My "iBuying Disrupted" Presentation

"Only Mike would start a 9 a.m. presentation talking about EBITDA and GAAP financials." – Anonymous Zillow executive

Two weeks ago I had the pleasure of speaking at Inman Connect Las Vegas -- one of the world's premier real estate conferences. My talk, "iBuying Disrupted: Battle of the Behemoths," was followed on stage by Rich Barton, CEO of Zillow, Glenn Kelman, CEO of Redfin, and Eric Wu, CEO of Opendoor. What a lineup!

Watch the video

At the Inman Connect Las Vegas 2019 conference, Mike DelPrete, an entrepreneur, analyst and real estate industry strategic adviser, took to the stage to explain the seismic shifts shaking up the residential real estate market.

Some of my favorite lines from the presentation:

“There’s a new competitive advantage in town: sustained unprofitability.”

"Red is the new black."

"Agents are the ultimate iBuyer aggregator."

“iBuying is the new Zestimate."

“Companies and agents that win will be the those that empower consumers to make the choice that’s right for them.”

In addition to the video of my presentation, you can also download a copy of my my presentation slides. I'd love to hear your feedback!

4 strategies for agents to stay relevant in the age of iBuyers

New content alert! I'm trying something new: crisp, strategic "quick hits" that offer actionable suggestions. I usually publish evidence-based industry insights, while my consulting work focuses on hands-on strategy and guidance. This is meant to bridge the gap between the two -- let me know what you think!

iBuyers are a rising force in real estate. Companies like Opendoor, Offerpad, and Zillow are collectively spending billions to offer consumers a new way to buy and sell homes. As iBuyers expand nationally, more and more real estate agents and brokers are being faced with a key strategic question: How do we stay relevant in the age of iBuyers?

As overall iBuyer activity exceeds 1,000 home purchases and sales per month in just one market -- Phoenix -- it’s a trend that can't be ignored.

I’ve conducted deep analysis on iBuyers for the past four years, culminating in the recently released iBuyer Report. Based on that background and my work in the industry, I offer four key strategies agents and brokers should consider when evaluating their response to iBuyers:

Be a trusted advisor. The role of a real estate agent has always been to help guide consumers through the home buying and selling process. An instant, cash offer on a house simply represents a new path to the same end. This doesn’t mean there isn’t a role for an agent; it’s simply another path that needs navigating. And the agent is uniquely placed to be that expert advisor.

Solicit multiple offers. As a trusted advisor who represents the home owner’s best interests, an agent is well-suited to solicit multiple offers on a home from multiple iBuyers, and to present those offers alongside a traditional market sale. The iBuyers’ online processes make it easy to receive multiple offers; the agent can do the work and provide guidance. Each major iBuyer offers partnership programs that pay a referral fee for a successful transaction.

Don’t ignore them. iBuyers are spending millions of dollars each month on direct-to-consumer advertising (TV, radio, and digital). Agents and brokers can’t (and shouldn’t) compete with that spend, and they can’t ignore the fact that consumers are being educated -- on a massive scale -- about iBuyers. Ignoring them won’t make them go away. (In the past two months alone, I’ve been quoted in the New York Times, the Wall Street Journal, and Marketplace -- all doing stories about iBuyers.)

Highlight the power of personal relationships. Real estate agents are people, and iBuyers are corporations. If you’re an agent, highlight the personal relationship you bring to the process. The power of human psychology is incredibly strong in real estate; brokers and agents should use it to their advantage.

iBuyers represent a significant shift in the real estate landscape, but it’s not a zero-sum game. Real estate agents and brokerages can employ specific strategies to stay relevant, highlight their strengths, and maintain their position as a trusted advisor in the center of the transaction.

iBuying is Zestimate 2.0

When Zillow launched in 2006, its Zestimate was its claim to fame.

The Zestimate was a lead generation tool that attracted consumers by giving them a starting point for determining what their home -- or any home -- is worth. It was online, it was fast, and it was easy.

Flash forward more than a decade later, and online valuation tools are a commodity. There are dozens of web sites that will determine a home's estimated value. Zillow’s unique advantage has diminished.

Zillow's strategic necessity

I believe Zillow's guiding strategic principle is that it must be consumers' first destination in the home buying and selling process. Zillow's sustainable competitive advantage lies in its massive audience and strong position at the start of the consumer journey.

In the past, other listing portal competitors were relatively undifferentiated. Zillow has been the clear market leader, and there was no credible threat that could unseat it from its powerful position.

However, the entry of iBuyers with a service that made instant offers on a home – online – was novel and compelling, just like the Zestimate in 2006. Suddenly, more and more consumers were beginning their home selling process not on Zillow, but on other web sites like Opendoor and Offerpad. This was a key existential threat for Zillow.

The iBuyer business model is Zestimate 2.0 – the natural starting point for determining your home’s value. What’s more accurate than an actual offer on your home?

Mass-market appeal

Opendoor's long-term vision is that every home owner will request an instant offer before selling their home. It's a natural starting point: It's easy, it provides value, and there's no commitment. What better way to value your home than an actual offer?

While Zillow only purchases around three percent of the offer requests it receives (that number is higher for the other iBuyers), a very large number of consumers are requesting offers each month. In established markets like Phoenix, anywhere from 25–35 percent of active home sellers request an instant offer before selling their home. The numbers are BIG.

Given the growing mass market appeal of an instant offer (tens of thousands of requests each month) and the simplicity of the process, it's no surprise that Zillow launched its own iBuyer service.

Strategic implications

If you're in the business of providing consumers an estimate of the value of their home, the bar has just been set higher. The inherit power and appeal of the iBuyer model is quite clear:

• Instant offers are simple, easy, and quick. All online.

• Instant offers are at the start of the funnel -- they attract consumers at the start of the home buying or selling journey.

• It's a novel concept that satisfies a consumer need, hence the high proportion of consumers requesting offers.

In other words, iBuying is the new Zestimate.

Zillow's New Strategy: Insights, Implications, and Analysis

Last week, Zillow announced a major strategic shift: Along with a new CEO, it made clear that its top focus is its Zillow Offers iBuyer business.

Today's email covers the highlights of that announcement. Additionally, next week I'll be holding a 60-minute webinar that dives deep into the strategy, numbers, and implications of Zillow's latest move.

Premier agent growth grinds to a halt

The most striking statistic from Zillow's results is the lack of projected growth in its flagship, billion-dollar premier agent program (which accounts for 67 percent of its revenue). Guidance for the first quarter of 2019 is only 1.5 percent -- a steep decline from past quarters.

And on a full-year basis, Zillow projects its premier agent program will grow at 2 percent -- a flattening from past, double-digit growth.

Both of these projections come on the back of difficulties rolling out new premier agent products focused on lead quality over quantity.

But what's most striking is the suddenness of the decline. Going from double-digit to flat growth in the span of a year is significant. More than rollout issues, I believe Zillow has reached the upper limit of what it can charge agents for leads. Which is what's driving such a significant shift in strategy.

Expensive homes and a longer hold time

Last week I wrote about Zillow's unsold inventory in its Offers program, and the significance of longer hold times. The latest data highlights the same challenge.

The homes Zillow sells are less expensive: an average sale price of $292,000. However, the houses it holds in inventory are considerable more expensive, with an average value of $320,000.

This data point matches up exactly with the latest data from Phoenix, which shows a considerably higher average purchase price for Zillow compared to the other iBuyers.

The more expensive the home, the higher proportion of unsold inventory. It takes longer to sell more expensive homes, and it looks like Zillow is more than dabbling in the expensive end of the market. This is a key metric to watch!

Profit projections

Zillow released a detailed financial breakdown for its Offers business, including initial profit margins on its sold homes. Adjusted EBITDA, which backs out a number of costs including stock-based compensation, shows a per-home profit margin of 0.6 percent, lower than the stated goal of 2–3 percent.

