Zillow, Q4/2020: The Prophecies Getting Fulfilled

As you all know by now, Zillow reported its Q4 and full year 2020 earnings yesterday. It was a monster quarter. As of this writing, ZG stock is over $200 and for good reason, since Zillow outperformed even the high end of their projections in Q4. The analysts I like and follow are very, very bullish and very happy with the results.

John Campbell at Stephens: The Puzzle Pieces Are Coming Together; Full-Steam Ahead; PT to $250

4Q20 results were shockingly good, and the ripple effect of optimism clearly made its way into the ZG stock (up +65% since last report/+2,800bps outperformance vs. the Russell). However, we do believe that many investors had some lingering doubts around the sustainability of strength, particularly in the IMT segment. Right on cue, ZG came through with a 4Q20 print that was even better. We really like the set up from here as ZG was able to: 1) materially beat high expectations, 2) guide 1Q21 well-ahead of consensus yet leaving plenty of room for outperformance and 3) leave the door open for another catalyst with eventual 2021 guidance. From a fundamentals standpoint, ZG is spinning up numerous positive developments across its bevy of offerings (Flex, traditional PA, ZO). All combined make us incremental buyers of ZG. We reiterate our OW/V rating, and we are
raising our PT from $200 to $250.

Lloyd Walmsley at Deutsche Bank: iBuying hits escape velocity in watershed quarter; Buy – TP to $225

We see iBuying hitting a major tipping point We think the Zillow Offers business – and iBuying broadly – is hitting a major tipping point. The cost of selling to Zillow Offers is now comparable to using a traditional agent…for so much more value. Stop and think about that for a second – Why would anyone with a more “commodity” type of home use the traditional home selling process versus getting cash from Zillow? And on top of that, Zillow has done this while getting the Offers business 589bps profitable in terms of return on homes sold after interest expense, which is much faster than we had expected (admittedly benefiting from nice home price appreciation tailwinds). On top of this, Zillow appears close to making the Zestimate almost a standing offer to buy a home. Zillow may be on the cusp of actually becoming a true marketplace for residential real estate, one of the largest asset classes in the world.

Tom White at DA Davidson: Zillow ‘2.0′ services starting to stitch together

We affirm our BUY rating on ZG and raise our PT from $150 to $215 (implies 23x our 2022 EV/Gross Profit). ZG’s core Premier Agent advertising business remains a key beneficiary of a U.S. real estate market that looks set to remain very strong in 2021. Buyer demand remains high and ZG’s dominance of online consumer engagement in the category looks as unassailable as ever to us. With no open houses due to COVID, ZG’s Premier Agent platform has become even more critical for U.S. agents looking for significant volume of high-intent leads.

Perhaps more importantly, the Pandemic is also accelerating the pace of digital transformation in the broader RE ecosystem, enabling CEO Rich Barton to forge ahead with some of his more ambitious product/solutions aimed at reinventing/streamlining the various friction-filled and disjointed processes that plague the typical real estate transaction experience for consumers.

So yeah, Zillow had a good quarter and a good year. But you don’t come here for that. You come here for the deep insights, from an industry analyst, not a stock analyst. I have some thoughts.

A Few Important Numbers

Since the financial performance is available everywhere, let us first look at the important key numbers for our purposes.

FY 2020

  • Total revenue of $3.34 billion, up 22% YOY
  • Gross margins of 47.4%, down 0.8% YOY
  • Net Loss of $162 million, a huge 47% improvement from a loss of $305 million YOY
  • Adjusted EBITDA of $343 million, up an eye-popping 782% YOY

People have already pointed out that IMT has had its best year ever, despite taking a big hit at the start of the pandemic, with revenues of $1.5 billion and profits of $263 million. And the big proof statement of them all is Zillow Homes having the Q4 and the year that it had, despite going on hiatus for a while, pausing everything at the start of the pandemic. Let me quote John Campbell here:

