Is it over for iBuying?

Is it over for iBuying? Pandemic causes major players to hit pause

It was just a few months ago that Zillow was being asked every five minutes to place an offer on someone’s home.

Demand was such that the listings giant — which historically made money off agent advertising — jumped headfirst into instant homebuying in 2018 and shifted its entire business model a year later. To ignore the burgeoning opportunity that iBuying represented would be an “existential threat” to the business, Zillow’s CEO, Rich Barton, said in a March 2019 interview.

A year later, and in the throes of massive economic turmoil sparked by the coronavirus pandemic, Zillow and other major players including Opendoor, Offerpad and Redfin have hit the brakes on iBuying — an industry that generated nearly $9 billion in sales last year.

“With whole cities shutting down nearly all commerce, no one can say what a fair price is right now,” Redfin CEO Glenn Kelman said in a statement last month, announcing his company’s withdrawal from homebuying for the time being.

But while some in the business say it’s a pause, others believe it could be a nail in the coffin for a risky model that’s saddled companies with thousands of properties on their balance sheets in addition to capital costs.

Generally speaking, iBuyers purchase homes at a discount from sellers who want the certainty of a sale, and after minor renovations, they look to flip the homes for a profit. Many of the larger companies, like industry leader Opendoor, have relied on outside funding to do so.

“It’s not clear these guys are going to survive,” said Gilles Duranton, an economist and dean’s chair in real estate professor at the University of Pennsylvania’s Wharton Business School, who was skeptical about the model in good times. “It’s as simple as that.”

To date, iBuying companies own a tiny fraction of the U.S. housing market — less than 1 percent, according to analysts. But with institutional investors eager to own a slice of the pie, the sector’s total dollar volume has doubled each year since 2017, and last year, the top four players closed $8.7 billion in deals across 60,000 home sales.

Opendoor — the venture capital-backed firm that has raised $3 billion in debt and $1.3 billion in equity from investors including SoftBank — was on track to close 30,000 deals in 2019. A year prior, the online real estate company bought 11,000 homes and sold 7,000.

And for publicly traded Zillow, iBuying injected $1 billion in revenue in 18 months’ time.

In 2019, its Zillow Offers platform accounted for about half of the company’s $2.7 billion in revenue, up from 4 percent a year prior. Zillow purchased 6,511 homes last year and sold 4,313.

Ironically, iBuyers were supposed to be a hedge against a bad market by offering people speed and certainty when selling their homes. The buyers could raise fees or slow home purchases in the event of a market correction.

Companies like Zillow and Opendoor typically charge sellers 6 to 15 percent of the home sale price, according to the real estate data firm Collateral Analytics. In the early days of the pandemic, some even considered iBuyers an alternative to in-person showings.

“You can sell without doing an open house,” said Mike DelPrete, a scholar in residence at the University of Colorado who studies iBuying companies. “There’s certainty that iBuyers provide at a time of uncertainty.”

DelPrete added that he has faith in the business model to withstand a downturn.

“Nothing that’s happening now is a repudiation of iBuying,” he said. “It’s about how much cash is in the bank. How long can they turn off the engines before restarting?”

Tangible threats

It was one day after San Francisco ordered its residents to shelter in place that Redfin became the first of several players to pull the plug. Kelman told investors last month that uncertainty in the market made it impossible for Redfin to continue its disciplined approach.

The Seattle-based discount brokerage had been a reluctant newcomer, following Opendoor into the business in 2017, in part to stay competitive and also to give clients another way to transact.

On an earnings call last year, Kelman called his rivals’ rush to rapidly scale their homebuying businesses a “race to the bottom.”

But by 2019’s fourth quarter, iBuying accounted for 42 percent of Redfin’s $233 million in revenue. “Redfin’s scrambling to buy homes as fast as we can because we know it’s on like Donkey Kong,” Kelman said in February.

Redfin’s abrupt pause was notable, but not nearly as big of a deal as Opendoor’s announcement soon after, according to DelPrete. He recently noted in a blog post that Opendoor was buying 40 times as many homes as its competitor and that “Redfin has many other sources of revenue; Opendoor does not.”

Representatives for Opendoor and Redfin would not comment for this story.

Eric Wu, Opendoor’s CEO, wrote on the company’s website in late March that health and safety concerns weighed heavily on the company’s decision. “Though major parts of our experience are virtual and self-service, there are still elements that require real-world interaction,” his statement read. “Given we will likely see delays in closings, we felt it was more appropriate to pause new offers so customers can plan accordingly.”

Opendoor said it will honor contracts it already extended to sellers. But it asked customers to expedite their closings — or delay until shelter-in-place mandates are lifted. “If customers would prefer to not move at this time, we are allowing [them] to cancel,” the company noted.

DelPrete said, however, that by pausing the purchase of homes, Opendoor had shut off its only source of revenue. “There’s no iBuying without buying,” he said. “If you are a car company and you’re not making cars, you have an existential question that needs to be answered.”

As of late March, as job losses related to the pandemic mounted, Opendoor had not announced layoffs or other cutbacks.

But others did. After suspending its iBuying program, brokerage giant Realogy said it would cut the salaries and workweeks of a majority of its employees, while its CEO Ryan Schneider would take a 90 percent pay cut.

Zillow’s Barton, who watched his company’s web traffic drop 20 percent in one week, told investors on March 23 that “things are pretty foggy and uncertain right now.” Zillow declined to comment.

