillow, with the fees and lost opportunity for gain, would cost the homeowner 8%, or $20K. The difference is $5K.
But if the seller uses Zillow Mortgage to buy their next home (which could be a Zillow-owned home, or could be some other home), Zillow stands to make $9K from the mortgage business. Knowing this, Zillow offers to charge only 4% as a fee to sell the home to Zillow, if the homeowner would use Zillow Mortgage for his next house.
So now, the homeowner sells to Zillow for $250K, pays 4% in fees, which is $10K. Now selling to Zillow costs the homeowner less than using a REALTOR. But Zillow ends up making an additional $9K on the mortgage, for a total of $19K in income from that coupled transaction. The consumer doesn’t care, because he has to get a mortgage from somebody at some point to buy his new home. Might as well be Zillow and save $5K (or make $5k more on the sale of his old home).
To review, then:
- Sell with REALTOR: $250K – 6% ($15K) = $235K
- Sell to Zillow: $250K – 8% ($20K) = $230K
- Sell to Zillow, but use Zillow Mortgage: $250K – 4% ($10K) = $240K
Now what percentage of consumers would use iBuyer?
All of that seems… quaint… when the consumer is actually netting more from selling to Zillow at the 7% Service Fee. Layering on mortgage alone and dropping the Service Fee to 4% means an additional $8K in the seller’s pockets.
Zillow Homes: Real Estate Investor Killer
I realize that some of the folks in the REALTOR crowd are going to panic, but… relax. If you were sharp, you caught that Zillow spent $13K in “Selling costs” and most of that was commissions paid to real estate agents. You’ll get paid; maybe not as much as you might want, but real estate agents are going to be fine.
Real estate investors, on the other hand…. If you need 20-30% discount off of the “market price” of a home to make your numbers work, Zillow Homes just killed your business model. They’re making money, a tiny amount of profit but still a profit, while putting more money into the home seller’s pocket than if she were selling at full price with a REALTOR. There is absolutely no reason for any homeowner to sell to an investor/flipper unless Zillow passes on the house.
That, of course, puts the kibosh on most of the so-called “we-have-iBuyer-too” stuff from real estate companies and real estate agents, which are really nothing more than hard money lenders and real estate investors in different clothing. Zillow Homes and real iBuyers are something different. The numbers say so.
Did I Miss Something?
As is normal, this post passed muster with the eagle-eyed and former-broker editorial standards of Sunny Lake Hahn. So I don’t think I missed anything major. But maybe I did.
If you see something obvious jump out at you, please let me know what I missed or what I got wrong.
But as far as I’m concerned, this whole iBuying thing got a whole lot more interesting and a whole lot more disruptive overnight.
50 thoughts on “Homeowners Net More Selling to Zillow Than With a REALTOR”
What an amazing Q4 Earnings call by Zillow. Wow! They have taken an unbelievable bold path forward. I do have a legal question that needs to be answered. How was the purchase of 850k shares & 703,497 shares of Z & ZG by Jay Hoag & Rich Barton not insider trading? The purchase was made in November when they must have know about Rich succession plan & the major pivot into I-buying? They then supply unbelievable revenue projections (20B in 3-5 years!) on the conference call. Of course the stock is going to rise!
I think that’s a question more properly directed to securities law attorneys. 🙂
By these numbers, Zillow isn’t buying the real estate investor type property. Our clients have an average renovation cost of more than $40k per unit. Even institutional rental buyers are in the mid $20k range. According to these numbers, Zillow is investing $9k on repairs, which is no more than paint, carpet and cleaning.
Great point, you’re right Jeff. I suppose I kinda hedged my bets there by saying “properties Zillow has passed on” but that probably is more in the buy box for investors.
I stand corrected.
I think you are more correct than we’d like think Rob. I had been an agent quite a few years before I moved to Maryland (20-years ago), never licensed in Maryland. We heard from a friend that a neighbor was almost ready to sell, needing to move to FL for health reasons. We called the owner, visited the property, knew the price was reasonable, then negotiated 7% off the asking price and put the transaction into the hands of the title company after a home inspection. Appraisal required by lender of course. Fast easy settlement. No need for a 57-page contract. Today, there is significantly more data available to a buyer. Over the past 7-years as a productive agent, I’ve rarely spent more than 25-hours on any transaction, buyer or seller agent, and get paid $10,000 on a typical $400k house (of course I’m in a 100% brokerage), which translates to $400/hour. Or more. Intelligent people know this…and rightfully question whether that’s reasonable pay for someone who attended a 60-hour course (online only takes about 30-hours) and passes a couple easy tests. Really? (But I’m special because I have a BS and MSEE. True, but my clients could care less.) I do not understand how “the industry” survives.
