This is going to be a relatively short post. Frankly, because I’ve run out of ways to say the same thing quarter after quarter. If you’re new around here, please go back and re-read everything I’ve written about Zillow after every one of Zillow’s earnings calls. Then you can check out my June 2018 Red Dot on Redfin, Zillow, Realogy as well as various other Red Dot reports including the September 2018 issue Game of Platforms. Everything I’ve ever written about Zillow has, is or will come to be. I don’t think I’ve been completely off on what those boys and girls in Seattle (and everywhere else now) have been up to.
Q1 of 2021 just continues the narrative of changing from a portal to something else, something new. At the end of 2020, Rich Barton said in his 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.
Well, that’s true… but then again, back in 2018, Spencer Rascoff talked about Zillow 5.0 which I called a very serious, very real effort to transform Zillow… which will transform the industry. So this has been a long time coming, and coming, and coming.
Q1 just adds to the building narrative of Zillow becoming The Platform, which I discussed at length in the September 2018 Red Dot. We see the first shoots that have grown from seeds planted years ago. What is there to add, really? Zillow is going down the road more or less exactly as I predicted three years ago.
Nonetheless, there are a couple of interesting bits from this quarter’s results and earnings call. So let’s talk about those.
A Few Important Numbers
2020 was a killer year, as we saw in the last earnings call report:
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
That was the best year that IMT has ever had, despite the pandemic. Well, in the first three months of 2021 — an unbelievably hot market — Zillow posted these numbers:
- Total revenue of $1.2 billion, up 8% YOY
- Gross margins of 44%, up 35% YOY
- Net Income of $52 million, compared to a Net Loss of $163 million last year, a huge 132% improvement YOY
- Adjusted EBITDA of $181 million, up an even more eye-popping 3,436% YOY
I mean… do we really have to keep wondering? Where are all of the naysayers now?
Last quarter, I wrote:
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.
Well, in Q1, Zillow purchased 1,856 homes. Yeah, they bought more homes in Q1 than they did in Q4. During the hottest seller’s market the world has ever seen. It wasn’t as much as they did in Q1 of 2020, prior to the pandemic, but it wasn’t that far off. How in the world did they manage that? In the earnings call, Rich Barton points out the obvious:
But as you noted in your question and Allen talked about in his script, our top of funnel indicators are good. Like, it turns out, speed, certainty and convenience are attractive to sellers no matter what kind of market they are in. So we are seeing record levels of folks raising their hand to get a Zillow offer.
Imagine that. People like speed, certainty and convenience? Whodathunk?
What about gross margins on each transaction?
| Q1/2021 | |||
| Total | Per Home | YOY | |
| Homes sold | 1,965 | (17.9%) | |
| Homes revenue | $ 700,974,000 | $ 356,730 | 11.0% |
| Operating costs: | |||
| Home acquisition costs (1) | 610,194,000 | 310,531 | 7.8% |
| Renovation costs (1) | 20,822,000 | 10,596 | (30.7%) |
| Holding costs (1)(2) | 4,552,000 | 2,317 | (42.3%) |
| Selling costs | 26,911,000 | 13,695 | (0.4%) |
| Total operating costs | 662,479,000 | 337,139 | 5.0% |
| Return before Interest Expense | 38,495,000 | 19,591 | 13893.6% |
| Margin | 5.49% | 5.49% | 12502.4% |
| Interest expense (1)(2) | 3,845,000 | 1,957 | (57.6%) |
| Return on Homes Sold After Interest Expense | $ 34,650,000 | $ 17,634 | 493.8% |
| 4.94% | |||
Home acquisition costs went up by 8% YOY, but the crazy market we’re in meant that price appreciation when selling was up 11%. Time on market obvious dropped precipitously as well, which accounts for a 42% and 58% drop YOY in Holding costs and Interest expense, respectively. The more intriguing piece is the 31% drop YOY in Renovation costs, which suggests that Zillow Offers team is getting better at figuring out what work the house needs, and what work it doesn’t need, especially in a red hot seller’s market. The buyer probably isn’t gonna bitch about the color of the carpet in today’s market, right?
All of that added up to a pre-interest margin of 5.5%, an eye-popping 12,502% improvement YOY. I had to triple check that before adding commas. Zillow made pre-interest profit of $19,591 on each home sold. But, hey, after you take some $62 million in overhead into account, Zillow Homes lost $58 million so Mike Delprete can tell us iBuyers are losing their shirts so there’s nothing to worry about if you’re a traditional broker.
