Zillow reported its Q1/2019 earnings yesterday, and it was the first “real” earnings call with Rich Barton at the helm. As much as I missed hearing Spencer Rascoff on the call, I have to tip my hat to Barton and team (his style appears to be having the senior operators on the earnings call) for an amazing amount of clarity.
I will also confess a bit of self-satisfaction as everything I saw and heard from Zillow confirms just about everything I have written about them over the years, but particularly over the past year in the Red Dot series. I have written over and over that the ultimate prize is the Iron Throne: to become the Platform for housing in the United States. I have said over and over that Zillow is the frontrunner in that race.
Everything I’m seeing and hearing confirms that view. Furthermore, the earnings call in particular makes me believe that the team at Zillow under Barton’s leadership is going after it in a much more aggressive, much more confident, and much more transparent way than before.
For at least 10 years, I felt that Zillow drove the conversation in real estate, that Zillow acted and everybody else reacted. In the past couple of years, that felt a bit changed, that others acted (Opendoor and Redfin in particular) and Zillow reacted. If that’s the case, the Return of the King has changed that back. This new Zillow is very much back in the driver’s seat.
Let’s get into it.
The Numbers
As always, we begin with the numbers.
The sea of red looks bad at first glance, but this was actually a very strong quarter for Zillow. Take out the Homes segment, and IMT and Mortgages revenues were up 8.6% YOY. Of real importance, that few are talking about, is the fact that Rentals revenues were up 30% YOY. Just as a point of comparison, Zillow now makes more money from Rentals than Re/MAX does from continuing franchise fees: $30 million vs. $25 million. (I’ll have my take on Re/Max coming soon; I just wanted to get to Zillow first.) Zillow made more money from Rentals than Redfin did in its iBuyer program, RedfinNow, by almost $9 million.
I thought the Financial Highlights was more interesting, but for the sake of completeness, here’s the actual Statement of Operations as well:
Yes, Zillow lost a ton of money in Q1. No, nobody who matters actually cares. The only really interesting piece of the Income Statement is a 71% increase in G&A… and I assume most of that is in the people Zillow hired to actually operate Homes, from corporate executives to the field staff, as well as ramping up staffing and other expenses for Mortgages, since those two segments increased G&A expenses by 708% and 157% respectively.
I also noted with great interest that Zillow is breaking out segment P&L now. It’s a fantastic amount of transparency and clarity. And I am loving that Zillow continues to publish unit economics of Zillow Offers that allows us to look and see what’s going on with the market maker model of iBuyer.
Speaking of which, the big headline action was in Zillow Offers of course. So we might as well dive into that.
Zillow Homes: The Future of Zillow Becomes Clearer
First of all, I found it interesting that Rich Barton led off the call with Zillow Offers rather than with IMT. Sure, part of it may be because everyone is far more interested in that piece of the business, what with Rich returning in mid-quarter earlier this year to jump on the Q4/2018 earnings call. But I think it’s more than that. I think it’s a hint that Zillow under Barton thinks of itself as an iBuyer with a giant advertising business, rather than a portal with an iBuyer business.
First of all, from the segment information, we see that Zillow Homes makes money on a gross profit basis with gross margins of 4.7%. That seems enormous significant to me, especially since I just wrote about Redfin’s gross margin problems with RedfinNow. Now, we don’t know how Redfin calculates gross margins for RedfinNow, so we might be comparing apples to oranges here, but it ought to be a giant red flashing light for Redfin that its gross margins are minus 9.5% while Zillow is posting a positive 4.7% gross margin on its iBuyer business.
Sure, after interest payment, Offers loses money. After all is said and done, Homes posted $45.2 million in losses. But with positive gross margins, it makes sense that Rich Barton would be confident about it, as he says in the earnings call:
I know we still have much to prove to you before the fog is fully clear on Zillow Offers. We must show you that we are not just buying dollars for $0.95. The unit economics of Zillow Offers are justifiable under the microscope. But even at small start up scale the economics show promise. Of course we will gain efficiencies from here as we gain depth and density in markets.