  • A truly standout-type quarter as ZG was able to take its “net margin” to new heights at 6.68% vs. the 2019-current avg. of -0.22%. The chart at the bottom of this section tells it all.
  • The meaningful turnaround stems from a collection of things, some temporary and some structural. On the temporary side, we believe that the velocity of home sales or the “cycle” time was clearly in the Company’s favor as U.S. housing is running at an incredible pace now. This keeps holding costs/home down as well as aides, to a degree, with selling costs. Additionally, the rate of home price growth helped lift gross margin/improved the spread on homes sold. While this should be viewed as temporary for now, they can also be viewed as cyclical (i.e., the good times will come and go) and over the NT, perhaps even MT, these positive benefits are likely to stay in place as U.S. housing has shown no real signs of slowing. On the structural side of things, we do believe that ZG is starting to benefit from experience and scale (i.e. renovation costs) and, of course, the Company should be able to benefit from lower selling costs as it has launched a new in-house agent/brokerage service. In addition, relative to the gross margin/spread, ZG showed a great deal of improvement from recent quarters as those quarters were heavily influenced by ZG’s COVID-driven flushing of its balance sheet homes inventory (i.e., it was forced to sell more seasoned homes).
  • ZG expects to see its net margin hover around the original +/- 200bps guard rails that the Company established from the onset. We see this as highly conservative given: 1) the favorable macro backdrop, 2) the structural savings that are emerging around renovations and 3) most importantly, the selling costs now being saved from the move to in-house selling agents.
  • Purchased 1,789 homes – more than double the rate purchased in 3Q20 and >20x 2Q20. The 4Q20 purchase rate, while well-above recent levels, was still only roughly in-line with the year-ago period.

The two most important numbers from my perspective are that ZG purchased 1,789 homes in Q4 — during the hottest seller’s market we have ever seen — and the gross profit margin on each transaction going up so much. Some of the numbers below tell the story quite well.

Total Per Home
Homes sold 923 (51.5%)
Homes revenue $ 301,703 $ 326,872 3.1%
Operating costs:
Home acquisition costs (1) 259,285 280,915 (1.8%)
Renovation costs (1) 9,298 10,074 (32.2%)
Holding costs (1)(2) 1,636 1,772 (54.6%)
Selling costs 11,335 12,281 (10.6%)
Total operating costs 281,554 305,042 (4.3%)
Return before Interest Expense 20,149 21,830 1543.8%
Margin 6.68% 6.68% 1500.9%
Interest expense (1)(2) 2,422 2,624 (46.4%)
Return on Homes Sold After Interest Expense $ 17,727 $ 19,206 399.8%

1544% improvement in return before interest expense? 400% return after interest expense?

Goddamn. That’s a helluva result for a lot of reasons, which I’ll address below.

I do know that Mike Delprete is unimpressed, saying that iBuyers are obfuscating true profitability picture:

A casual investor could be excused for confusing iBuying with a profitable business. Zillow’s latest shareholder letter claims, “Average return on homes sold before interest expense was a gain of $21,830 per home,” while Opendoor’s investor presentation highlights “positive unit economics” with a contribution margin of $11k/home.


Both statements are factually correct. However, the figures provided are cloaked in asterisks and notes. Opendoor and Zillow are emphasizing unit economics of iBuying that exclude tens of millions of dollars of expenses — ranging from salaries to marketing to technology — that are necessary to operate the business.

It’s the equivalent of an immaculate conception version of iBuying, where transactions magically occur without employees, customers materialize out of thin air, and technology is freely available for all.

When all indirect costs are included, profitability quickly drops into the negative for both companies.

Mike’s analysis is correct on the surface, of course, since adding in indirect costs does mean profitability drops for Zillow and for Opendoor. But unless he’s also showing that those tens of millions of dollars of expenses are growing along with the revenues, I’m not sure how valid that is. So for example, looking at FY 2020 vs FY 2019 results for Zillow Homes, I see this:

2020 2019 YOY
Revenue 1,715,375 1,365,250 25.6%
Costs and expenses:
  Cost of revenue 1,621,040 1,315,345 23.2%
  Sales and marketing 190,829 171,634 11.2%
  Technology and development 119,885 78,994 51.8%
  General and administrative 87,071 81,407 7.0%
  Impairment costs
  Integration costs
Total costs and expenses 2,018,825 1,647,380 22.5%
Income (loss) from operations (303,450) (282,130) 7.6%
Segment other income
Segment interest expense (16,804) (29,990) (44.0%)
Income (loss) before income taxes (320,254) (312,120) 2.6%
Cost of Revenue vs. Revenue 2.4%
Sales and marketing vs. Revenue 14.5%
Technology vs Revenue (26.1%)
G&A vs Revenue 18.7%

So while Revenue is going up at 25.6% clip, the Cost of Revenue (which is mostly the amount paid for the house) is only going up at 23.2%, or 2.4% better. The salaries and marketing are going up at a far lower pace — I believe that’s what tech companies call “scaling” and “operating leverage.” Yes, Technology costs are dramatically higher, but isn’t that in line with what both iBuyer have said all along? That they’re trying to apply technology to the thorny problem of pricing and buying and selling homes? Is it that unreasonable to expect that technology expenses would be higher today, but lower once the investment is made?