But look, I already discussed most of these ideas in Q4, Q3, Q2, Q1 of last year and well… for quite some time now. So go back and re-read those, and let’s try to talk about new details.
New Hotness #1: Rich Barton Lets the Truth Slip
First, I found one part of the earnings call extremely interesting. In response to a question from an analyst about Zillow Offers and purchases not being at the pace that Zillow expected, we have Allen Parker, CFO, saying this:
What I’d say is, if you look at our unit economics and as I mentioned 549 basis points of return on home sold before interest expense, being above our plus or minus 200 basis point guardrails, the driver that’s there that has improved from Q4 is home acquisition cost as a percent of the sale. So it’s at 87% of homes revenue versus 85.9 in Q4, but still higher than, we would expect and that’s reflective of this resale velocity and our selling of homes at rates higher than we would have expected or underwrote to, when we acquired them. And so, this expansion that we’re catching up with, there’s also a lot of nuance just in the offers and how we present them. That we’re also iterating.
So I guess what I would describe is, we are continually figuring out how to improve our offer strength in the way we communicate that to our customers, the top of funnel and the interest is strong. We’re seeing early trends in Q2 that give us confidence that this is something that we are going to be able to do.
If you didn’t understand what Allen said there, that makes two of us. I suspect that the analysts also didn’t understand what he was saying in this masterpiece of opaqueness. But then… Rich Barton:
Before I — let me editorialize on that just a little bit at the risk of keeping this issue open, Allen. The unit economics, the margins that we’re earning on a unit basis right now are, not what our goal is. I’ll just reiterate that. We want this and know this can be a giant business. And it’s only going to be a giant business when the pricing is perceived to be fair to consumers. So it’s not our goal, to have 549 basis points or whatever it is we just printed on a unit basis. No, it’s slightly better than last quarter.
In other words, it’s lower. But what we’re aiming to do is to provide a fair offer and charge a fair fee to our customers. And thus we believe we maximize the TAM, we maximize the number of transactions we can touch and participate in. And we have the ability to sell a bunch of adjacent services around those transactions. So it’s worth pausing there for a sec. [Emphasis added]
So to be clear, Rich Barton is not happy that Zillow made 5.49% on Zillow Homes. That’s not his goal. His goal is to more or less break even on each transaction. The +/- 200bps that they have been talking about for months is real. It’s not just sandbagging expectations so that investors would ooh and aah when Zillow prints 549 bps. He really wants to pay a fair market price for homes, so fair that the seller would perceive it as fair, and then sell that home for just a little bit more after renovations and whatnot.
The goal is to maximize TAM (Total Addressable Market), to be involved in as many buy-and-sell transactions as possible, then “to sell a bunch of adjacent services around those transactions.”
This is remarkable transparency and honesty. Just how remarkable? A bit later in the call, presumably after someone whispered in his ear, Rich Barton says:
At the scale we are right now, thank you for clarifying what I said Allen, I didn’t mean to imply we didn’t want to make money natively off this business. But we are subscale, dramatically subscale, right now in our estimation and while we are scaling it, we’re targeting this plus or minus 200. So anyway, thanks. Thanks for clarifying.
He didn’t mean to imply that Zillow doesn’t want to make money on Zillow Offers. Except that he kinda did, because the total opportunity is just so huge, so difficult for most people to wrap their heads around. So it’s hilarious that he had to clarify and say, oh yeah, of course we want to make money on Zillow Offers… but we’re subscale.
The truth is, as I have been insisting since oh… I don’t know… 2017 sometime… that Zillow and Opendoor want to be market makers. iBuying from the very beginning has not been about making profits on buying and selling houses. From the very beginning, iBuying has been about mortgages.
Which is why…
New Hotness #2: Adjacent Services Are Blowing Up
Possibly the most significant numbers from Q1 are these:
- Mortgages revenue of $68 million, up 169% YOY
- Mortgage loss down to $1.8 million, an 86% improvement YOY from a loss of $13.1 million
- Homes Segment Other revenue of $3.2 million, up 318% YOY from $761K.
That Homes Segment Other is title and escrow business from Zillow Closing Services (ZCS). It more than tripled in one year.