*Couldn’t care less.
So, I must be missing something here. They are going to pay over open market price, spend money on it, have reselling expenses and make an estimated $1723 per home. What kind of business plan is that?
It’s one that doesn’t concern you, unless you’re an investor in Zillow or an employee of Zillow.
Rob, iBuyers have not been through a shift in the market. How will they transfer risk and hedge their purchases – the futures markets? Moreover, how will a downturn in the market impact the velocity of Zillow purchases and their proforma income projections for this segment of their business? As you point out, holding costs could be important – in fact they are 150% of the $1,723 return on homes sold after interest expense. These are grocery store thin margins to begin with. What happens to the model (and liquidity) when DOM doubles or triples? Do Zillow and others pivot to a long term hold strategy from short term flippers? Won’t a downward trend in home prices, ceteris paribus, crush the the profitability of these models? How do Zillow’s pricing accuracy and their ability to “buy these right” impact revenue forecasts? I mean, after all, a licensed appraiser can be as much as 15% above or below true market value and still have a “defend-able” number. Now my head is really spinning – lots of questions…
It’s complicated and confusing, to be sure 🙂
Look, I’ve written many many words on some of your questions, none of which have to do with this particular post or these particular numbers. But for the sake of any new readers, I’ll try to answer them briefly.
The short answer to many of your questions is, “It doesn’t matter.” How ZG will or won’t transfer risk is up to ZG and their capable finance people. The thin margins don’t matter; that’s up to Rich Barton and team to figure out when that matters to them. DOM doubling or tripling doesn’t only affect Zillow; it affects all other sellers as well.
A downturn in the market doesn’t change the fundamentals: it’s not like only Zillow and other iBuyers suffer. Everybody else suffers too. So Zillow will bid less for homes, and sell their homes for less. Same with every other buyer or seller in the market. Difference is, Zillow has $1B in cash and credit lines *just to buy homes* with. So say they lose their ass, and lose $200 million. Well, that leaves them with merely $800 million to buy houses at lower price points.
All of the questions you’re asking are relevant if you’re thinking of buying ZG shares, or are holding positions in ZG and wondering if you should sell. I’d say, call your stockbroker or investment advisor on those.
Here, what we care about is what it means for the industry should these numbers prove out to be true. If the seller makes more money selling to an iBuyer (or at least Zillow) than she does by listing the home with a REALTOR… that’s a whole different game than the one we all thought we were playing.
An underlying premise of this post is that Zillow can have good economics long-term in the iBuyer program. If they don’t, and if they don’t have some broader strategic reason for doing so that leads to profits, you can bet it won’t continue. The bylaws of Zillow say the execs have to maximize shareholder value.
If they don’t have good economics long-term, in up and down cycles, then this will not be a primary transaction method for the industry going forward. So to say “it only matters to Zillow employees and investors” is a bit off the mark given that this post claims this method will change the industry long-term.
OK, Matt. I encourage you to read my previous post on iBuyer becoming the norm.
I also encourage you to read the ZG earnings call, in which the executives talk about how there is a profit margin in each transaction. I think that indicates good economics long-term in up and down cycles. I’d love to hear the reasoning on why that isn’t the case. 🙂
Writing false provocative headlines, invites more readers, more comments, more exposure to Zillow. I read articles in inman.com and there are many more articles on Zillow than on any other real estate company.
I read Zillow is planing to buy 5,000 houses every month. They will make more money in renting them out, than selling them. Rent prices will go up as affordable housing to own, is shrinking.
The new generation the millennials, can not afford to buy homes as their parents could. Zillow will rent them those houses they can not sell, in a good profit. Zillow will build a large real estate portfolio and investors will feel more comfortable investing their money invested in real estate than investing their money depending on the mercy of real estate agents to subscribe to premier agents.
