Why Wall Street Consistently Gets iBuyer Wrong

Over at Forbes, Peter Smirniotopoulos, a Contributor who writes about real estate, penned an article titled, “AI, and iBuyers, Oh My! Are There Structural Limits to PropTech?” It is such a great example of how mistaken Wall Street people are about the iBuyer phenomenon and how confused some of the smartest people in the world are about it.

I have now been talking about this misconception for over a year, and I thought, why not beat that dead horse a bit more, since it appears plenty of people in the world of finance and investment are still confused. I thought fisking Smirniotopoulos’s article would be a good way of going about it, because he writes well and clearly and eloquently about his skepticism with iBuyers. That clarity and eloquence, therefore, shows us why Wall Street consistently gets the phenomenon wrong.

iBuyer: It’s Not Proptech

Smirniotopoulos writes that Rich Barton is keen on its new PropTech venture, Zillow Offers, then writes:

Crudely stated, Zillow Offers is geared to attract Zillow customers who lack the patience and wherewithal to use Zillow’s core service of matching sellers and buyers through its market information platform as the principal vehicle for selling a home. Rather than being active participants in the traditional home-selling process Zillow was founded to facilitate—through which one or more buyers is enticed to place an offer on a home marketed for sale on Zillow’s site and, sometimes, Zillow’s Premier Agent network—Zillow Offers is for those sellers who want to receive the benefit of their home sales proceeds as quickly as possible, and get out of their existing home. In this regard, Zillow Offers may be the PropTech analog to those billboards and direct-mail postcards proclaiming “We Buy Ugly Houses.”

One wonders whether Mr. Smirniotopoulos has ever bought or sold a home in the past 20 years, because Zillow’s core service is not “matching sellers and buyers.” Zillow’s core service, IMT, is to advertise homes for sale for listing agents, then sell leads to buyer agents. You could make some kind of a theoretical argument that the buyer wants to look at a house, so that is “matching sellers and buyers.” But that’s just not how the modern real estate transaction works.

In 99.9% of the contemporary real estate transaction (there are some oddball auctions and such), the sellers and buyers are matched through real estate agents. Usually, there is at least one on each side: one representing the seller (listing agent) and one representing the buyer (selling or buyer agent).

Even after ten-plus years of operation, Zillow’s core service was to generate leads for buyer agents. It’s only paying customers were Premier Agents, who are predominantly buyer agents who buy impression and share of voice and a share of leads.

The consumer is an “active participant” in the contemporary real estate transaction in the most remote sense of the word. The consumer’s activity consists of searching for homes, touring them, then deciding to put an offer in. The consumer’s involvement in the hundreds and thousands of little steps, from negotiating terms to underwriting his mortgage, is extremely passive.

In fact, experienced real estate agents don’t particularly care for “active participant” consumers who often screw things up as they only buy and sell houses once every seven years, while the agents do it rather more often. Listen in on conversations of real estate agents and you’ll often hear the phrase, “manage your client” come up quite a bit.

One way to think about it: the modern real estate consumer is an active participant in his transaction in much the same way that a modern litigant is an active participant in his lawsuit, which is to say, precious little. Hire good professionals, listen to their advice, and then pay them: that’s the involvement.

Why People Sell to iBuyers

The consistent theme with Wall Street skeptics, as well as some self-interested observers within the real estate industry, is that people who sell to iBuyers are under some kind of a special time constraint. As Smirniotopoulos writes:

The on-demand homebuying market created through Zillow Offers and other competitors, such as Offerpad and Opendoor—sometimes referred to as iBuying—takes a high-tech approach to home owners who’d like to sell their “ugly houses” as quickly as possible: That is, houses requiring just too much prep work to make it worth the owner’s while.

I think everyone who thinks this, or says this, should immediately list and sell their primary residence, where they still live, to really experience what it’s like. Do it when you have small children and pets for that additional frisson of “worthwhile.”

As I said at a recent event in Houston, before an audience of brokers and agents, I think every two years, every since real estate agent should be required to live for a month in a house that has been staged for sale. Made eggs and bacon for breakfast? You’ll be spending 15 minutes cleaning up the grease splatters before you get to walk out the door for work. Sit on the couch to watch TV? You’ll spend 5 minutes fluffing pillows and cushions so the space looks immaculate.

