The wind down of Zillow Group Inc.'s (NASDAQ: ZG) iBuying business announced last week has thrown new scrutiny onto the direct-homebuying business.
Inability to predict home prices amid a volatile market was the key reason cited by Zillow for its exit from the iBuying business, a closely-watched segment of the residential real estate market. The program's shutdown, and subsequent expected layoffs of one-quarter of Zillow's staff, prompt questions about how sensitive the iBuying model could be to swings in the overall housing market.
The past 12 to 18 months have seen a housing market unlike any other, where investors — iBuyers or otherwise — have been able to snap up homes, invest some capital in renovations, then sell them for a sizable increase weeks later. The basis of iBuying is rooted in purchasing homes for a discount, then selling them a short time afterward for a profit.
But with home-price appreciation tapering off in recent months, albeit still growing, that prompted questions about how much profit iBuyers and others may be able to make selling homes they've purchased — after months of staggering price appreciation.
Before Zillow shut down Zillow Offers last week, an analyst with KeyBanc Capital Markets Inc. found, of 650 homes recently purchased by Zillow, 66% were worth less than the purchase price. Zillow was also purchasing homes at a rapid clip, especially in the third quarter, when it bought more than 9,000 homes.
Zillow disclosed in its Q3 earnings that it took a write-down of about $304 million within its Homes segment as a result of buying homes at prices that were higher than the company's estimates of future selling price. Zillow said it expected an additional $240 million to $265 million of losses in Q4, in particular because of homes it'll close on then.
Rich Barton, CEO and co-founder of Zillow, and Allen Parker, the company's CFO, in a letter to shareholders last week attributed an inability to accurate forecast home prices amid pricing volatility for the wind-down of Zillow Offers. They wrote the Zillow Offers unit economics swung approximately 1,200 basis points from Q2 to an expected -500 to -700 basis points in Q4.
Barton and Parker said the business model would only become consistently profitable at scale.
"We have determined this large scale would require too much equity capital, create too much volatility in our earnings and balance sheet, and ultimately result in far lower return on equity than we imagined," they wrote.
Volatility in housing volume, supply-chain issues and the fact that Zillow had converted only about 10% of sellers that asked for a Zillow Offer were named as additional reasons for the exit.
So what does it mean for iBuying?
Many observers say Zillow Offers' shutdown doesn't spell disaster for iBuying, although new scrutiny has been placed on the model.
Mark Vitner, managing director and senior economist at San Francisco-based Wells Fargo & Co., said he didn't think the end of Zillow Offers signaled the demise of iBuying. The concept of iBuying makes a lot of sense, he added.
He said companies in the iBuying space are essentially IT companies, constantly collecting data to determine pricing trends to make money off that information. Making money on that data, added in with a very unusual housing market, have been key challenges facing iBuyers.
"In this market, it's been very hard to collect accurate information," Vitner said. "We also seem to be on the back side of the price spike."
Tomasz Piskorski, a professor of real estate in the finance division at New York's Columbia Business School who's done research on iBuyers, said, so far, iBuyers have largely targeted markets and homes that are easiest to sell. Zillow Offers' footprint includes hot housing markets like Atlanta, Dallas and Orlando, Florida.
Other iBuyers have a foothold in those similar metro areas: typically fast-growing, lower-tax Sun Belt cities where home-price appreciation has posted double-digit gains for more than a year.
Despite the headlines they've garnered, iBuyers remain a small share of the overall housing market, although they're becoming more prolific. Market share for iBuyers in Q2 reached 1% of all U.S. home sales for the first time, according to Zillow research.