So let’s put the unit economics under the microscope, as Barton says:
414 homes sold in three months, and as mentioned in the earnings call, almost 900 homes purchased in Q1 is impressive to say the least. Maybe we can read into the fact that Zillow is paying more (and/or buying more expensive properties) and making more per home as a sign of increasing the size of the “buy box” by Zillow.
Somewhat eyebrow-raising, however, is the significant increases in renovation costs, holding costs, and interest expense: up 24%, 15.5% and 52% respectively. Those are some large increases in expenses. There wasn’t much of an explanation, and no one on the call asked Zillow about those.
But Barton sounded utterly confident as he talked about how Zillow will continue to gain efficiency as they scale the business, and Zillow is making enormous bets and investing in building the infrastructure and capabilities to improve all of those things.
That confidence seems warranted as the big story of the day, I think, was the level of consumer interest in Zillow Offers. Here’s what Rich Barton said: “In Q1, we received more than 35,000 seller request and that demand is rapidly accelerating. We now receive one request every 2 minutes, which is nearly $200 million in potential transaction value per day.” [Emphasis added]
With Zillow launching in six additional markets by end of Q1 of 2020, and promoting the crap out of Zillow Offers, that number will continue to go up.
Homeowners Still Net More Selling to Zillow
Now, I understand from friends who attended T3 Summit that Rich Barton kinda sorta downplayed the idea that iBuyer will become the default. That’s totally fine, as he needs to set proper expectations for his people, the industry, and Wall St.
I am under no such constraints however, and I’d like to update my previous post on this subject, where I said that homeowners net more money selling to Zillow than they do selling through a traditional listing. Here are the updated numbers, using Q1/2019 unit economics:
I changed one thing here. Once Zillow split out the interest expense on their deals, I thought it fair to add interest expense to the homeowner who lists and sells with an agent. I didn’t think any individual homeowner is likely to have better interest rates than Zillow can get, but you can make your own adjustments.
Based on that, using Q1 unit economics numbers, I’m showing that a homeowner makes almost $10K more selling directly to Zillow than he does by listing his home for sale. That’s on a house which sold for $290K, so $10K is almost 3%. It’s a big number.
Everyone is entitled to his or her own opinion, and people can say iBuyer will max out at 10% of the market, or 20% or whatever you wish. But unless you can provide some numbers and data, on the data I have in front of me, I’m sticking with this model becoming the default way people buy and sell homes unless the iBuyers don’t want the property.
Speaking of which, here’s Jeremy Wacksman, President of Zillow, who oversees Zillow Offers and answered most of the iBuyer-related questions during the earnings call:
Sure, and on the request that we see. I think we talked about last quarter, we’re still only buying 3% to 4% of the homes we see, and that’s mostly our choice. We’re mostly looking for the right type of home and where we can make the strongest offer and we’ll grow that and we’ll grow that conversion as we grow Zillow Offers.
The future of real estate is one in which you will buy or sell your house from and to an institution, unless the institution doesn’t want to bother. High-end luxury might not get much interest from market maker iBuyers, and really crappy fixer-uppers might have iBuyers passing on them. But the default will be selling to iBuyer and buying from an iSeller.
The Platform
More significant from a strategic standpoint, however, is the clear signal from Zillow that quite unlike Redfin (which I discussed in the Redfin post), Zillow intends to use Offers as the focal point of a total platform strategy. And in that context, Barton made an announcement (I assume intentional) that is not getting the play it deserves. Here’s Barton:
Longer term, we are also expected to benefit from other adjacent businesses such Title and Escrow, insurance, moving and other services we might explore. In fact, in the second quarter we are planting seeds for Title and Escrow services tied to Zillow Offers, which is another fundamental yet fragmented piece of the transaction, we intend to streamline.