(As a form of employee compensation, I believe stock-based compensation should be included in a true EBITDA calculation, so I've provided both options above.)

It's still early days, but this benchmarks current performance compared to where the business needs and wants to go in the future.

Strategic implications

I believe Zillow's guiding strategic principle is that it must be consumers' first destination in the home buying and selling process. Zillow's sustainable competitive advantage lies in its massive audience and strong position at the start of the consumer journey.

Think of this latest move as "Zestimate 2.0." The original Zestimate gave consumers a fun and helpful starting point when thinking about moving or buying a house. Now that online valuations are a commodity, Zillow needs to up the game: Instead of an estimate of value, how about an actual offer on your house? It's a compelling consumer proposition -- even if it simply serves the same purpose as the original Zestimate (attracting consumers at the start of the journey).

There's a whole lot more to discuss! If you want to listen and watch as I dive deep into the subject, register for next week's webinar.

Zillow Offers' most important metric

Later today, Zillow will announce its fourth quarter and full year 2018 results. Its activity as an iBuyer continues, and it recently overtook Offerpad to become the second-largest iBuyer in Phoenix. But my attention is focused on one key metric: Zillow's ability to quickly sell houses.

Why it matters: Zillow's goal is to hold houses for an average of 90 days. Any successful iBuyer needs to hold houses for as little time as possible, otherwise unsold inventory builds up, finance costs rise, and the whole model starts to blow up.

Overall activity grows; #2 in Phoenix

Zillow's overall iBuyer activity continues to grow, both nationally and in Phoenix (its biggest market). Based on the total number of homes purchased and sold, Zillow overtook Offerpad to claim the #2 spot in Phoenix for the month of January. Zillow is -- for the moment -- the second-largest iBuyer in the important Phoenix market.

Buying more than it's selling

While Zillow's overall activity continues to rise, its purchases are quickly outpacing sales. This is to be expected in the early months of a new market, but it's now eight months since launch. This is creating a growing inventory of unsold homes: around 350 in Phoenix as of February 12th.

It's natural for iBuyers to buy more houses than they sell when entering a new market. But over time, this Buy:Sell ratio is a critical metric for any iBuyer. Houses must be sold for the business to work!

Expensive homes, longer hold time

There are early signs that Zillow may be having difficulty selling houses. For iBuyers, time is money. The faster they can turn around and sell a house, the better.

The magic number for total holding time is around three months; Opendoor and Offerpad hold for between 80-100 days. Zillow currently has around 350 unsold houses in its inventory in Phoenix. Of those, it appears that around 110 homes have been owned for more than three months.

Part of the reason Zillow appears to have longer holding times may be the price of the homes it is purchasing. On average, it is buying more expensive homes than the other iBuyers in Phoenix.

Nationally, Zillow has purchased over 700 homes with an unsold inventory of over 500 homes.

The more expensive the home, the higher proportion of unsold inventory. It takes longer to sell more expensive homes, and it looks like Zillow is more than dabbling in the expensive end of the market.

Strategic implications

The key metric to watch is how well Zillow can sell its houses. Buying is relatively straight-forward; only once a house is sold is the entire business model complete.

To succeed as an iBuyer and appropriately manage its risk, Zillow needs to hold its houses for a minimum amount of time (on par with the other iBuyers), and avoid building up a large inventory of unsold homes.

It's still early days and Zillow has been quite aggressive in growing as fast as possible. But with its one year anniversary four months away, the pressure is on to demonstrate a consistent ability to buy -- and sell -- houses.

My Inman Connect Presentation

Earlier this month I had the pleasure of presenting at Inman Connect in New York City. My session, "iBuying Goes Mainstream: How Big Can it Get?" covered a range of topics, from the evolving role of portals to the latest iBuyer analysis.

My key points are outlined below. Watch the video of my presentation and download a copy of my presentation slides.

Growing iBuyer traction

The rise of iBuyers continues. During my presentation, I shared some of the latest national data available; a "sneak peak" at my upcoming iBuyer Report.

Opendoor in particular continues its strong growth in terms of houses bought and sold, clearly accelerating in 2018. Overall, iBuyers are small but growing: around 5 percent of the market in Phoenix.

The consumer journey

If you're an Inman subscriber, you can read the provocatively titled writeup of my presentation, "Opendoor's 'nightmare': KW agents backed by their own iBuyer." To quote:

 His point is that Opendoor, a tech-powered homebuying and selling startup with $1 billion in venture capital, is vulnerable to competition from companies that already connect with consumers on a massive scale at the beginning of their home-buying or selling journey.

Who wins?

The best new business models are exponentially better than the status quo, and the biggest companies are exponentially outspending their competitors.

Whether it's materially better efficiency with models like Redfin and Purplebricks, or Opendoor raising (and spending) 10 times the capital than its nearest competitors, the stakes are big. The trends that are impacting the industry are not incremental.

My presentation

You can watch the video of my presentation, and download a copy of my my presentation slides. I'd love to hear your feedback!

Zillow's billion dollar seller lead opportunity

Last week, Zillow announced its latest financial results, and the stock dropped 25 percent (losing $2 billion in value). But the story everyone is missing is the Zillow Offers iBuying business, and the huge potential of seller leads.

Why it matters: Last week I was quoted on MarketWatch saying, “If you’re thinking about Zillow doing iBuying and you’re not thinking about seller leads, you’re thinking about it the wrong way.” Seller leads are the real billion dollar opportunity.

Slowing premier agent growth

Here's the reason why Zillow's stock tanked 25 percent last week, in one chart:

Zillow's premier agent program accounts for over 70 percent of its revenue, or nearly $1 billion. Growth is slowing down. I'm not sure why this surprised anyone on Wall Street; I've been writing about it since early this year (Zillow's revenue growth slows and Zillow's strategic shift to iBuying and mortgages). I believe it's the primary reason Zillow has aggressively expanded into adjacent businesses.

The value of seller leads

Zillow's iBuyer business continues to grow, and the latest results crystalize the opportunity in seller leads.

Zillow says that since launch, nearly 20,000 homeowners have taken direct action on its platform to sell their home. Of those, it has purchased just about 1 percent of homes (around 200). That leaves about 19,800 leads who remain interested in selling their homes.

If Zillow simply sold those leads at $100 a pop, they're worth nearly $2 million.

But the real opportunity is giving those leads to premier agents in exchange for an industry-standard referral fee, about 1 percent, if the property sells (similar to the Opcity business model).

Here's the kicker: Zillow claims about 45 percent of consumers that go through the Zillow Offers funnel end up listing their home. That's a high conversion rate reflective of a high intent to sell; about 10 times higher than Opcity's conversion rate.

Assuming a 1 percent referral fee, a $250,000 home, and a conversion rate of 45 percent, those 19,800 leads are worth $22 million in revenue to Zillow, almost all profit.

Compare that to the estimated profit of its iBuyer business (1.5 percent net profit), which, on 200 houses, is $750,000. The value of the seller leads is worth almost 30 times the profit from flipping houses!

Total addressable market

Zillow says that based on its current purchase criteria, if Zillow Offers were available in the top 200 metro areas in the U.S., sellers of nearly half of the homes sold in 2017 across the entire nation would have been eligible to receive offers from it to buy their home directly. That equates to around 2.75 million homes annually.

Last quarter, Zillow said that it received offer requests from around 15 percent of the total for-sale stock in the Phoenix market. Interestingly, that number increased to 25 percent in September and 35 percent in October. That's a reflection of the strong lead generation power of Zillow Offers across its various web properties.

Based on these numbers, if Zillow goes national (200 metro areas) and sees 35 percent of the for-sale stock, it would receive 962,500 offer requests each year.

The billion dollar opportunity

Taking the latest numbers, which have been validated to the tune of 20,000 offer requests over five months in two markets, the total opportunity becomes clear with a national rollout.

