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Zillow's Strategic Transformation Presents New Dangers

- By John Engle

Zillow Group Inc. (NASDAQ:Z) has struggled in recent months thanks to a number of factors. A slowdown in its core business, CEO turnover and an aggressive plan to expand into other real estate verticals have all contributed to the malaise.

Moving toward self-reinvention

Zillow's core business is its online platform, which tracks real estate values, sales, in addition to offering a suite of digital transaction facilitation tools to buyers, sellers, broker and agents.


To combat the slowdown in its online business, Zillow has opted to expand the scope of its physical real estate business. Specifically, the company has made moves to enter two new business lines: mortgage lending and home-flipping businesses.

In its desire to reinvent itself, Zillow is setting out on a new path that will be fraught with challenges and risks.

Trying its hand at home-flipping

Zillow is making a push into the physical real estate business through a new service, Zillow Offers. This is how the company describes the business line :


"Zillow Offers, now available in nine markets, reduces the stress and uncertainty that typically goes along with selling and buying a home. Potential home sellers in markets where Zillow Offers is available can request a free, no-obligation cash offer from Zillow to purchase their home. If the seller accepts the offer, they choose their closing date and then Zillow will conduct a free home evaluation to finalize the offer."



Launched last April, Zillow Offers got off to a slow start at first. Between its debut and the end of 2018, Zillow bought just 686 homes. The company plans to scale its home-buying efforts in earnest. Its stated aim is to purchase 5,000 homes every month. The demand is certainly there; Zillow Offers receives a solicitation from would-be sellers every five minutes .

Making a play on mortgage financing

This month, Zillow announced yet another business venture. Zillow is now diving into the financing side of real estate. Rather than simply connecting buyers with potential mortgage financing providers, as Zillow's platform currently does, the company will now offer financing directly through Zillow Home Loans .

This move was anticipated by many analysts and investors in light of Zillow's Nov. 2018 acquisition of Mortgage Lenders of America . The newly acquired lender wrote a meager 4,000 loans last year, but Zillow aims to ramp up lending rapidly. It is targeting 36,000 transactions per year, which would represent a whopping $7 billion in loans .

Zillow's aim is to integrate Zillow Home Loans with Zillow Offers as they both scale aggressively.

A dangerous game

The expansion into home-buying and mortgage financing does make sense to some degree, given the company's extensive experience and wealth of data. But it is still a very risky bet, given the late stage of the current market cycle and signs of choppy demand for homes.

The scale and scope of Zillow's ambitions have impressed some analysts, but has sparked anxiety among many others. The fears are understandable, as CNBC's Jim Cramer recently pointed out :


"I think this headlong rush into the house-flipping business could prove to be very risky and, even if it works, there will absolutely be some brutal speedbumps along the way."



Jumping into a new line, even one adjacent to to your core business, is going to present unexpected challenges. Even if Zillow pulls it off, investors should brace themselves for harsh growing pains. At the same time, new risk exposure from both lending and owning homes will weigh on investor sentiment, and could end up materially affecting Zillow in the event of a cyclical downswing.

Verdict

Zillow's self-reinvention has resulted in a new business that is fundamentally different from what it once was. Cramer summed this up nicely last October:


"Investors...don't want an interest-rate-sensitive company that owns homes; they bought Zillow because it's a high-margin, asset-light online real estate play with a fabulous multi-year growth story."



For better or worse, Zillow is a very different business today than it was last year. Whether this reinvention will pay off is very much an open question. For now, investors would be wise to stick to the sidelines until this story has time to develop.

Disclosure: No positions.

This article first appeared on GuruFocus.