Ryan McKeveny of Zelman & Associates asked directly about attach rates… and Allen Parker did his linguistic jiujitsu and sidestepped it, except to say “nothing with respect to attach or any kind of data point yet.” Instead, he gave a lot of color on an important detail:
And then, our mortgage, I guess, the way I would describe it, as you think about our mortgage strategy coming together. When we purchased Mortgage Lenders of America way back in 2018, they were really a direct consumer non-conforming origination shop. Our initial strategy was to move to a broader mix of conforming mortgages, while updating and transforming the platform and bringing in new leadership.
Then Rich Barton has this to say:
So we’ve made these big bets over the last two and a half years when we really leaned into 2.0. And building out all the 2.0 components, like Zillow Offers, mortgages, Zillow closing services, even rentals. Anyway, the short answer to your question is, it’s working. All the children appear to be above average. I don’t know if we’re getting any chuckles out there to the Garrison Keillor reference, but all the businesses are performing really well beyond our expectations. So that’s a terrific proof point that the integrated strategy and the transaction strategy is working our revenue and profit on a per user basis and steadily rising, which is really nice to see and it’s still quite low. So we have a ways to go.
Big bets over the last couple of years. Losing money like cray-cray because Zillow was spending like drunken sailors on shore leave. But all of that spending was in building out components, like mortgage and title and escrow. Just look at the Technology and development spending on Homes and Mortgages as an example.
These adjacent services — or as the industry would call them, “ancillary services” — are growing at a rate that is difficult to match. Zillow’s ancillary revenues are still small compared to say Realogy (the only public company that breaks out title and mortgage) but at this kind of triple-digit percentage growth YOY, it won’t be long.
The factory is kinda built out and Zillow continues to pour money into it, building things out further. They’re hiring like crazy, investing like crazy, and “all the business are performing really well” beyond Rich Barton’s expectations. Things are working.
New Hotness #3: Crossing the Chasm
The final detail I found so interesting was when Rich Barton said something that really resonated with me:
And also, we’re leaning in because most consumers don’t even know what Zillow Offers is yet. They don’t even know. We’ve got to take Zillow 2.0 out of the kind of quarterly conference call realm and into the consumer awareness realm. And so we got a lot of work to do there and basis points penetrated in the business overall. So long answer, but we’re feeling we’re leaning in and feeling good. [Emphasis added]
He is, of course, absolutely correct. Most people have no idea what Zillow Offers is. Barton expanded on that theme later in the call:
Now the challenge is making sure that people even know Zillow Offers exists and what it is and is there a trick? Is it too good to be true and education and marketing? So we’re in that early phase of doing that right now Mark.
This is crossing the chasm. The book of the same name has a subtitle: Marketing and Selling Disruptive Products to Mainstream Customers. The description on Amazon says:
In Crossing the Chasm, Geoffrey A. Moore shows that in the Technology Adoption Life Cycle—which begins with innovators and moves to early adopters, early majority, late majority, and laggards—there is a vast chasm between the early adopters and the early majority. While early adopters are willing to sacrifice for the advantage of being first, the early majority waits until they know that the technology actually offers improvements in productivity. The challenge for innovators and marketers is to narrow this chasm and ultimately accelerate adoption across every segment.
This is the real challenge confronting Zillow right now. As a portal, Zillow is synonymous with real estate. The term “Zillow” gets searched on Google more than the term “real estate”. SNL does skits on Zillow because the brand is synonymous with “searching for houses.” But most people don’t know about Zillow 2.0, which is not about looking at pictures of houses, but about the transaction.
“Is it too good to be true?” is answered by the rest of the real estate industry in the affirmative. Brokers and agents are falling over themselves to tell consumers that yes, Zillow Offers is too good to be true.
By the increasingly large numbers of homes that Zillow is buying, in the midst of the hottest seller’s market we have ever seen, I think it’s safe to assume that at least the Innovators know about and have adopted the disruption that is market making. Maybe the Early Adopters are starting to get it. Zillow needs to cross the chasm to the Early Majority.
2021 might be the pivotal year, as Barton says. Then again, it might be just a big step forward. They have the pieces in place. The factory is built, even as it gets built out even more. The narrative is clear and getting clearer. Whether 2021 will be pivotal or not, I think, depends on whether Zillow can cross the chasm between early adopters and the mainstream.
-rsh
