Massive iBuyer Financial Losses Continue

The “Reinvention of Real Estate” comes with a staggering price tag. In 2020, the two largest iBuyers, Opendoor and Zillow, lost a total of $607 million buying and selling houses. That’s a loss of about $40,000 on each home bought and resold, about $1.6 million every single day, or about $1,100 per minute in 2020.

And that $607 million is on top of the $650 million lost in 2019 — well over $1.2 billion in the past two years.

Opendoor's Challenging 2020

Opendoor accumulated losses at a quickening pace during a challenging 2020. Like Zillow, it stopped buying houses earlier in the year, and its recovery since has been slow. This has corresponded to a striking decline in the number of homes sold throughout the year, especially compared to last year.

As expected, Opendoor’s decision to pause listing new homes for sale in late 2020 led to a dramatic drop in home sales in Q4 2020. Without a corresponding drop in corporate overhead expenses, Opendoor’s financial metrics reached a new milestone: a net loss of over $100k per home.

But it's almost certainly a temporary setback. On the plus side for Opendoor, and as a result of building up inventory in late 2020, it's going to have a blowout Q1 2021.

A Revealing Fourth Quarter

The key financial drivers for each iBuyer were quite different in the last quarter of 2020. Opendoor managed to blow Zillow away with a gross margin of 15.4 percent — which is a combination of service fees, price appreciation, renovation expenses, and ancillary revenue streams. Opendoor was better able to monetize the transaction.

The subsequent cost drivers show an equally revealing story. Especially Opendoor’s record-low selling costs of 2.1 percent. The bulk of this fee is brokerage commissions. The drop from 3 percent earlier in the year is notable, and is likely the result of Opendoor continuing to push down the buyer agent commissions offered on its houses.

Holding costs and interest expense are also lower — by about half — from earlier in the year, and both iBuyers appear evenly matched (aside from a slight interest expense advantage to Opendoor).

Good for Consumers

Despite their staggering financial losses, the evidence suggests that Zillow and Opendoor remain staunchly pro-consumer. Both businesses are determined to pass a financial benefit on to consumers alongside a streamlined experience:

• Opendoor lowering its service fee for homeowners, now down to 5 percent.

• Zillow Rewards offers savings when consumers bundle its services together.

• Opendoor offering savings when using its in-house services.

• Both iBuyers paying very close to fair market value.

Contrast this with another real estate tech disruptor, Compass, which is self-admittedly obsessed with agents (and not consumers). The difference shows. Compass’ strategy of gaining market share and promoting exclusive listings available only on its platform is good for business, but not for consumers.

Opendoor Withholds Listings From the Market

In late 2020, while Opendoor continued to purchase hundreds of homes each week, it stopped listing new homes for sale. This unusual behavior lasted four weeks, and reveals an interesting consequence of the rise of new models in real estate, specifically iBuyers.

Between November 10th and December 10th, Opendoor listed no new homes for sale in any market, nationally (Opendoor also did not list homes during the week of Christmas). For comparison, during the same period Zillow continued purchasing and listing new homes for sale.

During this time, Opendoor continued to purchase homes from consumers. Its purchase levels in November and December -- while still well below the levels of 2019 -- remained robust, with no visible slowdown.

The result of Opendoor's action -- during the run up to its IPO -- created an artificial buildup of inventory. It was a concerted, company-wide effort -- but what was the purpose?

Understanding Why

Here's a hypothesis: An iBuyer books revenue when a home is sold. By withholding listings for a month, Opendoor pushed back the likely period when those houses would sell (and it would book revenue) into 2021 -- to its first full quarter as a publicly listed company.

Regardless of the specific reason for the action -- pumping up revenue numbers, maximizing home appreciation, or simply taking a break before the holidays -- a decision was made, and the results are the same: Opendoor's inventory of houses increased by withholding new listings from the market.

Implications for Consumers

While a relatively small move that kept 300⁠–400 houses off the market for an additional month, Opendoor's action is an example of what happens when home purchasing power aggregates to one company. (A previous example is Opendoor and Zillow's systematic move to reduce buyer agent commissions.)

What happens when a company -- backed by Wall Street and motivated by profit -- has the ability to withhold listings from the market in the midst of a once-in-a-generation housing shortage? With the rise of new models that change the paradigm of home ownership, careful attention should be paid to a possible collision between what's good for a company, and what's good for the consumer.

iBuyers Turning Obfuscation of Profit into an Art Form

A casual investor could be excused for confusing iBuying with a profitable business. Zillow's latest shareholder letter claims, "Average return on homes sold before interest expense was a gain of $21,830 per home," while Opendoor's investor presentation highlights "positive unit economics" with a contribution margin of $11k/home.

Both statements are factually correct. However, the figures provided are cloaked in asterisks and notes. Opendoor and Zillow are emphasizing unit economics of iBuying that exclude tens of millions of dollars of expenses -- ranging from salaries to marketing to technology -- that are necessary to operate the business.

It's the equivalent of an immaculate conception version of iBuying, where transactions magically occur without employees, customers materialize out of thin air, and technology is freely available for all.

When all indirect costs are included, profitability quickly drops into the negative for both companies.

Zillow's average return on homes sold before interest expense​ is a gain of around $22k per home, but after all expenses are included, the net loss per home is $72k. Tracking this number shows the true unprofitability of the business over time.

Both companies are unprofitable, losing roughly $300 million each in 2020. When all expenses are included, each company is losing tens of thousands of dollars per home. Opendoor is losing less money per home than Zillow, in both 2019 and the first nine months of 2020.