This fact, changes the game for Zillow and also for real estate agents. The question, does Zillow`s real estate portal still fit to advertise listings from real estate companies?
The,”‘We are a media company making money from advertising listings of real estate agents” is the past. Real estate agents should remove their listings from Zillow ASAP!
Hey Bert, if you’re going to call my “headline” false and provocative, you kinda have to prove it false first. Show your numbers. Because I’m a little sick and tired of your soapbox bullshit and casually throwing insults around with no backup.
You wanna go on your anti-Zillow crusade? Be my guest. Start a blog. I don’t much care. But if you’re going to call me out, you’re going to have to put in some work. Let’s see your math.
“They will make more money in renting them out, than selling them.” Show your work! Let’s see the numbers. Let’s see your research.
Otherwise, you’re just full of crap like all of the NPCs drinking the Zaterade. #CallingYouOut #YesIAm
I also highly doubt they could make more as a rental. Obviously several iBuyers do already sell the homes directly to buy-and-hold investors. But most homes bought at full market value in these price ranges aren’t going to have rents that justify the cost. Especially if the iBuyer is flipping their money 3x/year, that means their PROFIT(3) + MORTGAGE(2*) > NET RENT + TAX BENEFITS? I’m not a finance guy to work out those numbers, but I doubt it. (*assuming 66% mortgage adoption)
I did not mean to insult you or anyone else. I am sorry you feel that way. What I am saying is, Zillow new business model is to buy homes. Zillow is only doing that for a very short period of time and without great success.
Zillow is entering the market and offering higher than their competitors.They are willing to sacrifice millions just to enter to this market of buying in cash.So to say that sellers net more with Zillow than a Realtor and basing it on a business model that have not proved really profitable yet, is still a big question.
So if Zillow is in buying homes, it becomes a real estate investor and not a media company anymore, especially when they advertise listings from their competitors. As a realtor you should think twice if you really want to have your listings on your competitor website.
I do not have the numbers cause I did not buy Zillwo shares. But, I do read many complains from sellers who will not go iBuyer style sale.
“They will make more money in renting them out, than selling them.”
I concur. If Zillow used their iBuyer offering to become a corporate landlord or property management firm, I think that would be a great path to revenue.
I think that Bert Stein raised a very good point. If Zillow is offering more than their competitors and the market already showing signs of a slowdown in sales, and I see many price reductions, how Zillow will make a profit selling those houses they have not sold yet? Zillow will not have a choice but to rent out those houses.I have been an investor for 17 years now and flipping homes is not a walk in the park. Zillow must play the game buy the flipping rules and one of the rules is, you can not have a one buying and selling system who fits all.In the long run Zillow will make more money by renting homes and build a big portfolio.Their investors will have more security on their investment.
I am not sure I consider holding costs of one living in a house that they sleep in a true expense. In this assumption it also assumes that the owner would have done the $9k+ in improvements which they seldom do. I also believe the home should sell for more than the Z offer (I don’t have any research to prove this). When the hedge funds came into our market they paid market value for homes, did the improvements and are now selling for a significant profit. With Z’s new focus on this being their bread and butter it’s possible they come in and pay market value and truly disrupt the industry.
But in my market 2/3 of homes sold are vacant. For a variety of reasons, this is the most common occupancy status that homeowners sell homes in. It would absolutely save them holding costs if they could close in two weeks rather than endure a 3 month listing to close process. Sure, homeowners living in the home up until closing day wouldn’t have the same costs.
You’ve got to include the improvements in order to compare apples to apples.
OK, so if the homeowner doesn’t do $9k+ in improvements, do they still get the final sale price? Wouldn’t the buyer agent point out that the home needs $9k+ worth of work to his buyer, and the final sales price would be lower?
It really depends on the individual, some people don’t need new carpeting or painting in there house. Repairs are subjective to the individual buyer.
The main item on your math it seems to me that makes this true is that the listing costs 1% in one scenario and 3% in the Realtor scenario. That’s a savings of course of $5000 on a $250,000 home.
If it were 1% in both scenarios, listing traditionally with an agent would still be a few thousand better off in the net.