I’m not sure what to make of Delprete’s line of thinking, so popular among big brokerages in real estate… as if their own profitability numbers are stellar. But that’s a whole other story. So let’s move on.

Prophecies, Fulfilled

My overwhelming impression of Q4 and 2020 results is one of self-congratulation. I know, that’s not the most admirable trait and I struggle with it all the time (ask Sunny), especially by trying to learn from Marcus Aurelius. But I’m human, so grant me a bit of grace.

Fact is, Q4 results and the related commentary from Rich Barton and Allan Parker are fulfillments of a few of my predictions made way, way back. Let us go through a few.

The Game of Platforms, 2018

In September of 2018, I released a Red Dot named The Game of Platforms where I laid out the definition of a platform business:

The answer is that a platform provides four core functions to its network:
• Audience building
• Matchmaking
• Providing core tools and services
• Setting rules and standards
Easiest way to think about this is to think about a shopping mall—once the pre-eminent platform for retail.

Then I discussed the hybrid model, using Amazon as an example:

The linear part of Amazon’s business allows it to control the quality and availability of important items that keep bringing shoppers back to its website, which in turn brings more and more merchants into the Marketplace. The linear business also subsidizes the investment and costs of the infrastructure that Amazon has built, from warehouses to logistics to technology, which can then be used for the Marketplace platform business as well.

The conclusion I drew was that Zillow was in the lead for the rush to become The Platform for real estate:

Zillow’s pivot is not away from being a media advertising company to becoming a brokerage, or a iBuyer. Zillow’s pivot is towards becoming a hybrid.

Zillow is the frontrunner for the Real Estate Platform for many reasons. Perhaps the most important is that its senior leadership appears to understand that the goal is to become the Platform. With some of the other contenders, that isn’t as clear. So far, they’re doing everything correctly.

Here’s Rich Barton during the earnings call:

We see this [acquisition of ShowingTime] as similar to the work we did to build our connections platform a few years ago and wider acceptance of this technology has the added benefit of improving the experience for the broader industry as well as for our Premier Agent partners as our platform grows.

We envision a future experience that begins on our mobile app, where a customer can immerse herself in a home via our 3D home technology, looking in-person tour through ShowingTime with an agent, get pre-qualified through Zillow home loans, work with a Premier Agent to buy the home and close the transaction with Zillow Closing Services. We have spent the last year bringing out Zillow Offers, bringing our Zillow Offers and Premier Agent businesses closer together to orient around customer success and customer choice. While I know you all think of these businesses as distinct, our customers arrive at Zillow, simply trying to move. It is our job to deliver for them in any way that we can, be it through our own services or with our best-in-class partners.

That’s a Platform. The agent is not removed, but the agent works within the Platform in much the same way that a retailer operating on Amazon works within the Amazon Marketplace platform. And in case there was any doubt about the hybrid linear-plus platform that Zillow was building, here’s Rich Barton during the call:

On the Zillow Offers stuff, it’s still really, really small. It’s just beginning to look big, but it’s still really, really small. We’re way less than 1% of the market right now with this. But in Zillow Offers is the seeds of the future of a streamlined transaction, which is why you’re seeing us do so much innovating and integrating and testing on that product right now. And that is spilling over into bringing a much more accountable transaction, partner quality, integrated mindset to our Premier Agent and IMT businesses as well.

I thought this was where Zillow was headed, so I do consider 2020 be the fulfillment of that prophecy.

No Doubt that Market Making Is For Real

Speaking of Zillow Offers… I think I took the most grief over the years as being one of the biggest iBuyer bulls, whether it’s Zillow or Opendoor. Everyone (except for a few visionaries) seemed to think that the whole buying houses then reselling it was a giant waste of money, a huge distraction, and ultimately doomed to fail. Even today, we have Delprete talking profitability as we discussed above.