In addition to suspending its iBuying platform, the company froze hiring, suspended marketing expenditures and cut discretionary spending to offset lost revenue.

“We hope this will be enough,” Barton said on the investor call, noting that Zillow would keep the infrastructure and staff in place to “resume iBuying when the pandemic is under control.”

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How long that takes is anybody’s guess.

“Unprecedented times”

February home sales rose 7.2 percent year-over-year, according to the National Association of Realtors, but economists are predicting deals will plummet due to the highly contagious and rapidly spreading coronavirus.

By late March, residents of many cities and states around the country were effectively told to shelter in place. And despite the availability of virtual showings, agents predicted deals would slow drastically as Americans lose their jobs. A record 3.28 million people filed for unemployment benefits during the week that ended March 21. 

London-based research firm Capital Economics predicted that U.S. home sales could drop as much as 35 percent during this year’s second quarter compared to 2019’s fourth quarter.

“[We’re in] unprecedented times,” said Lawrence Yun, chief economist at NAR, which projected a 10 percent drop in March alone. “People who advised clients to list in March and April, well, now they’re saying don’t list in the current environment.”

Unlike other iBuyers, though, Keller Williams has remained in the game — not just in spite of the pandemic but partly because of it. The Austin-based brokerage is doing so through partnerships with various local, regional and national cash-offer companies that purchase homes. Keller agents offer the companies’ services to their clients.

“Consumers need us more than ever,” said Gayln Ziegler, COO of Keller Offers. “We have no intention of stopping that.”

But under the circumstances, many analysts say, iBuyers that put empty homes on their balance sheet were prudent to hit the pause button and preserve capital.

For its part, Zillow slowed its homebuying and began selling down inventory as coronavirus fears picked up. As of March 23, the company was holding 1,860 homes, down 31 percent from 2,707 at the end of last year.

“People are staying indoors and dealing with economic uncertainty,” Justin Patterson, an analyst at Raymond James & Associates, wrote in a March 23 research note. “As such, it makes little sense for Zillow to buy homes when sale periods are elongating.”

Tom White, of the wealth management firm D.A. Davidson Companies, upgraded the company’s stock from “neutral” to “buy” — a vote of confidence in Zillow’s step to “de-risk the business.”

Jack Micenko, an analyst at Susquehanna Financial Group, noted that some iBuyers had already pulled back, albeit to a lesser degree, in 2018’s fourth quarter when buyer demand slowed due to rising interest rates.

“Back then, companies actually reported better revenue as they sold down existing inventory without replenishing new investments,” he told TRD by email. But Micenko cautioned against reading too much into the move just yet.

“I don’t see this as a precursor of a strategic shift in the industry at this point,” he maintained.

The bigger they are…

Skeptics, however, say the strategy of instantly buying and selling homes in bulk is inherently risky.

Shaival Shah, co-founder and CEO of the homebuying startup Ribbon, called the business model used by larger firms like Zillow and Opendoor an “institutional fix-and-flip.” Many of those iBuyers walked into the pandemic with massive portfolios, and now “they’re scrambling to get rid of those homes without putting new ones on their balance sheet,” he said.

Ribbon, which has raised $550 million to date, guarantees cash offers for homes, too, but the company has a leaseback program that charges owners a per diem fee and covers Ribbon’s carrying costs. Shah noted that large iBuyers have no such backup, meaning they’re left holding the bag in a down market.

“We’re not taking on all the costs of having an ‘empty home,’” he said.

Jarred Kessler, CEO of New York-based EasyKnock, which also has a sale-leaseback service, put it this way: “If you’re buying a $100,000 house for $95,000, you’re betting the market won’t drop more than that,” he said. “If the market drops 20 percent, your entire portfolio is under water.”

Founded in 2016, EasyKnock plans to roll out a bridge loan program called MoveAbility in the second quarter, according to the company.

Industry observers told TRD that the nuances of each model do matter.

“It’s not that iBuying is flawed,” said Jonathan Miller, founder of appraisal firm Miller Samuel. “The formula is just dependent on a functioning market.”

But with the market at a standstill, he added, “the math just doesn’t seem to work, because the spread is very tight and they’re extremely dependent on the market moving higher.”

On borrowed time?

Even before the pandemic, Zillow was losing money on each house it bought and sold. During the fourth quarter, the company lost $6,407 on each resale after paying interest on a revolving line of credit it uses to purchase homes. (Zillow lost $1,512 per resale before interest payments.)

“What I will say is we have a team that’s very focused on what’s the right amount to spend on renovation to make the home great for our customer but without overdoing it,” the company’s CFO, Allen Parker, said during an earnings call in February.

Zillow has also sought to minimize the losses by saying it expects iBuying to drive business to new revenue streams such as title insurance and mortgage services.

But Wharton’s Duranton balked at the rationale.

“There’s something deeply problematic in the business model if you think of it as a loss leader or not a moneymaker,” he said.

Even before the pandemic, Duranton had other issues with iBuying. For one, sellers may turn to large publicly traded and venture-backed companies only with homes that are hard to sell — or what he called “lemons.” And if iBuyers were to compete with one another for specific properties, he added, the seller would go with whichever company agreed to pay the most.

In the post-pandemic world, another consideration for iBuyers is “what the VC world will look like next time they need to raise funds,” Duranton said. “Limiting the ‘burn’ for now probably makes sense.”