You address this point saying 6% is still common, which I am sure is true. But of course, Redfin boasts 1% listing commissions. So there is a prominent model active in the same markets and price points that matches that, and therefore would be on paper a better net than selling to an iBuyer. Right?
But I do agree with your general conclusion that the difference is a small price to pay for many of these consumers to skip the traditional process altogether.
That is a great point, Brian. You’re right.
IF the REALTOR charges only 1% listing fee, as Redfin does, then the homeowner would net… $249,991 vs. $245,645 from Zillow.
Then the question becomes: Is $4,346 worth the hassle and the 60-90 days and the uncertainty to the seller? That depends on the individual, of course.
Rob – Zillow’s homes will all be vacant when they sell. Vacant homes sell for less on average than occupied homes (I’ll try to hunt down the studies I’ve seen on this). So, there is a logical reason to assume sellers will get more money on the open market than Zillow. I’d also point out vacant homes expose more flaws than occupied homes so the renovation costs are often higher.
Two more reasons Zillow might get less on the open market: Agents refusing to show Zillow listings and buyers making lower offers because the home is owned by a corporation instead of a person.
I’m not a financial expert by any means. So, I can’t speak to the numbers in the report. But my understanding is these iBuyers report numbers based on properties they’ve bought AND sold. The numbers don’t include properties they’ve bought but that are still on the market. If that’s the case, it would skew the numbers.
Thanks as always for the insight!
The seller hitting the market with no renovation and Zillow hitting the market post renovation are two entirely different sellers.
For the sake of setting a par, you’ve presumed that a seller would renovate before listing with a Realtor.
If the seller doesn’t renovate first, does it cause it to sell for less? Sellers don’t get back the money they put in for a renovation prior to a sale. Only time a renovation is recommended is if the seller is going to live in the house for years to come. In other words, it’s recommended only if they’re NOT selling.
Also, we find that buyers most often pay more than fair market value when they see “potential” in a home. Therefore the seller that does not renovate often nets more than the one who does (Zillow). All the seller would have to do is not do any renovating at all and net more than the $1000 spread. They’d have a higher likelihood of netting more than the $1000 difference by not spending the time or money in ANY renovation.
Always enjoy the insights – total bonus when the remarks section grows!
I’m still trying to understand selling certainty; the iBuyer’s core value prop.
We all know there is no such thing as certainty, especially when talking real estate deals.
Cash and quick close or not……..IMO, the model may be just a couple of broken deals away from losing their greatest differentiator.
We’ll see…. 🙂
Seems like that would be the easiest piece of this to understand, rather than these numbers.
Homeowner gets a commitment to pay cash for her house. Close when she wants (within reason… something like 90 days I think). From a buyer who absolutely has the cash in the bank.
What’s more certain than that?
ROB – shooting one across the bow or friendly jab….
Oh well, you asked.
I’ve done hundreds of cash quick close deals. The only time I, and my client, feel certain is when the checks have been dispersed at closing. My point is that “certainty”, like “guarantee” is a big offer to make consumers and one that IMO, over time, is hard to fulfill let alone stake your company on it – I don’t own any ZG, I’m just sharing my opinion.
I have a calculator, but didn’t even look at the numbers – not because I wouldn’t understand them or that it’s “easier”, but because I rejected the premise of selling to ZG as a better financial decision from the start.
The only way to know if you’ll net more by selling to ZG is to call Opendoor, Offerpad, Knock, Redfin, CB etc. etc. and have them compete.
Or just call Homelight – they’re aggregating the iBuyers. https://www.homelight.com/simple
In a competitive situation – all the (i)buyers will need to sharpen their pencils as those numbers begin to change – and the one that usually goes up is the offer price, which throws a wrench in the model.
Ok, well, yes… I suppose nothing is certain except for death and taxes.
When Bank of America tells you “You’re clear to close”, that’s not 100% certainty. But it’s damn close. Similarly, when a multi-billion dollar public company says, “I’ll sign this contract here to buy your house for $XXX in cash,” you’re correct that it isn’t 100% certain. But it’s damn close. It’ll be enough to put the average person’s mind at ease and she can start packing to move.
As for netting more by calling other iBuyers… that isn’t the topic at hand. 🙂 But it’s a good bet that consumers are going to start getting multiple offers to see which one is the best deal. Competition is good for everybody after all.