But back in 2014, when nobody was talking about iBuyers, I wrote this post about this brand new startup called Opendoor that was bringing a radical new concept into real estate – market making:


Rabois looks at the same situation and asked Why the transaction must be complex, emotional, expensive, and infrequent. Could that be changed?

His answer appears to be that yes, that could be changed, IF there were some company with enormous financial resources sitting between the home seller and the home buyer. Market makers exist in the stock market and in the commodities markets. Why not real estate?

And I said that this would be immensely attractive to a lot of sellers, based on my personal experience of trying to sell a house. Speed, convenience, certainty — these three things were the core value proposition of market makers, and I thought sellers would go for those in a big way, even at some cost.

Over the years, I’ve been very active and very bullish on the whole iBuyer thing, eventually differentiating between market makers like Zillow and Opendoor, bridge loan models like Knock and FlyHomes, and flippers/lead-generators like Redfin and Offerpad.

Last year, when COVID happened, I wrote an in-depth research paper under 7DS Capital “COVID-19 and Real Estate.” In that paper, I predicted that iBuyers would make major gains, despite the suspension of operations.

Nonetheless, in speaking with some of the top producers in the industry, it became evident that the better agents and brokers see the truth: the iBuyers will have an enormous advantage in the aftermath of this crisis.

First, in the short and medium term, sellers will have greater urgency to sell when the market reopens.

Second, and more long-term, the psychological impact of COVID will not entirely fade away until and unless a simple, over-the-counter cure being not only introduced, but proven.

The selling process was already inconvenient, uncertain and time-consuming. If the seller has to worry about strangers walking into his house and whether they are infectious, and the showing process now has to involve booties, masks, disinfectants, and the like… the incentive to simply sell to an iBuyer increases significantly.

We believe that the iBuyer model, so misunderstood and so maligned, is about to become far more mainstream in the aftermath of this crisis.

Well, as noted, in Q4 of 2020, Zillow blew through all expectations in the Homes segment. But the two key numbers, as I mentioned, is how many houses Zillow bought during the hottest seller’s market anybody has ever seen, and the gross profit margin improving so much. Let’s discuss that.

Value of Zillow Offers in a Hot Seller’s Market

Sometime in Q3 of last year, I recall having a lot of conversations with industry friends and colleagues, as well as clients and friends on the investor side, about the insane seller’s market we were starting to see and whether that would depress the value proposition of iBuyers like Zillow and Opendoor. Opendoor has not reported, but Zillow has. And the answer is most definitively, No, hot seller’s market does not depress the value proposition of iBuyers. (Or if it did, then I invite you to imagine what kind of numbers Homes would have posted without that depressed value proposition.)

When sellers can list a house on Friday, and have a dozen offers all over asking by Monday, would they still want to sell their home to an iBuyer and potentially leave a bunch of money on the table?

The answer is a resounding Yes, they would because Zillow bought 1,789 homes, roughly in-line with how many homes they bought in 2019, long before COVID was even a word we knew.

But Rich Barton gets asked a question specifically about this “market headwinds” issue. His answer:

Well, it’s working. Look, our acquisitions were up year-over-year in Q4 for the first time since COVID started. So I mean, the answer to your question is unknowable. I’m sure there are a bunch of puts and takes. Clearly, this is such a head slapping really obvious, better, easier, more convenient way to do things than the old way that I don’t think the interest in the product is going to change a whole lot based on the hot or cold markets, I really don’t, but it’s unknowable. And then there may be some COVID-related hesitancy that makes ZO more attractive right now. But honestly we don’t really know, but we’re looking at the trends.

Sure, it’s unknowable. But it is predictable, and I say that because I predicted it. And Zillow’s own promotional video in the Shareholder Letter clearly suggests why:

Ms. Lee specifically says she felt overwhelmed about the timing of having to sell one house and buy another. She specifically says she felt it wasn’t safe to have so many strangers in her home. And she specifically says she didn’t want to have to do repairs.

I mean… do we need any more evidence that the prophecy is fulfilled?

Margin Improvement

Zillow’s Q4 results, and when we see it, Opendoor’s results, show that market making is for real. It’s making money, at least in the disputed gross profits level, and it’s still very very early. Zillow and Opendoor are both learning all kinds of operational things as they go, and they’re spending hundreds of millions on technology to improve all of that.

We all knew or should have known that a new radical idea like market making in houses would take time and money to get profitable. We all knew or should have known that these companies were going to learn lessons and figure things out.