Then on Saturdays, randomly load your kids and your dogs into the minivan and drive them around for an hour. Do that three times on Saturday, and twice on Sunday. Then a couple of times during the week for good measure.

Once you have lived through that, you’ll understand.

Here’s the secret: nobody, and I mean nobody, likes selling his house. Nobody likes the traditional way, because the traditional way sucks. They use it because it’s the only real way to sell the house.

We know this by looking at the ultra-rich and how they sell houses: they buy a new house, move into it, then sell the old house. Or they go hang out at the Beverly Wilshire for a couple of months while the house is being sold. They can afford it. But what the rich like, the average American likes as well.

The story of American business innovation is the story of bringing to the masses things and experiences that were once reserved for the wealthy, like running water, electric lights, motorcars, and food prepared for them by someone else.

People aren’t selling to iBuyers because they require too much prep work; people are selling to iBuyers because they can afford to sell to iBuyers to avoid the discomfort, uncertainty, and the long time it takes to sell a house in America today.

iBuyer is Not Flipping

Which is why it is so bizarre that Wall Street continues to insist that iBuying is like high-tech house flipping, despite everyone from Eric Wu at Opendoor to Spencer Rascoff and now Rich Barton telling them that they’re not flipping homes, but providing convenience. Smirniotopoulos writes:

As with any house-flipping operation, it is in the best interests of the potential profitability of the direct buyer (aka the “iBuyer”) to underbid the purchase price at least somewhat, leaving plenty of room for profit and to account for risks. Profit is essentially defined as the difference between i) what Zillow Offers pays the seller for the house; plus any improvements needed to remarket the house effectively and efficiently, including staging expenses; plus transaction costs; plus carrying costs, and ii) what Zillow Offers can garner as the sales price through its remarketing efforts (i.e., after all improvements have been completed). This approach is not new to residential markets. It is derisively referred to as “bottom-feeding”: Pay as little as possible for a property on the front end, and sell it for as much as possible on the back end.

This kind of “journalism” is derisively referred to as “mainstream media” because it is just so lazy.

The simplest bit of research would have shown that real iBuyers do not pay as little as possible for a property on the front end, nor do they sell it for as much as possible on the back end. Zillow itself publishes unit economics of its Offers business that clearly shows that it pays market price for properties, and sells at market price.

For that matter, a bit of Google-fu would have revealed this post from Zillow itself:

Does Zillow Offers Make a Fair Offer?

Recently, some analysts have suggested that traditional sales models will deliver far better value to home sellers than our approach. The reality however, is that selling on the open market may not result in a significantly higher price than Zillow’s offer. We looked at 3,200 homes where a seller declined a Zillow Offer and then went on to sell traditionally within 120 days. We found that these homeowners sell for an average of about 0.22% more than Zillow’s offer. What’s more, a recent study conducted by a third party analyst has come to a similar conclusion, with the results reported in the Wall Street Journal.

Consumer-oriented iBuyer vs. industry-oriented iBuyer

In my August 2018 Red Dot on iBuyers, I went into detail about the difference between what I called consumer-oriented iBuyer programs and industry-oriented iBuyer programs. Consumer-oriented programs are about solving the broken process for buyers and sellers, while the industry-oriented programs are about preserving the role of the real estate agent:

Just like the consumer-oriented iBuyer, the industry-oriented iBuyer has to apply capital to the problem of the broken process, but the end goal is not about the process itself. The end goal is to preserve the role of the real estate broker/agent as a necessary part of the process, and to defend the agent’s value proposition.

This kind of thing is really inside-baseball; we’re talking about differences in philosophy that result in major differentiation. So it’s understandable why someone in the world of finance, instead of in the world of real estate, would blur the differences and lump everything together.