I believe there are 3 plaucible reasons which propelled Zillow to make this extraordinary change.
#1. They were not going to make revenue in q4 2018 or Q1 2019. Zillow’s stock is solely dependent on continued revenue growth. If the combination of slowing real estate market in the back half of 2018 & the unsuccessful new role out for the premier agent platform was going to slow revenue for Q4 2018, Zillow propped up revenue by buying houses instead. Remeber each house they buy is counted as total revenue. It’s an accounting trick. Glenn Kelman clarifies this precisely on Redfin’s CC. Zillow doesn’t make the clear distinction and Zillow Instant Offers props up Revenue.
Point blank: If Zillow was forced into Instant Offers, it will be a total disaster.
#2. It’s temporary. They use Instant Offers to leverage the slowdown in revenue for the premier agent and bump up quality leads in the meantime. Mike Delprete does a nice job of providing statistics on this point. This supports the primary business and doesn’t create nearly as much risk. HOWEVER, Rich Barton said the goal is 20B in 3-5 years. 5,000 houses a month! That’s not temporary.
#3. Rich Barton & team are going “all in”. They really are going to try and change the entire industry & they will either succeed or fail mightily. The Netflix reference is fascinating, BUT…. what about Redfin?
I need to understand why Zillow Instant Offers will beat Redfin Now. Imho, Redfin wins, because the agents are employees. Redfin wins, because Redfin has been building an integrated logistics system, market by market for the past 14 years. Redfin wins, because Glen Kelman has seen this coming for over a decade and has been preparing by doing things such as mentoring Matt Williams CEO of pro.com. A company that employees contractors city by city in the same manner as Redfin for years. Redfin even just funded pro.com & GK has a seat on the board.
Well, since I’ve written at least three Red Dot reports on more or less this exact topic, I’ll just leave it at that. 🙂
Redfin is a very serious competitor in this area, absolutely. Just flying under the radar.
Very thoughtful article, thanks for writing it. Two thoughts/questions on the mortgage piece.
1) Where does the 9% Zillow will make from the mortgage come from? Note that they won’t get 100% uptake of this, unless they make that a requirement of iBuyer, so you might need to haircut that estimate.
2) Brokerages also offer the mortgage and title piece and get those economics (ex: Redfin). So presumably the ability to offer the mortgage and cut commissions is not exclusive to the Zillow or the iBuyer program.
You’re welcome! And thanks for your kind words. 🙂
But I’m confused about the reference to the “9% Zillow will make from mortgage”. If you mean the $9K from the previous post, that’s in the earnings call:
“If Zillow Offers is buying and selling, say, 10,000 homes a month, that’s about 2.5%, 2% or so of the market. If we’re doing that type of home buying and selling volume, homebuilders typically have a 75% attach rate on their in-house mortgage of homes that they’re selling. At a 75% attach rate on 10,000 homes a month at 9,000 in revenue per mortgage origination, that’s $67 million a month of mortgage origination revenue or about $800 million a year.”
As for #2, yes, Redfin will absolutely get those same economics. Which is why the race for the Iron Throne is between House Zillow and House Redfin. If other brokerages are offering real iBuyer services (instead of investors dressed up as iBuyers), I’m not aware of any who are. But they’re free to share or publish their unit economics numbers so we can compare.
No risk, no reward. No vision, no change. No guts, no glory. No ideas, more of the same.
But so much for all those naysayers that love to hate something – and then – hate that something even more when it takes risks, has a vision, secures great rewards, takes guts and then turns out to be a great idea that delivers more than simply more of the same.
Try it sometime. You too might be amazed at the outcome.
Great article – this blog is always a place that makes you go “Hmmmm…”
Since you brought in the GOT reference of “House Redfin and House Zillow” – I must bring in the reference of the Whitewalkers… All of this speculation about the brokerage business, iBuyers, Premier Agents, Portals, etc. etc. etc. presumes an economy and housing market that has spent the better part of the last 7 years in an upward trend. All of this works so long as we continue in that direction and assuming mortgage rates remain below 5%.
The question is, like the doomed home builders and buyers/sellers of the early 2000’s who speculated massively, can the iBuyer format of these behemoths withstand the Great War? (a down market – or even a flat one)
Winter is coming…
Ok, so let’s try to model that out a bit.