Hold up. Wait a minute.
Did I miss an announcement that Zillow bought a title company? Escrow? Seeing as how I don’t think I did, I’m assuming we’re in for a couple of major announcements from Zillow… and that right soon, as we are in the second quarter as I write this.
Allen Parker, the new CFO, did say this:
And Title and Escrow we’re just kicking off, it will be reported in the Home segment, but it’s so early and the fact that we are just giving guidance one quarter out, there’s really not much of significance included in the 2Q guidance.
I think I can safely say that inquiring minds wanna know. It’s so early, you say, but I can pretty much guarantee that ears are wide open across the real estate industry and companies like First American and Fidelity and Chicago Title and literally hundreds of brokerages with affiliated title and escrow companies are going to be quite eager to figure out what the hell these words mean.
Because they ought to be terrifying for the vast majority of companies out there.
Barton continues:
We’ve also been making solid progress in our mortgage business. Last month we rebranded the recently acquired Mortgage Lenders of America as Zillow Home Loans.
We’ve been focused on integrating this loan origination business into our operations, while building out a digital mortgage technology platform. In the future we will more tightly integrate Zillow Home Loans with our Zillow Offers consumer experience. This will take some time, but I’m encouraged by progress to date. [Emphasis added]
In addition, we get this from Jeremy Wacksman:
And on seller listings, you know, it’s still early. We’re focused very much on trying to figure how to have the right conversation with the customer whether they sell to us or less traditionally with one of our Premier Agents, but we’re focused on ideating on the right product there with our agent partners in our Zillow Offers markets and that’s just a handful for now.
It’s still early… but it’s most definitely on their mind.
I can go on and on, but really, you should go listen to the earnings call (or read the transcript).
I can’t wait to see what Zillow does going forward, but longtime readers (especially Red Dot Subscribers) should be able to easily discern all of the things I have been talking about for a while now.
The idea of iBuyers as market makers, of iBuying not being a real estate play as much as it is a mortgage play, the concept of “Push Button, Magic Happens” and how that translates into the Platform for Real Estate… all of them are right here in Zillow’s Q1 results.
The Changing Relationship Dynamic
Last year, in the June Red Dot Q1/2018 earnings, I wrote that Zillow was transforming into something new, something beyond an advertising portal. And I wrote:
Throughout this transformation, perhaps nothing transforms more than the relationship between Zillow and the Premier Agent.
Today, the Premier Agent is an advertiser on Zillow. For a certain amount of money, Zillow promises a certain number of impressions (CPM-based pricing) of that Premier Agent.
Tomorrow, the Premier Agent becomes something far closer to the windows installer for HomeDepot. Sure, she is still an advertiser. She will still have a customer service rep at Zillow, and a salesperson at Zillow who will be trying to get her to spend more with Zillow.
But when Zillow holds the relationship with the actual buyer or seller, passing them on to her only after they have been “validated”, the relationship changes slightly… but in a profoundly important way.
Now Zillow becomes more like a source of revenue for the Premier Agent, in much the same way that a local windows installer regards HomeDepot as a source of revenue, not as an advertising platform.
Zillow has long maintained, and still maintains, that its success depends upon the success of its partner agents, its Premier Agents. That remains true, of course, and Rich Barton’s lofty goal of hitting $2 billion in IMT revenues ensures that will remain true going forward. But I still consider Q1/2019 to be validation of what I predicted after Q1/2018.
The relationship between Premier Agents and Zillow has fundamentally changed. And it won’t be changing back.
Pay attention to the following exchange:
Ryan McKeveny — Zelman & Associates
But I wanted to focus on the selling costs and the leverage there that you mentioned. So I’m just curious, do you expect things will look meaningful different in the future in terms of how those kind of third party agents are involved in the transactions. And I guess the question to be blunt is over time, does this look more like a brokerage type structure where maybe you actually employee agents, shift some of those variable commission costs to kind of a fixed point of leverage or is that kind of too extreme with maintaining things on the IMT side? Any thoughts there would be great. Thank you.