Seller leads can be a billion dollar business for Zillow if you believe the current numbers. Even if a national conversion rate is lower, or the % of for-sale stock fluctuates, it's still worth several hundred million dollars in revenue annually.

Should Zillow even buy houses?

Given the value of the seller leads, should Zillow even be in the business of buying houses? Yes, if it wants a credible product for consumers. The real question is: What proportion of houses should Zillow actually buy?

Zillow's "big picture" is 5 percent national market share, which equates to buying around 10 percent of all offer requests (it is currently buying around 1 percent of offer requests). At a 1.5 percent net margin, that's around $1 billion in profit.

But to reach that scale, Zillow would need to spend $68 billion to purchase 275,000 houses annually. Assuming an average holding time of 90 days, it would need a credit line of $17 billion to fund the effort. Big numbers.

A more realistic target would be to only purchase around 1 percent of requests. Nationally, that would be 27,500 homes, which is only around double what Opendoor is currently doing, so it's feasible.

In any case, the point is clear: Zillow doesn't need to actually buy and sell a lot of houses for this model to generate significant profits for the company in a national rollout.

Strategic implications

Zillow is a lead generation machine, and its recent foray into iBuying is no exception. 

If you're in the industry and your value proposition to agents is seller lead generation, there's a new game in town. Zillow will be able to generate a massive volume of seller leads with higher intent than almost any other source. If successful, this will have significant implications across the industry.

Further analysis

If you're looking to dive deeper into the world of iBuyers, consider the following:

• iBuyer Business Model Overview and Analysis: all of my free research and reports on the iBuyer space.

• iBuyer Intelligence Briefing (Recording): a 60-minute conference call I conducted on the latest iBuyer news, key insights, and strategic implications for the real estate industry.

• Phoenix iBuyer Report: the only source for accurate, timely iBuyer market data for Phoenix. Available as a monthly subscription.

Opendoor's pivot to agents

According to a report on Inman, Opendoor is launching a new preferred agent partnership program where it is co-listing a growing portion of its for sale properties with partner agents.

Why it matters: This is a significant pivot for Opendoor, aligning it closer to agents in a major way. It signals that working with the traditional industry -- rather than trying to disrupt it -- is an important part of its growth strategy.

Working with agents

Opendoor's new preferred agent partnership program brings the company much closer to agents. As opposed to the company's hallmark of buying and selling direct to consumers, with a do-it-yourself open home model, this latest move represents a big pivot.

Before this program was announced, the way Opendoor sold its homes was fairly uniform: it would list direct without an agent, offer self-guided tours, brand everything Opendoor, and not pay seller agent fees since it was selling direct. But things have changed:

An unknown question is how Opendoor is compensating co-listing agents. There are three possibilities, listed in order of likelihood:

• The agent receives a referral fee (likely 1 percent) for representing Opendoor.

• The agent receives a fixed fee ($1,000) for representing Opendoor.

• The agent receives no direct compensation, but benefits from potential leads while hosting open homes.

Why the pivot?

This is a big move for Opendoor, and it would only make a change if there was a business benefit.

Opendoor is moving towards an agent-centric model, where it's co-listing and co-branding with a traditional real estate agent (and the traditional process it is aiming to disrupt). That's a non-trivial shift. And assuming Opendoor is compensating co-listing agents as outlined above, there's a significant economic shift as well.

Opendoor is in the business of buying and selling houses. So any pivot must enhance that capability, leading to two possible reasons for the change:

• Sell more houses, faster.

• Attract more agents representing sellers (buy more houses).

For a co-listing arrangement to make business sense, it must enable Opendoor to buy or sell more houses. Either its existing process isn't quite where Opendoor wants it to be, or there's an external reason to cozy up to agents...

The Zillow factor

There's one other factor to consider, and that's the relatively recent arrival of Zillow to the iBuyer game. As a reminder, Zillow's angle is to include agents in each step of the process, using its premier agent network to represent all sides of the transaction.

Opendoor's latest move puts it squarely at parity with Zillow in terms of agent involvement and the value proposition for agents.

Now, if you're an agent, the benefits of working with Opendoor are the same as working with Zillow. For Opendoor to make this degree of change, and give up image and economic value in order to appeal to agents, it must really want to work with agents!

Strategic implications

There's a long history of would-be real estate disruptors that attempted to disintermediate the traditional industry, only to change their minds and pivot back.

It's hard to go against real estate agents. There's just so many of them, and psychologically consumers want to keep using them. Many disruptors start with anti-agent tendencies but eventually come back to the fold. It's easier and more profitable to work with the industry than against it.

This is not a full-scale retreat on Opendoor's part; far from it. But it's the strongest signal yet of the importance of agents to its current growth strategy.

Zillow, Opendoor, and controlling the consumer journey

Last week I conducted the iBuyer Intelligence Briefing -- a conference call on the latest iBuyer news, trends, and insights -- with listeners from around the world.

After the call, one particular question lingered: Which part of the industry controls the starting point of the real estate transaction, portals or iBuyers? Who has the advantage, and what are the implications for iBuyers?

Zillow's lead generation machine

Zillow announced its Zillow Offers program in Phoenix earlier this year, and started buying houses in May. It is heavily promoting the program across its site. While looking in the Phoenix market, a prominent message is displayed on all active for sale listings.

And if a visitor looks at an off-market listing (like their own home), this is the call-out at the top of the listing.

In its latest quarterly results, Zillow revealed how effective the promotion was: "Since launch, we have received more than 10,000 offer requests from potential sellers." And: "...in Phoenix, for example, we are seeing about 15% of all dollar value that's being sold in Phoenix any given month." That translates to about 1,600 offer requests per month.

Opendoor is on record saying that more than "one in two sellers who received an Opendoor offer" will accept it. It's currently buying around 300 houses per month in Phoenix, so that's about 600 offers made per month.

There's a difference between an offer being requested, and an offer being made. What's clear, though, is that Zillow is generating a massive amount of offer requests each month, at volumes that rival (and exceed) Opendoor.

Most importantly, Zillow's leads are coming with zero incremental customer acquisition cost, while Opendoor and other iBuyers must advertise directly to consumers to generate leads.

The Zillow effect

The ultimate question is whether Zillow's entry into the market is having an effect on Opendoor. Is Zillow soaking up demand from consumers, to the detriment of Opendoor?

The chart above shows a clear picture: the number of homes that Opendoor is purchasing in Phoenix has plateaued. But there are two possible explanations for what's going on:

• Zillow is having an effect on Opendoor's traction in Phoenix by soaking up consumer demand.

• Opendoor is slowing its buying activity for other reasons (we've seen this before).

It's too early to say if Zillow is having a direct effect on Opendoor's business in Phoenix. Opendoor may slow its buying activity for a variety of other reasons, namely a potential market slowdown.

But what's clear is the leading position Zillow holds in the consumer journey and its massive reach give it a competitive advantage in acquiring customers -- which has long-term consequences.

Strategic implications

Back in February, I wrote the following: "The most logical response from a major player such as Realogy or Keller Williams would be to launch their own iBuyer program." Which is exactly what happened last week. More competition is coming to the market.

As incumbents, portals, and other new entrants enter the iBuyer market, they have the potential to soak up consumer demand and adversely effect Opendoor's business.

But for Zillow in particular, the evidence is clear: Real estate portals are in pole position to capture consumer demand for iBuying services, because they are at the start of the consumer journey. Will other global portals follow Zillow's lead?

Zillow will beat its Q3 homes revenue guidance

With September wrapping up, we can look at the latest iBuyer numbers out of Phoenix and see how Zillow is doing.

Why it matters: Based on the data in Phoenix alone, Zillow will beat its Homes revenue guidance of $2 - $7 million. But other indicators, including a lower-than-expected margin and higher purchase prices, are worth watching.