So here’s Alan Parker, CFO:

The other – the other three cost lines; renovations, holding costs and selling costs, which improved 250 basis points over Q3 include in these improvements, some real operational improvements that are durable. We’re constantly learning and improving over time, which results in continual improvements in our customer value – proposition value of our offers. So, that’s we’re glad to be back up and running. And as we learn, we’re able to provide more value proposition to our customers. We do expect some of the pricing spread to be temporal over time, but we will continue. We still see continue to see opportunities for improvement across all four of the cost components. I expect this metrics going to continue to be a little bumpy as we continue to come out of the air gap and the post-pause. but the direction I’ll give is we’re still maintaining the plus or minus 200 basis point guardrails. And we’re going to continue to have those as guardrails as we grow and scale. And as we continue to learn, we’ll be able to provide real cost improvements that will benefit our ability to provide value in our customer offers.

Translated to normal English, what he said is that they learned a bunch of lessons which led to operational improvements which led to way better profitability. They’ll still try to improve all of those, so they can become really efficient at buying and selling homes, so that they can pay the seller more for the house.

I have long maintained that the real tipping point for market making comes when the cost to the seller is either the same or less than listing a home the traditional way. That tipping point is now fiction, not science fiction — years, not decades.

Zillow’s Vision is Clearer Than Ever

Let’s leave off with one final fulfillment of prophecy. A year ago, in the VIP Post about Zillow’s Q4/2019 earnings, I wrote:

I think 2019 goes down as the year when Zillow turned the page on the real estate industry in the United States.

To be sure, the transformation has been going on for a while. I’ve tracked that change since sometime in 2015 when I wrote The Future of Real Estate, According to Zillow. In 2018, I wrote No Hat, Lots of Cattle: In Which Zillow Transforms. And now, all is proceeding as I have foreseen.

The plain fact that Zillow now generates more revenues from Homes than it does from IMT means that 2019 proves what I’ve written previously: Zillow used to be an advertising portal that did other things, but is now a market maker that happens to operate the largest portal in real estate. Wall Street analysts keep saying that Zillow’s core business is IMT; I don’t believe that’s true anymore. I believe Zillow’s core business is market making, and its very profitable side hustle is operating a portal and selling leads to agents.

I’m certain that there will still be Wall Street analysts talking about improvements in Zillow’s “core” IMT business. I remain convinced that is the wrong way to think of Zillow now. And this last earnings call makes things crystal clear.

Rich Barton says in the prepared remarks:

We expect 2021 will be a pivotal year for Zillow. I’ve spent some breadth here in the past two years, talking about our transition from Zillow 1.0 a media focus business and Zillow 2.0, a transaction focused business. Today, I believe that we have the pieces in place, the vision, the team, the technology solutions and customer products and services to execute on Zillow 2.0 now. We will undoubtedly keep innovating and adding products and services on the long road to customer one-click trade in Nirvana, but our entire company is now relentlessly focused on transactions and ready to scale from here.

And then later, during the Q&A:

Tom, we’re – with Zillow Offers and now, the brokerage that’s associated with Zillow Offers, we’re finally actually in the end user customer satisfaction customer service business. We used to be in the kind of media customer traffic business and not in the customer service business. And so that’s – I talked about it a little more on previously on the call, the spillover effect from having an owned and operated operation, where we’re actually buying and selling homes and we’re actually closing these transactions. The spillover goodness to the core business is difficult to quantify how important it is and we see it’ll drive a ton of opportunity in the core business on a go-forward basis.

And as I said on the call, these businesses, ZO and PA are getting a lot closer together, because that’s happening, because of all this learning, And because we’re seeing common solutions that we’re building for ZO to be applicable to the whole in the industry as a whole, just like with the ShowingTime acquisition today. That’s one of those things that we see. And as they come closer together, they’re actually opening up even larger swaps of kind of unknown grass, just like bigger chunks of opportunity that we see given all this traffic and engagement we have. So, we’re excited.

That emphasis on the “customer service business” is an important one. And no, I don’t care that Barton himself seems to call IMT the core business, because if you actually listen to what he says, it is 100% clear that IMT is just a cash cow.

Turn the page, to quote Barton himself from last year. Zillow is in the customer service business, using Offers as the linear business then leveraging that to create the Platform for real estate.

Everything is proceeding as I have foreseen.