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iBuying Is Transforming The Real Estate Market

Daniel Laboe

The 10-year US Treasury note dropped below 2% today, its lowest level since 2016, following the Federal Reserve’s increasingly dovish verbiage. The markets have now completely priced in a rate cut for next month on the heightened concern over consumer tariffs which China and Mexico.

Decreasing interest rates and unemployment’s levels at a half-century low makes for an attractive mix for US residential real estate. Investors are buying up US real estate like hot cakes making up 11% of total home sales in 2018, the highest on record, according to WSJ. Zillow ZG is one such investor that has pivoted to be more than just a real estate tool.

iBuying

The tech world has been nudging its way into the residential real estate market for some time with virtual open houses, mortgages closings with just the press of your finger, and now real estate agents are being outsourced by apps. Zillow, the most popular real estate website for those individuals looking to lease or buy homes, is now digitally flipping houses. They are integrating instant buying (aka iBuying) into their product offering through Zillow Offers. Zillow Offers began buying residential housing in April of 2018 and started to sell them in July 2018.

Zillow Offers is going to completely shift Zillow’s top-line driver from one primarily driven by advertising to one that is driven by capital intensive investments. This is an extremely risky and speculative move for the tech giant, but Zillow is confident that its algorithm will prove to be profitable.

They are expected to be buying 5,000 homes a month in the next 3 to 5 years, generating $20 billion in annualized revenue. This is an extremely capital intensive business with paper-thin margins that could disintegrate if the economy were to see a downturn.

Zillow Offers approach is relatively simple. They will be buying the homes at fair value minus need renovations for a 7% fee (compared to the roughly 5-6% that real estate agent charges). The advantage of selling your home on Zillow Offers is that the seller doesn’t have to wait for a corresponding buyer to sell their home neither are they required to make the needed renovations for a sale.

The key to this business model is the upcharge associated with the minor renovations. Zillow is estimating a 2-3% net margin for this segment as it matures.

Zillow is not the first mover on the iBuying trend. Tech unicorn, Opendoor, started 5 years ago and has already served more than 40,000 customers. Opendoor was proof of concept enough for Zillow to beign its own iBuying platform.

Zillow Performance & Valuation

Zillow has traded all over the board since they went public back in 2011. ZG traded up to a high of $159 in 2014, down to $18 in early 2016, and has recovered a bit to $46, which it closed at today. Zillow is still yet to turn a consistent profit and this is likely not to change with the firm’s new source of revenue expecting to deepen its deficit in the near term.

The company has had strong revenue growth that has not fallen below 20% year-over-over. ZG is currently trading at a favorable forward P/S multiple but this should only be taken with a grain of salt considering the low margin iBuying business they are now perusing.

 

Take Away

Tech is yet transforming another industry as iBuying in residential real estate takes center stage. This could have a long term adverse effect on traditional real estate brokerages like Century 21 RLGY and Sotheby’s BID.

Redfin RDFN is an example of a real estate brokerage that has been able to pivot to the shifting consumer, working with potential home buyers and sellers online.

Zillow’s iBuying strategy is precarious for a firm that’s prior revenue driver was low capital advertising. The exposure that Zillow already has in the real estate sector gives them an enormous leg up on competitors like Opendoor. The mere website traffic should be enough to keep Zillow Offers afloat as long as the real estate market does. The razor-thin margins in iBuying are going to make or break ZG.


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