Q3 Revenue beat

During its last earnings results, Zillow provided Q3 revenue guidance for its Homes unit of $2 - $7 million. Based on our proprietary data set for Phoenix, Zillow sold 30 properties in Q3 for $9.3 million in revenue. So in Phoenix alone, Zillow will beat its revenue guidance.

Thirty sales over three months is a modest amount. By comparison, Opendoor sold 26x that number in the same period. Zillow is clearly still in its ramp-up period and has some ways to go.

This result highlights a few other observations:

• Guidance is hard. Zillow is still finding its way in this new endeavor, and is having to constantly readjust its assumptions. It’s a positive sign, but clearly highlights how new to this business Zillow is.

• Zillow's full-year revenue guidance of $20 - $40 million in Homes revenue is achievable (it simply needs to sell the same number of houses in Q4 to hit the low end of that range), but a lot depends on traction in other markets. I would expect Zillow to revise this guidance during the next earnings call.

Buying momentum up

In Phoenix, Zillow continues to expand its operations on a month-to-month basis. The number of homes purchased is increasing by about 40% month-on-month — to over 60 in September. By comparison, Opendoor is buying around 5x as many houses in that same period (solely in Phoenix). Zillow is clearly serious and committed to this new initiative.

Unsold inventory

One of the potentially worrying indicators, however, is the amount of unsold inventory Zillow has in Phoenix. While the number of properties it is buying is increasing, the number sold is low.

To-date, Zillow has purchased over 150 properties and has sold 30.

In September, the ratio of homes bought to homes sold is 0.14 — down from 0.34 in August. Comparatively, that ratio for Opendoor is 1.01 and 0.95 for Offerpad.

Clearly Zillow is still ramping up its operations so it’s natural to expect a lag between buying and selling properties. But even accounting for a 90 day holding time window, the September number should have been larger (I would have expected a buy:sell ratio closer to 0.50). All eyes are on October.

There are a number of other interesting indicators worth watching:

• A lower-than-expected margin (the difference between what Zillow buys and sells a house for).

• A median purchase price that is materially higher than its iBuyer peers (but is starting to drop).

Traditional agents wade into instant offers

A Keller Williams team in Phoenix recently launched OfferDepot, an instant offer play, to "help with all the confusion with cash offers vs bringing your home to market."

Why it matters: This is the first move from a traditional real estate company into the instant offers space.

Welcome, incumbents. Seriously.

The idea that traditional real estate incumbents would enter into the iBuyer's instant offers party isn't new. Back in February, I wrote:

"...the more successful Opendoor becomes, the more of a threat they become to industry incumbents, which forces them to respond. The most logical response from a major player such as Realogy or Keller Williams would be to launch their own iBuyer program."

This isn't a top-down corporate initiative on the part of Keller Williams. Rather, this is a local team reacting to the rising interest in iBuyers and pushing to stay relevant.

The Keller Williams team isn't buying houses directly. It is collecting inbound leads from potential sellers, gathering information on the home, receiving instant offers on their behalf, and presenting everything back to the home owner (including an option to list the home on the open market) in a comparative analysis.

Why now?

We can speculate as to the reasons this Keller Williams team decoded to jump in to the fray:

• It doesn't want to miss the boat. Whether it's Opendoor raising another $325 million or Zillow jumping in with both feet, interest in the space has never been stronger. Traditional real estate agents -- and Keller Williams -- are in the business of selling homes. Why would they let this new model pass them by? Doing nothing is not an option.

• A one-stop-shop. It's relatively easy for traditional agents to bolt on an instant offer service, thereby turning them into a one-stop-shop for home sellers (and negating the need to contact an iBuyer like Opendoor or Offerpad).

• Seller leads are super valuable. This is another form of lead generation for traditional agents, with each request representing a likely customer.

Implications for iBuyers

In my previous analysis, I summed up the major implications of incumbents entering the instant offer space. The first deals with the user experience:

"Make no mistake, the offer and the experience from the incumbent is going to be bad. They’re simply not set up to provide the same quality of service as Opendoor."

The online experience isn't great. In a design reminiscent of the mid- to late-90's, users must struggle through a form to submit their home's information. It's a far cry from the premium experience Opendoor strives to offer its customers through the entire process.

But it works. It does what it needs to and collects leads. And it is this dilutive effect that is the biggest implication to dedicated iBuyers like Opendoor. As I wrote in that same analysis:

"The proposition from the incumbents will be poor, but it will be enough to soak up a portion of the demand in the market and take momentum away from Opendoor and other iBuyers."

It's simple economics. If we assume the demand remains constant, the addition of supply will dilute the amount of business any one iBuyer receives.

There will also be more customer confusion as incumbents get into the game. When Opendoor was the only option in town, it was simple. But now there are a variety of choices: multiple dedicated iBuyers (Opendoor, Offerpad), a popular web portal (Zillow), a tech-enabled brokerage (Redfin Now), and a traditional real estate agent (OfferDepot). What's the difference? Who do I trust? It's difficult to explain the various propositions to consumers.

At the end of the day, that's good for traditional brokers and agents (as they can soak up additional demand), and bad for dedicated iBuyers (because of the dilutive effect and customer confusion).

Where to from here

This is just the start! Expect a lot more activity in this space by the incumbents. It's only a matter of time before a big incumbent launches a well-funded, well-designed initiative. And it may not stop at just presenting offers on an iBuyer's behalf...

The Opendoor Paradox: A Strategic Analysis

Last week I had the pleasure to visit Opendoor, the billion-dollar real estate disruptor, to give a presentation on emerging models in real estate around the globe. The presentation covered my two-year research into the winning models that are changing how houses are bought and sold.

There were some great questions from the audience, both on international models but also my thoughts on the Opendoor model itself. These thoughts, in addition to a number of recent conversations with investors interested in the space, led me to contemplate Opendoor’s future strategy and the complex competitive situation it faces.

The end result is what I call the Opendoor Paradox, and the premise is simple: the more successful the business becomes, the harder it will be to succeed.

Business model challenges

The business model of Opendoor and other iBuyers (those that buy houses directly from consumers and then sell them on) has a number of challenges:

• An undifferentiated product. At its core, all iBuyers offer the same basic product to consumers: certainty and simplicity. There may be price competition or various technologies to support the process, but those advantages lie in the margins. The typical consumer only cares about one thing: instantly selling their house.

• Resource intensive. The iBuyer model is expensive, and not just because it’s buying houses. To be successful, iBuyers need a lot of boots on the ground in each market they operate. These businesses are people intensive.

• No repeat customers. This is true for all of real estate, but it doesn’t change the fact that without repeat business the cost of attracting new customers is expensive. There are no economies of scale around attracting and retaining a loyal clientele. Most importantly, this levels the playing field and reduces the barriers to entry for competitors.

Competitive tension

The U.S. is big, but for whatever reason the growing pack of iBuyers have all decided to launch in the same bunch of cities. Phoenix, Las Vegas, Atlanta, Orlando -- that’s the battleground. It’s a mess of a competitive situation where they will end up spending valuable time and resources competing against each other instead of growing the market.

Markets in bold have three or more active iBuyers.

Traditional marketplace businesses have a first-mover advantage. The first to enter a market builds brand and audience, and with each day that advantage becomes harder to overcome (network effects).

But that’s not true with iBuyers. Being first to launch in a market doesn’t necessary bestow an unfair advantage.

Because of this, it’s most likely a winner-take-most market, similar to Purplebricks and the online agencies in the U.K. With a distinct lack of network effects, an undifferentiated consumer proposition, and no customer base, you end up with a healthy competitive field that, over time, is most likely dominated by one large player.

I would expect to see more competitors launch in 2018. The market is going to get very crowded very fast. And that forms part of the paradox: the more successful Opendoor and its model becomes, the more competitors will enter the space to get a piece of the action.