That is a mistake. For example, here’s Smirniotopoulos:

This low percentage of completed Zillow Offers transactions may help explain at least one complaint about the Zillow Offers process: Zillow automatically refers each rejected applicant to a Zillow Premier agent (in case the applicant would like to try to sell their home the old-fashioned way: Through a brokered transaction). In that regard, some regard Zillow Offers as a fishing expedition benefitting its Premier Agents, rather than a transactional platform. That may change, however, as Zillow Offers continues to enter new markets and, presumably, increases the percentage of applications ending in completed sales.

If we’re talking about so-called “iBuyer” programs launched by brokerages, from Redfin to Keller Williams to Realogy, then yes, most of them are fishing expeditions. Those companies think of these programs as listing tools. Realogy even calls its iBuyer program, cataLIST.

Zillow may have begun its Offers program that way, but I really think that all changed when Rich Barton took over. As Smirniotopoulos himself notes, Barton lamented that Zillow didn’t change the home buying transaction. He’s not interested in generating seller leads to sell to real estate agents; he’s interested in fundamentally changing the world. Super-rich ambitious guys usually are interested in that sort of a thing. (See, e.g., Elon Musk, Jeff Bezos.)

Going forward, you’re really going to want to differentiate between consumer-oriented iBuyer programs that are interested in changing the world as much as possible and industry-oriented programs that are interested in preserving the world as much as possible.

It’s Not the Product, but the Process

Finally, I think Wall Street continually gets iBuyers wrong because it’s still focused on the property being bought and sold. In that way, Wall Street is no different than the residential real estate industry.

Smirniotopoulos writes:

While it may be affirming to believe there’s a technological answer to every consumer problem, it may be prudent to consider that PropTech may have its limits in solving First-World problems, like selling a home.

Thing is, he fundamentally misunderstands the whole situation. He thinks that the problem to be solved is the home. He writes:

Zillow and Zillow Offers may continue to struggle to reach the transactional fluidity the co-founders, Barton in particular, originally envisioned (or, at least, hoped for), because residential transactions are nothing like streaming movies, finding rides, or having a restaurant’s menu items delivered to a customer’s door when that restaurant doesn’t offer delivery. Homes are unique; the locations of homes are unique; and the sheer scale of a single transaction can be completely overwhelming, particularly for first-time homebuyers. In other words, a home is the least-widget-like product imaginable.

Even something as genuinely personal as a dating app, where the products are, arguably at least, similarly unique, doesn’t have the market resistance of home-selling/buying apps because the consumer can easily bail on that bad Tinder choice after a single date, without adverse consequences. Making the wrong choice in the purchase of a personal residence, on the other hand, can be nothing short of disastrous emotionally and financially. [Emphasis added]

I think it’s enlightening that he compares iBuying to online dating, because the products are similarly unique. The he actually talks about bailing on the date vs. making the wrong choice in the purchase of one’s home.

Thing is, iBuying is not about the property at all. It’s about the process.

Using the dating analogy, iBuying isn’t about the person but about the date. Imagine that to go on a date, you need to fill out a dozen government forms, have some health examiner approve the date after consulting a lengthy (and regulated) dating underwriting standards, and spend thousands of dollars on new clothing, new makeup, and maybe plastic surgery… and then the date itself consists of poking and prodding at you to see if you fit their ideal mate standards. Who would date?

Despite some changes in recent years, the process of dating is supposed to be fun and pleasant. It’s called online dating, after all, not online marriage.

With homes, of course it’s unique and not widget-like. No one denies that. Yes, making the wrong choice can be disastrous emotionally and financially. No one denies that. Nobody is suggesting that with iBuyers, people will just go buy houses willy nilly sight-unseen.

What iBuyers are suggesting is that the transaction experience can be improved, not that the homes are widgets. All of the obsession with homes in inventory, prices paid and prices sold, etc. all ignore the plain fact that this new iBuying movement is not about the home/product but the transaction/process.

So let’s wrap up here.

I didn’t really want to pick on Smirniotopoulos. As I said, he writes clearly and logically about his skepticism with iBuyers. He makes excellent points… based on wrong premises. Therefore, he makes for an excellent example of how otherwise intelligent, insightful, and smart people on Wall Street consistently get iBuyers wrong.