What sort of down market, with what kind of mortgage rates do you want to assume?
The collective memory of the buying public is about 5 – 7 years. I teach real estate, and my students are aghast at interest rates hovering at 5%. They are “entitled” to 4%. I put up the 60 year history of interest rates and demonstrate the interest rates of the 80’s and they are stunned. Hell – even the early 2000’s of 6.5% astonishes them. A 5% in 2018 Q4 impacted the market… So lets say… God forbid – a rate in the 6-7% range. Affordability crashes, absorption rates stretch to “normal” (normal is a moving target I admit) and everyone thinks the end of days are near.
The young hedge fund analyst of today thinks of the Great Recession like you and I think of WW2 – history – they didn’t live it. Hedge funds move on to the next shiny object or run for cover. (think of MBS’s in 2006-2007) With the burn rate of these portals, a billion won’t last long…
It seems terminal velocity has been reached in the pricing of homes (at least in my market of Southeast GA) and Sellers are no longer commanding the process as they have for the last 4 years. The “smart money” i.e. top 10% of the market is already showing signs of sagging. Buyers are gaining leverage. Funny thing about being a Buyer or a Seller today – you soak your adversary on one side, and then you get soaked on the other side – no matter the market.
I note in some comments the idea of the iBuyers becoming Buy and Hold investors. This presumes the iBuyers have the infrastructure to manage property – a little more than just collecting rent as some platforms now promote and offer. Managing property at scale, if you have ever done it, is not an easy task.
Sorry for the word salad here, but it seems to me there are SO many factors involved in what makes the iBuyers dream even possible today – and the fundamental belief is the market stays where it is. Question is, can it stay long enough for them to get a foot hold on the process, before the rules change and everyone runs for cover.
So Tom, say rates go to 7%. What do you want to say that does to home prices? Down 10%? 20%?
What other effects do you want to model in? Longer time on market?
I guess fundamentally, I’m asking the combination of factors where iBuyers exit the business, while “normal” family buyers stick around.
Although this is merely a thought experiment, and a fun one at that, let me put some finer points on it. The cone of uncertainty will be defined as a top interest rate of 6.5, and a bottom rate of 3.5, with the median hovering at 5%. Moving forward and interest rates move to 5.5% (non-jumbo loans), affordability takes a hit and prices flatten or even dip slightly by 3%. Absorption rate slows to a “normal” of 5-6 months from the blistering pace we have seen over the last 3-4 years. All assumptions we have made in the past begin to change.
Sellers / Buyers are separated by those that “want” to move and those that “have” to move (relocation, expanding family, etc.) Those that want to move, if they cannot get their price, put their move off – as was done in the recession. Those that “have” to move, take the hit on the sale, but are the hitter on the buy side – a wash for them in most cases. Timing is everything for these.
The iBuyer is an investment vehicle with pure profit motive. The “wants” don’t have to move, so to me the “wants” will use the iBuyer only if it matches their situation perfectly.
I put the iBuyer in “have to” category. These homes are vacant and carrying costs are real. Occupied homes have carrying costs – but not viewed the same in this. If prices begin falling iBuyers have a declining asset, will dump it as fast as they can and take as little a hit as possible. It switches from managing profit to a focus of mitigating loss. Agreed, some get lucky in the beginning of the correction, while others take a hit because they don’t believe their lying eyes.
Now EPS reports roll in and iBuyers start missing targets Wall Street has set for them, and investors bale on the stock. This starts a spiral where the core business gets threatened, and the cash stores go empty. Kind of like the PA change of Zillow – Sounded good on paper – but flopped in the real world.
All of this said – I agree it sounds a little cynical and I am not by definition a cynic, but our economy has boom/bust cycles baked in. Housing has been booming for a while, and I believe we will hit terminal velocity in this cycle of boom, if we have not hit it already. iBuyers, if they become Buy and Hold in a flattened or market in decline, will have to hold those assets for a long time to realize a gain – which presents a whole new problem.
I’m no financial guru but I play one on TV To me it seems we should stick to what we do best. Zillow/Realtor/HomeSnap sell ads and create great technology, and we gobble that up and pay through the nose for it. If it ain’t broke – don’t fix it.