The real competitive threat: incumbents

While the various iBuyers might beat each other up through tough competition in each market, that’s not the biggest competitive threat they face. The top competitive threat is the massive real estate incumbents themselves.

This forms the next part of the paradox: the more successful Opendoor becomes, the more of a threat they become to industry incumbents, which forces them to respond. The most logical response from a major player such as Realogy or Keller Williams would be to launch their own iBuyer program.

This is what Redfin has done with Redfin Now. Redfin was able to spin this test up quickly and is now able to adopt a “me too” proposition when attracting new customers. For a small amount of effort, incumbents can blunt the iBuyer proposition.

It’s a simple extension: If a consumer decides to sell their home with an incumbent, they can choose the traditional agent services for a commission, or they can sell it instantly for a fixed offer and certainty.

Make no mistake, the offer and the experience from the incumbent is going to be bad. They’re simply not set up to provide the same quality of service as Opendoor, and most likely will lowball the seller to protect their margins. But the offer will be present and it will appeal to some sellers.

The proposition from the incumbents will be poor, but it will be enough to soak up a portion of the demand in the market and take momentum away from Opendoor and other iBuyers. And if Opendoor can’t scale or if it becomes too expensive to attract new customers, it’s game over.

The more successful Opendoor becomes, the more incumbents will be forced to react, and when they do it will harm Opendoor’s growth and profitability.

Scaling challenges

Opendoor faces a number of challenges over the next 12 months. The most pressing of which is how the business scales nationally.

The previous two years have been spent proving out the model. Opendoor has been refining its processes in its two core markets, Phoenix and Dallas, trying a partnership model in Las Vegas, and just recently launched in Atlanta, Orlando, and Raleigh.

But 2018 is the big test: going national. I expect Opendoor to meaningfully be in ten markets this year. This will put a tremendous amount of pressure on the business, the management team, and the well-refined processes to see if they can all truly scale. It’s like NASA going to the moon after conducting tests in Earth’s orbit (which is exactly what they did). It’s a big step.

It will also be interesting to see how Opendoor approaches advertising. In the U.K., Purplebricks ran a national above-the-line advertising campaign (TV and radio) to build brand. That will be expensive in the U.S., but it’s a critical component to scaling the business, especially long-term customer acquisition costs. It’s also necessary to start building a moat between itself and its iBuyer competitors.

Opendoor will also face a significant challenge as it scales its people. As I mentioned above, scaling the business is resource intensive and is people dependent.

To win, Opendoor needs to provide exceptional customer service and needs to hire exceptional people. The more markets it expands to, the more people it will need. And the more people it hires, the more effort it will take to find exceptional people.

This contributes to the paradox. The larger Opendoor gets, the more difficult it will become to find quality people and maintain a high level of quality across a growing employee base -- all critical ingredients in delivering a superior customer experience.

The question of fees

Opendoor -- and its peers -- will also face ongoing challenges around its fees, both clearly explaining them to consumers and reducing them.

Opendoor needs to be price competitive with traditional real estate agents to succeed. The lower it can drop its fees, the more customers will flock its way. From the outside looking in, it appears to be doing this with the current fee structure, which happens to coincide with a noticeable uptick in activity in Q4 2017.

But more fundamentally, explaining fees is complicated. The pricing charts on Opendoor and OfferPad’s websites are long and complicated, as they attempt to explain holding costs, hidden costs, and somehow compare apples to oranges. If it takes more then five seconds to explain this to someone, you’ve already lost them.

Key strategic questions

Opendoor’s path forward is far from clear. As with all trailblazers, the future is uncertain, and in this case there are a number of threats. I believe the key strategic question -- and the area of utmost importance and absolute focus for Opendoor -- must be how to deliver the best experience possible to its customers.

Growth is key. Opendoor must reach scale for the business model to be sustainable and turn a meaningful profit. So it must venture forward aggressively, enter new markets, compete with fellow iBuyers, and be prepared to meet the incumbent’s threat head-on.

Opendoor must continue developing technology to automate the process (to improve efficiency) and deliver a superior customer experience (all-day open homes).

As it scales -- and because the business is so reliant on people -- it must attract and retain exceptional talent in each market it enters. This will be a key challenge, but not impossible. Maintaining a customer-focused culture with each new hire and each new contractor is easier said than done, but a critical task nonetheless.

And lastly, Opendoor must grow as efficiently as possible. It must continue reducing its fees and maintain its impressive operational efficiency. The holy grail would be combining the low-fee proposition of a Redfin or Purplebricks with the certainty of an iBuyer, but it may not be possible.

Growth comes with its own challenges and that is especially true of Opendoor. And as it grows, it will face the paradox of its greater and greater success bringing greater challenges to overcome. But only with great risk comes great reward.

The Opendoor Machine: 4 numbers you need to know

Opendoor, the real estate startup that purchases homes directly from sellers, leads the pack of a new breed of real estate tech companies. It continues to innovate and improve the experience of buying a selling a home, and as the analysis below shows, is making significant improvements to its business model as it continues to grow.

150 percent

I believe Opendoor’s ultimate metric of success is how many homes it sells. More than just buying homes (which anyone can do with enough money), the successful completion of Opendoor’s business model requires it to re-list and sell the homes it buys.

So it should come as no surprise that the first key number -- 150 percent -- is the growth in homes Opendoor has sold in 2017 compared to the same period last year. This is in its two biggest markets, Phoenix and Dallas.

The year-on-year growth is driven by Dallas, which came online in September of 2016. Entry into new markets will drive Opendoor’s overall growth. Over the same time period, Phoenix experienced a 55 percent increase in home sales.

The more recent growth in home sales has been driven by the Phoenix market, where Opendoor is selling a median average of 130 homes per month over the past three months, compared to 90 homes per month for the preceding three months.

After a big bump in Q1 of 2017, home sales in Phoenix are tracking in-line with last year.

However, there is a notable uptick in the number of homes purchased by Opendoor in recent months. Given that, we can expect a corresponding uptick in sales for the rest of the year and into early 2018.

13

This is the median average number of “prep days” between when Opendoor buys a home and subsequently lists it for sale. This is based on 50 recent transactions in Phoenix and Atlanta (where Opendoor recently launched).

Opendoor Prep Days

Impressively, this number is down from a median average of 20 days when I last did an analysis in December of 2016. That’s a 35 percent improvement! To quote that earlier analysis, “...given that Opendoor generally borrows 90 percent of the purchase price and is servicing that debt, time is money!”

That earlier analysis also predicted that a “battle-tested and efficient flip process” was one of three sources of competitive advantage for Opendoor. This improvement reflects strides made in Opendoor’s operational efficiency. It is clearly standardizing its operations and learning from past success and failures on big and small levels, to truly become a home flipping machine.

And it’s not just in Phoenix, Opendoor’s first market. It’s newest market, Atlanta, is on track just as impressively. Looking at 20 transactions shows a median average of 11 prep days. That’s a great start.

Most importantly, this shows that Opendoor’s growing operational efficiency is a transferable competitive advantage between markets. This is a critical ingredient for national expansion.

41

This is the median average number of prep days for Opendoor’s top competitor in the Phoenix market, OfferPad. This is based on a selection of transactions in July, August, and September.

It clearly shows that OfferPad is holding homes longer than its competitor -- over three times as long!

OfferPad Prep Days

In a world where time is money, this represents a significant business model and financial disadvantage for OfferPad. The longer it holds homes, the higher its holding costs.

It’s not clear what’s driving this number. Could OfferPad be spending more time and money fixing up houses before flipping them?

Regardless of the answer, the comparison of prep times between Opendoor and OfferPad illustrates stark differences in their respective business models. Opendoor aims to flip houses as quickly as possible with a super efficient process. OfferPad either has a different model, or is still working on optimizing its operations.

