The Future of Home Buying & Selling
It is no secret that I have made a rather large bet on Zillow. I’m pushing a significant portion of my net worth to the center of the table in what amounts to one of the bigger positions I’m likely to take over the next 5-10 years. If there was ever a time to be right, it would be on this subject. As much as I’m acknowledging my own bias, my intention is to express how much skin I have in the game with this particular viewpoint.
In this post, I’m going to argue that buying and selling a house online, by computer or smartphone, will become the default. I’m not saying Zillow is going to be the winner, although that’s what I’m betting on with portfolio. Rather, I believe that transactions involving iBuyer will become the most common way Americans buy and sell residential real estate.
What is an iBuyer?
Zillow, Redfin as well as other startups, such as Opendoor and Offerpad, are increasingly being labeled as iBuyers by those in the real estate market.
At the most basic level, iBuyers are companies that use technology to make immediate online offers on residential homes, aiming to shorten the transaction process to days, before turning around and reselling them.
This is an innovative concept in the real estate industry and has created a new option for home sellers, the party most disadvantaged under the current, broken system.
The Disadvantaged Home Seller
Admittedly, I have never bought or sold a home. The only first-hand experience I have is actually the second-hand experience when my parents put my childhood house on the market earlier this year. But even one step removed from the process I saw how painful and frustrating it is sell a home.
My parents used a real estate agent, Kathy. Despite the obvious misaligned incentives of realtors and home sellers (which everyone read about in Freakonomics), the frustration my parents felt had nothing to do with Kathy, who was otherwise professional and knowledgeable.
My parents’ irritation came from every other aspect of the process, which is completely fucked I might add. The process of staging a home is fucked. The process of being on-call, ready to clean the house at a moment’s notice to show the home is fucked. The mortgage process? Fucked. Let’s say realtor Kathy comes with great news of a potential offer.. Great! But of course she can’t guarantee the bank would approve the potential buyer’s loan. What happens if the buyer doesn’t get the green light to close? Well, mom and dad have to re-list the home and start the whole process all over again. Fucked.
It might not seem like much but most Americans, like my parents, have the majority of their net worth tied up in a primary residence which makes the long, drawn out act of selling a home all the more stressful.
Portfolio managers and financial analysts might not understand why companies like Zillow, Redfin or Opendoor would willingly take on the burden of buying and selling homes, turning their balance sheets into a potential cluster fuck. But ask anyone who has recently sold a house. Ask them to give up a couple percentage points on the homes total value for the speed, convenience and certainty of an iBuyer sale and you’d find a trade that many sellers would gladly take.
The Price of Speed, Convenience and Certainty
From where I stand, iBuyers are the superior method when it comes to selling a home but how do we put a price on the value of speed, convenience and certainty?
Well, for starters, we know that in 2016 Opendoor charged a 9% fee for its iBuyer service. Digging into Zillow’s most recent 10Q, we can see that the price appreciation (difference between what it paid and what it sold a house for) was 3.3%. Zillow doesn’t disclose what it charges the seller in fees but let’s say it’s the same 9% as Opendoor. So we are working off the assumption that it costs a homeowner 12%, all-in, to use an iBuyer service. That’s a significant chunk of money.
The average purchase price for the 62 homes Zillow purchased in Q3 was $324,000, so let’s make the math easy and assume on a $300k house the seller is paying $36k in fees. Compare that to selling the traditional way, with your very own Kathy the realtor, and you’re paying 6%, or $18k in fees before repairs and staging.
At that kind of a cost, I think most critics are right that iBuyer is a niche product for a niche market: people who value speed, convenience and certainty over an extra 6%.
But here’s what I’m betting on…
The Price Will Drop
As was the case with disruptive services that came before iBuyers (think Airbnb/hotels or Uber/taxis), price drops as the company providing a service gets better, more efficient, and sees increasing user adoption.
I don’t know what the tipping point will be—we’ll find out as Zillow, Redfin, Opendoor and Offerpad mature—but let’s say iBuyers settle in charging 8% (2% more expensive than using a traditional real estate agent). That’s an extra $6k on a $300k property. How many people will say, “Fuck it, it’s only $6,000, let’s just sell to Zillow and call it a day?”
We can pretty easily construct a narrative for iBuyers to achieve significant marketshare if it only costs 2% more than using a traditional real estate agent. But here’s another, more interesting, mental exercise…
An Inflection Point
What if using an iBuyer costs less than using an old school real estate agent?
Of course that’s really difficult to imagine at present time since all of the iBuyers have pivoted to using agents on buying and selling houses. Zillow has done that from the beginning. Redfin has done that from the beginning (albeit, only in-house Redfin agents). Opendoor has pivoted to using agents on their deals. All those agents have to get paid.