Jeremy Wacksman — President
This is Jeremy. I’ll take that one. So, when you think about the cost leverage it is important thing about across all this, so buying and selling is one, but closing and transaction cost and that’s why we talked about Title and Escrow a bit here and then holding costs and turns, those all add up to the leverage of scale. As it relates to selling specifically, we absolutely expect to see better leverage there on the work that we ask, whether it’s employees or partners, to do as we scale. We currently are using our great agent partners in every one of our transactions and we plan to continue to do that. But you can imagine, as we’re scaling to hundreds of listings in each market that we’re looking to do that you can scale that work across many more listings and we can drive efficiencies in the work we’re paying for.
Let me translate this from Financialese to plain English so it’s easier to understand.
[START TRANSLATION]
Ryan McKeveny
Are you guys gonna make more profits as you get bigger, by driving cost of selling these houses down? Would you do that by hiring agents to do the selling in-house like Redfin?
Jeremy Wacksman
Of course we expect to drive costs down as we get bigger. But we’re doing that with Premier Agents, and we’ll probably keep doing that. But, if we’re giving somebody hundreds of listings, we expect them to give us sweetheart rates and be really efficient and effective at selling our properties. Or we’ll take the business elsewhere.
[END TRANSLATION]
It is a weekly, if not daily, occurrence in real estate today that someone somewhere goes on a rant about Zillow and how brokers and agents need to stop paying Zillow, and how MLSs need to cut off the data feed, and so on.
That might have been scary three years ago; hell, it might have been scary just 12 months ago.
Today? I’m not getting that vibe from Rich Barton and crew. I’m getting a different vibe altogether from this earnings call, one that says, “You need me more than I need you.”
If Agent Team XYZ stopped paying Zillow its $10,000 a month, that would have been a disaster a year ago. Today? Am I the only one getting the feeling that Greg Schwartz would shrug and call Agent Team ABC and say, “Hey there! How would you like to be the lucky person we pick to sell the hundreds of homes we need to dispose of every month? Oh, and would you like to represent us, the single biggest home buyer in your MLS, on all of our hundreds of purchases? You do? Well, it sure would be nice to see some sign of love and commitment from you… let me see what your team spent on Premier Agent last month….”
I’ll have to maybe expand on this idea more in a future post, but look, the coin of the realm in real estate is listings. The power belongs to those who have listings. In at least one earnings call, Glenn Kelman of Redfin laid out why there are huge strategic benefits to having listings, which is why they went down the 1% Listing Fee route. Zillow leapfrogged over that stage and went all the way to becoming the principal, the actual homeowner. Zillow of the future will be the biggest customer of the biggest agent, who is the biggest customer of the brokerage, who is the customer of the MLS.
The power dynamic, and therefore the relationship dynamic, in real estate is in the process of being flipped on its head.
Conclusion
If I’m being honest, I wanted to get this out sooner rather than later. I’m certain there’s more depth here, especially looking at Zillow’s complete confidence and transparency compared to what I’m seeing from other public companies in real estate. So I’ll have to return to some of these themes and issues.
For now, let’s leave it there. The big takeaways for me are:
- Zillow is now an iBuyer with a portal, not an ad-supported media company experimenting with Zillow Offers;
- The level of consumer interest is absolutely shocking, and it justifies the ginormous risks that Zillow is taking;
- The unit economics of Zillow Offers suggest that it’s still quite rational to conclude that the only consumers who would still list and sell with a REALTOR are those who Zillow turned down;
- The power dynamics and therefore the relationship dynamics in real estate are changing;
- Zillow is most definitely making a play to be The Platform for residential housing. It is the clear frontrunner. The risks are high, but the rewards are higher still.
More to come. I promise.
-rsh