7.4 percent

All businesses need to make money, and Opendoor is no exception. Outside of charging homeowners a fee for its services, the second way Opendoor makes money is the difference between what it buys and sells a home for. This difference is the gross margin, and in Q3 of 2017, Opendoor’s gross margin in Phoenix was 7.4 percent.

Gross margin is a top line number (hence “gross” and not “net”), meaning it does not include the numerous costs associated with holding, repairing, and reselling a house.

What’s notable about this number is that it’s up considerably over the past year. My previous analysis in December 2016 showed a gross margin of 5.5 percent, and a comparison to Q3 2016 shows a gross margin of 5.6 percent.

This data is based on all publicly recorded transactions, so it’s not just a selection or a sample.

So Opendoor has managed to increase its gross profit on each home it sells by about 30 percent. We can speculate that this is in line with its recent strategy of lowering the fees it charges to homeowners. If it can make a bit more on each home and charge homeowners a bit less, it all evens out in the end.

Final thoughts

Working through this analysis highlighted a few key takeaways.

First off, Atlanta is off to a good start. The average number of prep days is strong and the gross margin is in-line with the more mature Phoenix market. It’s still early days, but this shows that Opendoor is able to transfer its honed operational efficiency to new markets, which is a requirement if it’s going national.

Secondly, Opendoor won’t achieve its goal of being in 10 markets by the end of 2017. Expansion is slower than originally thought. With over 100 employees in Phoenix alone, perhaps the Opendoor model is more time consuming and resource intensive than originally thought?

Lastly, and I believe most importantly, Opendoor continues to grow. The customer proposition is resonating with consumers in increasing numbers. The business model is being refined. And Opendoor is learning as it expands into new markets.

This new model of buying and selling homes is not going away. The entire industry can learn from the likes of Opendoor and the growing number of competitors that are popping up. Consumers are being increasingly drawn to new models that improve the customer experience of buying and selling a home.

A note on data: this analysis is based on MLS records, listings from Opendoor’s web site, the Maricopa City Assessor’s public property records, public records sourced from Redfin, and The Cromford Report, a specialist web-site monitoring the Greater Phoenix housing market. If you’re researching Opendoor and on the hunt for data, check out the iBuyer Analysis Pack.

iBuyer Market Update: Opendoor and OfferPad in Phoenix

iBuyer Market Update: Opendoor and OfferPad in Phoenix from Mike DelPrete

Are you researching iBuyers like Opendoor and on the hunt for data? Do you work at a consulting or venture capital firm? Check out the iBuyer Analysis Pack.

Growth in new markets: An analysis of Opendoor, Knock, and OfferPad

Last December we conducted a wide-ranging analysis of Opendoor, the real estate startup that purchases homes directly from sellers. A look at of thousands of MLS records formed the basis of that piece, showing trends and extrapolating insights from the data.

At the time there were a number of unanswered questions we wanted to dig into: how much money does Opendoor make per transaction, how big could the model really get in the U.S., and does Opendoor have a sustainable competitive advantage against competitors?

Four months later I’m once again looking at the data, with these questions on my mind:

• What does Opendoor’s traction look like in its (relatively) new markets, Dallas and Las Vegas?
• Are there any notable changes in Opendoor’s fundamental business operations and metrics?
• Opendoor has two well-funded competitors in the market, Knock and OfferPad. How are they doing?

After looking at the data, there are three main observations:

• Dallas, Opendoor’s second market, is doing remarkably well. The transaction volumes there reached parity with Phoenix after only six months.
• Las Vegas, Opendoor’s third market, is off to a slow start. Key metrics suggest Opendoor is still finding its sweet spot in that market.
• Knock, Opendoor’s Atlanta-based competitor, is very early stage and has yet to ramp up in any significant fashion.

A snapshot of current volumes

Last time we looked at the data (at the end of November 2016), transaction volumes in Phoenix were going strong, Dallas was on a promising upswing, and Las Vegas was still small.

Since then, overall transaction volumes have surged from around 200 home sales per month to over 300 sales per month in February. In other words, in February, Opendoor was selling ten houses each day (including weekends) across all three markets. Not bad!

This growth appears to be driven by sustained volumes in Phoenix and very strong growth in Dallas -- putting that market on par with Phoenix after only six months.

Opendoor does Dallas

Let me be clear: I’m impressed with the growth in Dallas. When I’m evaluating new businesses and new business models (see my article, The Two Principles of Startup Success), I always look for business model validation (does this work in one market?) and then the ability to scale (can this be replicated in another market?).

Opendoor’s success in Dallas is a resounding answer to that question. Yes, the business can scale beyond one market. This is a noteworthy achievement for the firm.

Like Phoenix, the average selling price in Dallas is well-clustered. During the past three months, Opendoor’s median sale price in Phoenix was $210,000, compared to $212,000 in Dallas.

This suggests that, like Phoenix, Opendoor has found its sweet spot in the Dallas market. It deals with houses in a narrow and specified value range and (generally) does not deviate from that.

Opendoor credits its success to the team in Dallas and their focus on providing customers an experience they love. “We're seeing that customer love translate to growing word of mouth, and a growing business there,” said JD Ross, one of Opendoor’s co-founders.

What about Las Vegas?

I’m so glad you asked. Opendoor started listing and selling homes in Las Vegas at about the same time as in Dallas, last September. But growth has been slow ever since.

The sale price is not as well-clustered as in Dallas and Phoenix. There’s quite a spread of prices that Opendoor sells its homes for.

The median sale price in Las Vegas is also materially higher than Opendoor’s other markets, sitting at $322,000 (compared to $210,000 and $212,000 in Phoenix and Dallas). It’s not a factor of higher house prices in Las Vegas, either. According to Zillow, the median home price in Las Vegas is $209,000 and the median listing price is $247,000 -- which is on par with Phoenix and Dallas.

In Phoenix and Dallas, Opendoor is selling homes for roughly the market’s median home price. But in Las Vegas, it’s considerably higher.

Opendoor has been selling homes for six months in Las Vegas; perhaps its median sale price started high but has been falling to normal levels over time? Nope.

There’s a noticeable oddity in the Las Vegas market, with slow growth, a less-clustered sale price, and a sale price that’s higher than normal. Why?

It’s because Opendoor’s approach to the Las Vegas market is different. “In Vegas we've been focused on partnerships, and haven't pushed to expand to the broader market there yet,” says JD.

This is a different approach than Opendoor has taken in its other markets, with correspondingly different results.

Opendoor has partnered with Lennar (a new home builder) to offer the Lennar Trade Up program for Las Vegas homeowners. It’s a way for homeowners to “trade in” their existing homes to Opendoor as part of a package to buy a new home from Lennar.

This is a different approach than Opendoor has taken in its other markets, with correspondingly different results. My guess is that it’s a lower-cost option for the firm that effectively outsources lead generation to a partner while allowing Opendoor to focus efforts elsewhere. In other words, it’s a test, which is exactly what a you’d expect from a young, growing company.

Knock, Knock

Since the last analysis, two well-funded competitors have entered the U.S. market: Atlanta-based Knock and Phoenix-based OfferPad. Both announced that they raised over $30 million each in January of this year.

Knock is live in Atlanta and currently trading with tiny volumes; we’re talking about one home sold each of the past two months. It also has a very small number of new listings each month, anywhere between one and six over the past four months.

Knock either does not have the price discipline we’ve seen work so successfully for Opendoor, or is not yet enforcing it.

The median sale price for Knock’s ten listings that sold is $290,000. But underneath that, if we look across all listing prices, you can see they’re not clustered at all. The home values are all over the show, meaning Knock either does not have the price discipline we’ve seen work so successfully for Opendoor, or is not yet enforcing it.

There are several key takeaways in looking at Knock:

• This is a difficult business to be in. Raising money doesn’t give you market share. It takes time, skill, and good operations to build scale.
• Knock is super early stage. Its transaction volumes suggest it is still tinkering with its core operations and proving it can make the model work before attempting to scale up.
• Price discipline is important. It may be tempting to deal with higher-value homes where the fees are correspondingly higher, but Opendoor has shown us where the sweet spot for this model really is.