Good stuff, Tom. And we’ll actually see this play out in the real world over the next couple of years, so we can engage in armchair prognostication just to see where things end up.
So let’s say interest rates move to 5.5% like you say, prices dip by 3% and DOM move to 5-6 months. All of the assumptions that iBuyers made change, exactly like you said.
*Going forward*, it’s clear that ZG would pay less for homes, taking into account both the drop in prices as well as longer holding periods. The people running ZG’s Homes division, after all, are seasoned pros from Invitation Homes and other companies with experience in down markets. They would make the same margins as today (because buying for less money, with longer holding period) but that’s for NEW properties they acquire in the changed market.
Thing is, the traditional list-with-a-REALTOR model is also affected by 5.5% interest rates, 3% drop in prices, and longer holding periods. Today, if the list with a REALTOR, the home sells in two weeks and for top dollar; tomorrow, it takes five months and they have to do price reductions until they hit the market clearing price. That’s exactly the same as ZG as a seller with a REALTOR listing agent. So on a going-forward basis, there is no reason to think that somehow the seller would net more in a changed market than they would today.
The obsession that many people in the industry have is that somehow, this would force ZG to lose money on their “declining asset” homes, and those losses would be so severe that Wall Street would punish the stock and drive ZG out of the business of buying and selling homes. That applies, however, only to those homes that ZG bought before the market shifted, paid too much for, and now must sell into a changed market. But by your own numbers, we’re looking at a 3% decline in price.
I ran the model using those assumptions: final revenue is 3% less, and I’ve tripled the Holding costs as well as Interest costs to reflect the longer time on market. Given the above numbers, instead of making a tiny profit of $1,723, ZG would lose $17,514. Big loss. Now let’s multiply that by (let’s say) 1,000 such homes in ZG’s inventory which it bought before the market correction. Total loss: $17.5 million.
Zillow would only have $982.5 million to buy homes with going forward. However will they survive?
But, what if the market continues to decline? The above scenario is a singular event. What if there is a steady decline? Zillow, as a publicly trading company, must report revenue every 3 months, plus they aren’t profitable. One flat or declining quarter, Zillow’s value is toast! If Opendoor was smart, they’d never go public.
I came up with similar figures.. The point is very well-received. It’s incredibly counter intuitive. Of course, this relies on the assumption that Zillow purchases just $10k below the true fair market value of the property. Perch, Offerpad, Opendoor, fees are much higher. Zillow can count on mortgage origination fees and premier agent revenues. It will be interesting to see how firms like REX homes, who charge 2%, total, will impact the iBuyer industry. They keep the home off the MLS and pay no buyer’s agent fee – just closed a $45MM series C.
SELLING TO ZILLOW
Seller: Notorious ROB
Property: 102 DURHAM RD
Settlement Date: 5/15/2019
Sale Price: $264,134.00
Gross Equity: $264,134.00
CHARGES PAID BY SELLER
Zillow Commission: 7%: $18,489.38
Total Charges to Seller:
Sale Price: $264,134.00
Charges to Seller: ($18,489.38)
Net Proceeds to the Seller
SELLING WITH A REALTOR
Seller: Notorious ROB
Property: 102 DURHAM RD
Settlement Date: 5/15/2019
Sale Price: $274,752.00
Gross Equity: $274,752.00
CHARGES PAID BY SELLER
Transfer Tax (1%): $2,747.52
Brokerage Commission: 6%: $16,485.12
Total Charges to Seller: $28,282.64
CREDITS TO SELLER (PRORATIONS)
Municipal Tax: $58.10
County Tax: $315.65
School Tax: $324.68
Total Credits to Seller: $698.43
Sale Price: $274,752.00
Charges to Seller: ($28,282.64)
Credits to Seller: $698.43
Net Proceeds to the Seller: $247,167.79
Sounds like mumbo jumbo to me. Who’s paying the 7% service fee? So go with Zillow’s plan and there’s 7% in fees to be paid by someone and 4.75% fees paid in closing costs. That comes to 11.75% total in closing costs and fees. In our area total seller paid closing costs (that’s total costs including someone willing to pay 6% in re fees which are negotiable) are approximately 8.5 to 8.75% depending pro-ration of taxes. So the math doesn’t work for me.
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