Well, for one thing, it’s possible that the iBuyer companies get so efficient, so good at buying, repairing, then selling houses that they can charge 4% to the seller, pay the agents 1% each, and still make a profit on the remaining 2%. That’s possible.
There is another possibility, which comes to us courtesy of Zillow CEO Spencer Rascoff, on the company’s Q2 earnings call (emphasis mine):
We think we can make a lot of money in the buying and selling of Homes business by charging sellers a fee, doing a light remodel, paying agent commissions in the transaction and training our capital 4 or more times a year, so having a pretty short hold time. So we’re very comfortable having agents in the transaction. We think most other iBuyers are also paying agent commissions in the transition. But I can only speak to our unit economics, which are attractive at, albeit at a low margin, high-volume game. The mortgage business provides an opportunity to monetize the Zillow Offers business even further. So just what we intend to do here is, on a Zillow-owned home, when we’re reselling that to a consumer, we will provide mortgage origination for a homebuyer of a Zillow-owned home through MLOA, which we’ll rebrand post-closing the Zillow Mortgages.
So just to give you some napkin math for a second. About 400,000 homes sell a month in the United States. If Zillow Offers is buying and selling, say, 10,000 homes a month, that’s about 2.5%, 2% or so of the market. If we’re doing that type of home buying and selling volume, homebuilders typically have a 75% attach rate on their in-house mortgage of homes that they’re selling. At a 75% attach rate on 10,000 homes a month at 9,000 in revenue per mortgage origination, that’s $67 million a month of mortgage origination revenue or about $800 million a year. So for anybody who is wondering why we just bought a mortgage lender, just to hit some of those numbers again, at a mere 10,000 homes sold a month from Zillow Offers, a 75% attach rate gets to over $800 million a year of revenue opportunity for mortgage origination. In addition, it allows you to sell the home faster, which, as we’ve talked about extensively with investors, that’s critical to improving the return on equity of the Zillow Offers business. And then the final piece I just want to point out on Zillow Offers is the opportunity to create a listing lead generation business for our Premier Agent is significant. So take a step back. We think the core Zillow Offers business can be profitable with commissions. We take the mortgage origination opportunity as large. We think the sell-side listing lead generation for Premier Agent opportunity is large as well. And I’m very, very pleased with the progress we’ve made so far in Zillow Offers after just a couple of months. [Emphasis added]
Assume that Zillow Offers improves to the point where it is only 2% more expensive than using a traditional real estate agent. On a house that ultimately sells for $300k, selling with an old school realtor would cost the homeowner 6%, or $18k, as we have already established. Selling it to Zillow, with the fees and opportunity cost, would the homeowner is charged 8%, or $24k— a difference of $6k.
But if the seller uses Zillow Mortgage to buy their next home (which could be a Zillow-owned home, or could be some other home), Zillow stands to make $9k from the mortgage business. Knowing this, Zillow offers to charge only 4% as a fee to buy the home, if the homeowner would use Zillow Mortgage for her next house.
So now, the homeowner sells to Zillow for $300k, pays 4% in fees ($12k). Selling to Zillow costs the homeowner less than using an old school realtor. But Zillow ends up making an additional $9k on the mortgage, for a total of $23k in income from the complete transaction. The consumer doesn’t care, because she has to get a mortgage from somebody to buy her new home. Might as well be Zillow and make $5k more on the sale of the old home.
The back-of-the-envelope math looks like this…
Sell with old school realtor: $300k – 6% ($18k) = $282k to the seller
Sell to Zillow: $300k – 8% ($24k) = $276k to the seller
Sell to Zillow then use Zillow Mortgage: $300k – 4% ($12k) = $288k to the seller
Using Zillow + Zillow Mortgage, our once disadvantaged home seller now gets the speed, convenience and certainty of an iBuyer while also yielding an extra $6k in the process. What percentage of consumers would sign up for that?
A lot, me thinks.
The iBuyer / Ride-Share Comp
It is virtually impossible to say how fast an iBuyer might take hold. Residential real estate isn’t the same thing as the taxi industry but, nevertheless, I’m going to make an unorthodox comparison.
According to Business Insider, Uber and Lyft went from single-digit market share to 60% market share in three years (Q1, 2014 to Q1, 2017). And the duo is still trending upward as of Q2, 2018 with 72.5% share.
Yes, again, I realize that ride-sharing is not housing. But my point is that Uber and Lyft are (1) more convenient, (2) less expensive, and (3) usually a better experience than hailing or riding in a cab. Even if you’re skeptical, as I was when I first tried Uber, once you experience just how much better it is than standing on a street corner in the rain with your hand in the air, you won’t be going back.
Think how fast we all went from “are you fucking insane?” to “lmao you still take taxis?” when it comes to Uber and Lyft.
That’s the power of speed, convenience and certainty. It’s coming soon to a real estate market near you.