OfferPad, on the other hand, is a more mature business with better traction -- at least in the Phoenix market. With the help of friends at ATTOM Data Solutions, a real estate data company that aggregates data directly from property records (as opposed to my usual MLS sources), I was able to gather a snapshot of relative traction for both businesses in Phoenix.

It's worth a deeper dive into OfferPad, its model, and relative merits. But that will have to wait until another time.

A look at Opendoor’s operations: anything interesting?

To wrap everything up I took a quick look at Opendoor’s core business metrics to see how things are tracking.

To begin with, the much-talked-about home value appreciation has stayed the same with a median average of 5.4% (looking at 43 recent sales). That’s the difference between what Opendoor buys a home for and eventually sells it for -- about $11,000.

And listen: That’s the difference between the buy and sell price. Opendoor takes on a number of costs associated with sprucing up, holding, and selling a house. So don’t confuse that number with profit; it’s not.

If you prefer small dots to blue bars, below is another way to visualise the same data.

The average days on market in Phoenix has seen a slight improvement, moving down to a median average of 41 days from 47 days in the last analysis. That’s a 12% improvement, which if I were running the business I would have as a key metric. It’s a small improvement -- but when time is money -- a welcome one!

Opendoor also has a new logo.

It will be interesting to watch Opendoor’s progress from here. With Phoenix and Dallas firing well, will it expand to a handful of new markets, or is Las Vegas the next area of focus? When it enters new markets, will it follow the partnership model? And will Opendoor launch in Atlanta before Knock puts the foot down on the accelerator?

Are you researching iBuyers like Opendoor and on the hunt for data? Do you work at a consulting or venture capital firm? Check out the iBuyer Analysis Pack.

Inside Opendoor: what two years of transactions say about their prospects

Read every analysis I've posted on Opendoor, Zillow Offers, and the iBuyer business model.

This article was co-written with Sib Mahapatra, former manager of strategy at Redfin, and now an entrepreneur and real estate tech enthusiast based in San Francisco. 

Raising $210 million is enough to get any business into the news. That’s especially true when the business in question is Opendoor, the 2-year-old real estate startup that aims to bring simplicity to the housing market by purchasing homes directly from sellers and flipping them over to buyers after a quick spruce-up.

This latest infusion of capital, announced in late November, brings Opendoor’s total war chest to $320 million. Based in San Francisco and led by CEO Eric Wu, Opendoor plans to use the capital to expand its active market presence from Phoenix and Dallas to 10 cities by the end of 2017.

Investors and stakeholders in residential real estate have eyed Opendoor with wary interest since the company was launched as “Project Homerun” in July 2014 by former PayPal exec Keith Rabois. With tons of dry powder and two years of operations in Phoenix behind it, Opendoor is building momentum: the company is already the largest brokerage in Phoenix by transaction volume.

Key questions

Now that Opendoor has a track record and a mandate to grow, it’s a good time to assess its progress to date and provide an informed perspective on the following question: is Opendoor the way forward for residential real estate? Does the Opendoor model represent a sustainable, profitable and scalable platform for reinventing how homes are bought and sold? 

Several thought-pieces have explored the pros and cons of Opendoor’s business model and its impact on the real estate industry at a high level. Our goal is to dig deeper by using public records and MLS data to shed light on Opendoor’s transaction history and inform a bottoms-up analysis of the unit economics and viability of the business. By the end of this analysis, we’ll provide answers to three questions that underlie the proposition above:

• How much money does Opendoor make per transaction? Is Opendoor offering its customers a fair value for houses?

• How big could this model really get in the U.S.?

• Does Opendoor have a sustainable competitive advantage against competitors that might enter the space?

Business model

Before jumping into the overall revenue opportunity in the U.S. market, it’s worth understanding Opendoor’s business model and how it makes money. Here are the key takeaways:

• Opendoor buys houses and owns them, acting as a middleman (as opposed to a matchmaker) in residential real estate transactions.

• Opendoor won’t buy every house -- qualifying properties include single-family homes built after 1960 with a value between $125,000 and $500,000.

• Opendoor makes money in two ways: from the service fees it charges, and from any difference between what it buys houses for and what it sells them for.

• Opendoor works with real estate agents, offering to pay full buyer commissions, as well as seller commissions if a sale comes from an agent.

Opendoor charges a variable fee for its services, starting at 6 percent and rising to 12 percent for more risky properties. The average fee falls between 8 percent and 9 percent for sellers, which is higher than the standard 6 percent fee charged by traditional real estate agents. But with the higher fees come certainty around a transaction.

The customer proposition for using Opendoor is strong. For home sellers, Opendoor offers to eliminate all of the hassle and uncertainty of selling a house with a simple, transparent offer. In other words: don’t worry about fixing the fence, mowing the lawn, picking the right agent, and wondering if and when your home will finally sell. 

Opendoor takes care of it all, completing the whole process in a matter of days. In our opinion, it’s a seller experience that’s truly 10x better than the status quo.

Opendoor’s unique model lets it offer industry-leading benefits to buyers, too: 

• All day open homes, seven days a week

• 30-day satisfaction guarantee (if you don’t like the home, they’ll buy it back)

• 2-year home warranty

Upside and revenue opportunity

It’s hard to argue against Opendoor’s compelling seller value proposition. But can the business make money and become profitable enough to justify its massive valuation?

First we need to understand how much money Opendoor makes on each transaction. We’re going to stay focused on revenue for the moment and not worry about costs (yet). As discussed above, Opendoor makes money from the service fees it charges, plus any difference between what it buys houses for and what it sells them for.

The analysis of average purchase value and appreciation below is based on over 350 recent listings in the Phoenix market where Opendoor bought a home, relisted it on the market, and in the case of 235 listings, eventually sold it. We also looked at over 1,500 Opendoor MLS listings throughout 2016 to get a sense of the firm's traction in Phoenix.

The chart below shows the number of sales per month in the Phoenix market over the past 20 months. As you can see, traction has increased to over 120 sales per month.

The average price paid by Opendoor for a home in Phoenix is $217,370, and is tightly clustered. Opendoor knows its sweet spot and generally sticks to it.

Our analysis shows an average appreciation of 5.5 percent from the price Opendoor buys houses for and what it ends up selling them for. Again, this figure is generally well-clustered, with the few loss-making outliers offset by a few big-profit outliers.

When we plug these figures into our model, we can build up a revenue estimate for the Phoenix market in 2016:

It’s possible that Opendoor books additional revenue from service fees when it buys a house, but the cash only hits its bank when a house is sold. Assuming another 400 houses in the Phoenix market that are active and will eventually sell, that’s another $7.8 million in booked revenue.

Cost and profitability

Opendoor’s seamless experience comes at a high price. By serving as an active middleman in the transaction, Opendoor effectively doubles transaction costs and incurs a wide variety of rehab and holding costs.

Below, we have done our best to estimate Opendoor’s gross profit per transaction in the Phoenix market. Again, we assume that on average Opendoor pays $217,370 for a home and charges a 9 percent fee, holds the home for 88 days, and sells it for 5.5 percent more than it paid:

Many costs are out of Opendoor’s control. For the foreseeable future, Opendoor will rely on the MLS to help it market and sell homes fast, making it tough to avoid paying the buyer agent commission. Phoenix is probably as good as it’s going to get in terms of closing costs, since it charges no transfer tax on real estate transactions.

Opendoor has more control over holding time and rehab expense. For every month Opendoor holds a home, it spends roughly $500 per $100,000 of home value. Flipping homes faster will lower the variable cost per transaction while freeing up dollars to deploy on the next purchase, reducing its effective cost of capital. By hiring in-house staff, buying supplies in bulk, and using data to identify high ROI improvements, Opendoor could shave precious basis points off the process of maximizing curb appeal. 