The analysis is wrong because it focuses on buzzwords and popular concepts, like proptech and flipping and homes are not widgets. What everyone looking to understand this trend needs to do is to focus on the process, the process, the process.

It’s not the home, but the transaction. It’s not the person you swiped on Tinder, but the date.

-rsh

 

 

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6 Comments

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  1. Rob,

    You are so good at writing & so insightful & smart that undoubtedly you get a large variety of interested consumers of your thoughts.

    Currently, Zillow is paying market price for homes with the idea of blitzscaling I-buying (Reed Hoffman). But, it’s fundamentally challenging. No business has low margins (below 30%) & a high multiple (enterprise value/price). Something has to give. Is I-buying amazing for consumers? Yes. Can I-buying be a successful business? Probably. But, Zillow only sold ~1200 homes last quarter. Could someone please post the attachment rates of title & mortgage?

    All of these arguments by Keith Rabois & such show the economics of I-buying from the consumers point of view. BUT, it’s a terrible business from an investors standpoint. A SaaS valuation with worse margins than a traditional brokerage. Grubhub / WeWork, hello!

    If I’m a seller, I want to know what’s the number inside the envelope. If I’m an investor, I want to own a share of a real estate marketplace (Redfin Direct!).

    1. Excellent points, all. And frankly, I am not a sell-side analyst though I know a few really good ones who cover real estate stocks. I think you may be on to something in terms of margins for an investor perspective.

      Thing is, I don’t think Rich Barton cares all that much about multiples and such either. I think he’s out to change the world. And the margins are actually not that horrible if you dig in a bit deeper. Those will continually improve as iBuyers scale as well.

      From an investor standpoint, I think it’s worth thinking about the multiples of market makers (Glencore is the only one I can find that is public, and they’re at 37.98 P/E ratio, but of course they have significant non-trading operations/assets as well).

      If iBuying is amazing for consumers, the rest will work itself out, AFAIC. The challenge for traditional real estate is to somehow make the consumer experience better than it is. Improve the date, not the person.

    2. Zillow is currently at 4x EV/Revenue based on last 12 month’s revenue and 2x EV/Revenue based next year’s projections… hardly a SaaS valuation.

  2. ROB,

    I think most of us can agree that price is at the center of a transaction. All the surrounding activities (the process) only happen if the buyer and seller can agree on price.

    This is where I struggle. Call it “proptech” or whatever…IMO, the pain point for the model is pricing. Unless, they have troops (partners, agents etc.) on the ground helping out – which would create something new.

    I do agree with the Forbes author when discussing the uniqueness of houses. I think agents that do business in markets outside of iBuyers parameters (above $400,000 or below $200,000) would agree that establishing a list price is one of the toughest components of the process.

    So, I’m back to “how big is the market” and “how will the purchase price be determined as the model expands into more unique housing”?

    The reality for this interest is happening now in certain Chicagoland markets. A listing price of $500,000 becomes a sale at $425,000. A $3MM listing can result in a sale at $2.3MM. I’m not sure all the title, insurance and mortgage fees can cover those kind of losses?

    We’ll see!

    Thanks,
    Brian

    1. All of the “proptech” involved in iBuying is just around trying to get accurate pricing. And pricing is an area where I do think AI and Big Data and such could really help. There are studies that show that AVM’s are superior to human agents in pricing homes, after all.

      Also, with iBuyers now in places like Los Angeles and Denver, I think you should expand your idea of what the buy box is. It’s way over $400K in some markets.

  3. Great analysis Rob! To take the viability of the I-Buyer model one step further, consider this: most of the markets where I-Buyer companies have operated in are seller’s markets. In a more balanced market or a buyer’s market, I believe the I-Buyer share will grow substantially. Currently, in seller’s markets, there’s less incentive to take a lower than market offer. But in a tough market, when Days on market approach 3-6 months, an offer to buy, even significantly below market price, will be very attractive, given the alternative: try to sell for 6 months, stressed, showing the property, dropping the price incrementally but never catching up. If I-Buyer works in a seller’s market, it most certainly will work in balanced or buyer’s markets and that portends good things for the likes of Z and OpenDoor.

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