There are two big takeaways here. First, given the costs associated with the middle-man model, it’s tough to imagine Opendoor being price competitive with agents. The best disruptors are both better and cheaper than incumbents, and we think cost has implications for Opendoor’s addressable market. Second, our analysis shows that on average, Opendoor’s fees barely cover its costs; appreciation on the sale is critical to profitability.

Fair value for homes?

Many people question whether Opendoor is really doing what it claims: offering a fair value for the houses it buys. 

To recap: an analysis of 235 houses that Opendoor bought and eventually sold in the Phoenix market shows an average appreciation of 5.5 percent.

The analysis also shows an average of 20 days between the time Opendoor buys a house and then subsequently lists it back for sale. That gives its team three weeks to fix up and prepare a house for sale on the market. That’s a quick turnaround, and given that Opendoor generally borrows 90 percent of the purchase price and is servicing that debt, time is money!

Once a home is prepped and listed for sale again, what sort of premium does Opendoor list it at? The short answer is around $20,000.

There is a tight clustering right around the $20,000 mark, with an actual average of $21,570. But keep in the mind the final sales price is half of that, an average of $10,245 for our sample of 215 homes that sold.

At the end of the day, we believe it’s a fair assessment to say Opendoor offers generally fair offers for the houses they buy. It does not lowball sellers. But it does not seek the high returns that a typical home flipper would look for, only looking to recoup its investment in the property plus a small margin. (This conclusion was later validated in this extensive research study: Do iBuyers Like Opendoor and Zillow Make Fair Market Offers?)

Market opportunity

How big could Opendoor really get in the U.S. market? In order for Opendoor to reach $1 billion in annual revenues, we’d need to believe the following:

The key assumption is that each new market Opendoor enters can reach the same maturity level of Phoenix. There will be overs and unders in terms of market size, average house price, and closing costs. But for a quick, back-of-the-envelope estimate, we’re keeping things simple.

While we have no certainty of what future market traction will look like, we can look at the Dallas expansion (Opendoor’s second market) for early indications. It started listing properties in August and selling in September, giving us three month's worth of data to review.

The comparison above shows good traction -- just under half the volume of Phoenix in three months.

In other words, it’s not farfetched to imagine Opendoor reaching $1 billion in annual revenues. It sees its total addressable market as between 50 and 70 markets in the U.S., with plans to expand to 30 markets by 2018. Given the data we’ve seen, this is achievable. The major brakes on Opendoor’s ability to reach this scale are the availability of financing -- purchasing 30,000 houses a year would require a revolving credit line of approximately $1.5 billion, assuming its average hold period and purchase value stay the same -- and whether its automated valuation model will work well in markets that have less liquid and homogenous housing stock than Phoenix.

Risk

For investors and industry observers, the scariest part of the Opendoor model is market exposure of directly holding homes. To its credit, Opendoor clearly takes risk management seriously (it is hiring several capital markets and risk associates), and defends its robustness against market risk by making the following claims:

• It can monitor price and market liquidity to detect a market correction early and adjust fees and home pricing, minimizing any loss.

• As Opendoor gets bigger, it will have a more diverse portfolio of homes; all markets and asset types won’t collapse at the same time.

• In a downturn, Opendoor doesn’t have to sell; for example, it can rent homes.

We’re most compelled by the first strategy. If Opendoor can predict a downturn before it’s widely known and shed old inventory fast with a preemptive discount, it can effectively employ a “stop-loss” mechanism that constrains the total downside. 

We are less convinced by the second and third tactics. Diversification across U.S. geographies smooths risk in placid markets, but the most recent financial crisis suggests that American real estate markets are heavily correlated during the kind of market correction that would threaten Opendoor.

Finally, Opendoor’s ability to wait out a downturn by renting homes depends on the terms of its agreement with its debt issuer. We don’t know what that agreement looks like, but it isn’t likely to be as flexible as that of a hedge fund, for example, which often benefit from flexible investment mandates and “lock-up” periods where investors can’t get their capital back. In the last crisis, banks weren’t exactly known for their patience with capital calls.

The indisputable fact is that Opendoor’s extraordinary opportunity also exposes it to deep and intrinsic risk. For the purpose of a venture investor with a five-year horizon, perhaps this doesn’t matter, but it raises questions about Opendoor’s ability to endure across economic cycles and exist as a durable franchise that permanently changes real estate. With such a thin margin, even a slight market shift could mean the difference between profit and loss.

Competitive advantage

Let’s assume that Opendoor’s model works well enough to attract the attention of potential copycats. What is the moat that will keep new entrants at bay? We’ve identified three sources of competitive advantage for Opendoor: 

• Proprietary automated valuation model (AVM)

• Access to capital

• Battle-tested and efficient flip process

Ultimately, we believe a major long-term risk to Opendoor is that the key elements of its seller customer experience -- a fast and well-priced offer -- are replicable. Lack of access to capital and an accurate AVM may keep smaller aspirants out, but won’t dissuade big asset managers from entering the fray; Blackstone has directly invested in residential real estate for years. If Opendoor continues to profitably flip homes, we don’t see a compelling reason why an institutional investor with deep pockets won’t enter the market by hiring data scientists (or licensing an AVM from Redfin or CoreLogic) and undercut Opendoor by offering to beat any offer by an extra grand.

If it comes down to the highest offer, Opendoor is still well positioned to win. Its trusted brand will provide a barrier against new entrants, a better automated valuation model will let it charge less for market risk, and its experience flipping homes will pay off in lower holding costs. But victory won’t be free: we predict that competitive pressure will drive Opendoor’s unit margin below where it sits today.

Concluding thoughts

The real value of Opendoor is that it’s forcing the industry forward. The current home selling process is filled with friction, and Opendoor should be applauded for taking a gutsy approach to solving many of these pain points in a single stroke.

The data and analysis above suggests that Opendoor has a sustainable business model. It is buying and selling hundreds of homes each month with upward traction. At scale, it is reasonable to see Opendoor generating over $1 billion in annual revenues and operating profitably. Traction and market potential like that cannot be ignored.

As the first mover and brand leader in this space, Opendoor is in a strong position, but we see two roadblocks that could prevent it from succeeding at scale. The first is proving out its risk management approach to the satisfaction of lenders who will need to issue a massive amount of debt to fund tens of thousands of home purchases. The second is figuring out how to differentiate from new entrants and avoid getting dragged into a race-to-the-bottom price war that would decimate its slim margins.

Whether or not Opendoor emerges as the eventual victor in this space -- is this model definitely the next step for residential real estate? The main barrier we see is cost. Opendoor could become a very successful business by serving even a small percentage of U.S. home sellers, but its addressable market will fall short of its true potential unless it can make its service both better and more affordable than the status quo. 

A note on data: our analysis is based on MLS records, listings from Opendoor’s web site, the Maricopa City Assessor’s public property records, and public records sourced from Redfin. We used industry benchmarks to estimate the costs and fees associated with flipping homes in Phoenix. The data out is only as good as the data in, and the MLS system can be inaccurate. The analysis should be taken as such -- a review of available public records -- and not a verifiably complete picture. While absolute numbers may be off, we believe that directionally our analysis provides a very good look at the business.

Read every analysis I've posted on Opendoor, Zillow Offers, and the iBuyer business model.

At the Inman Connect Las Vegas 2019 conference, Mike DelPrete, an entrepreneur, analyst and real estate industry strategic adviser, took to the stage to explain the seismic shifts shaking up the residential real estate market.

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The 2020 iBuyer Report

The iBuyer Report is a 150+ slide, evidence-based look at the world of instant home buyers. Unmatched in its breadth and depth, it explores behind-the-scenes, national data and presents an unbiased strategic analysis of the sector, the players, and the implications for the industry.

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