The profitability measure each company highlights is Adjusted EBITDA, which presents its own challenges. The "I" in EBITDA stands for "interest," which means that Zillow and Opendoor are excluding their collective interest expense from the calculation. Interest expense is a large and necessary component of the iBuyer business model, and amounts to tens of millions of dollars each year.

In 2019, Opendoor's interest expense was $105 million, which is not included in its only visual profitability measure. To find the true net loss (over $300 million), readers need to scroll to the very last slide in Opendoor's investor deck, in the appendix.

Turn On The Lights

One of Zillow's corporate values is to "Turn On The Lights." To quote: "We believe that information is power, and we’ve made it our business to increase transparency in real estate and within our company. Our purpose is to unlock information and empower our people, customers and partners to make better decisions."

I agree: information is power, and transparency is powerful. It leads to better decision making. Much of my work is aligned to the necessity of transparency.

iBuying is a new business model fueled by billions of investment dollars. The first question on many people's minds is, "Is it profitable?" Not when necessary expenses are excluded, but the entire business model.

My request is simple: talk about profitability. Don't shy away from it. Don't make readers flip to the appendix or supplementary financial tables and do a series of calculations to get their answer. Turn the lights on.

iBuyer Market Share Set to Drop By Half in 2020

From a transaction volume standpoint, the pandemic of 2020 was not kind to iBuyers. Overall volumes and market share are set to drop by 50 percent compared to 2019, a reflection of the iBuyer business model coming to a complete standstill followed by a slow recovery.

This drop stands in sharp contrast to the overall U.S. housing market, which is on fire. Overall transaction volumes are running well above last year's levels.

All of the major iBuyers saw a significant drop in 2020 compared to 2019, but Opendoor stands out for several reasons. First, it remains the largest iBuyer, with around 2x the transactions of its closest competitors. But it also saw the biggest year on year drop in volumes: down about 60 percent from 2019.

This is a reflection of both Opendoor's high-flying activity in 2019, and its painfully slow post-lockdown recovery. Opendoor's purchases are still down over 70 percent from the same time last year. Recovery is slow; much slower than the overall market.

Segment market share continues to shift among the big four iBuyers. Opendoor's share of the market is down to 50 percent -- a gradual decline from 2018 as new players entered the market and the overall segment grew rapidly. Zillow has made a strong entrance while Offerpad has maintained its position.

The pandemic of 2020 affected real estate in a variety of unprecedented ways. The drop in iBuyer market share and transaction volumes isn't a failure of the model, but it is a result of the model. The iBuyers face a slow climb back to the levels of 2019, as they conservatively ramp up operations in a new, uncertain housing market.

The Economics of iBuying

Sometimes it's easy to forget how much money iBuyers are losing. Investor presentations focus on positive unit economics, which don't include non-trivial expenses such as employee salaries, customer acquisition, technology development, office rent, and more. Neglecting these expenses -- which account for hundreds of millions of dollars per year -- paints an incomplete picture of iBuyer economics.

In the case of Opendoor, that's an additional $366 million -- or nearly $20,000 per home sold -- of expenses in the "Everything Else" category. Contribution margin is a perfectly legitimate metric, but it doesn't tell a complete story of profitability.

From Profit to Loss

A key measure of the iBuyer business model is gross profit, which is driven by service fees, purchase price, sale price, ancillary services (like title insurance and mortgage), and any necessary repairs. The metric focuses on the physical asset itself, and doesn't include costs associated with the process of selling the home.

In the first half of 2020, Zillow and Opendoor managed to generate around $17,000 in gross profit for each home bought and resold.

Zillow is catching up to Opendoor. If gross profit is a reflection of accurate pricing algorithms, competitive fees, and attaching adjacent services, the evidence suggests that operational efficiency is not the exclusive domain of Opendoor.

After gross profit, the largest direct expenses are selling costs (primarily composed of commissions paid to agents), holding costs, and interest expense. The data reveals that Opendoor has lower costs across all three categories.

Opendoor's lead in holding costs and interest expense are marginal. Zillow's recent announcement that it was hiring its own internal agents -- and will no longer be working with (and paying) premier agent partners on the homes it sells -- will reduce its selling costs to be closer in line with Opendoor.

Last come the indirect costs (employee salaries, marketing, office space, etc) -- perhaps indirectly linked to selling a home from an accounting perspective, but still critical to operating an iBuyer business. Zillow Offer's financials highlight how significant these costs ($266 million) are in an overall picture of profitability.

Once all expenses are included, the economics are complete: each iBuyer is losing tens of thousands of dollars on each home it buys and resells.

The overall economics are improving; between 2019 and the first half of 2020, each iBuyer lost less money on each home. But the totals are still negative, and when buying thousands of homes, total losses add up quickly: in the first half of 2020, Opendoor lost over $118 million and Zillow over $178 million.

Red is the New Black

At the end of the day, does it really matter? The information above is no secret; it's readily available in the public disclosures and filings from both companies. But it does take a rainy afternoon to find, compute, and digest the meaning of it all.

The public-facing presentations and shareholder letters focus on a single piece of the equation: unit economics, or contribution margin. An equally easy to digest explanation of the full economic picture is not always present.

The iBuyers are playing by a different set of rules where profitability doesn't apply. It doesn't matter that iBuyers are unprofitable; to-date, shareholders don't mind, and are happy to subsidize massive losses. Disruption in real estate is being led by companies -- and shareholders -- willing to bet and lose billions of dollars.

The iBuyer War on Real Estate Commissions

For years, the traditional real estate commission structure in the U.S. has remained relatively impervious to change. Buyer agent commissions -- the fee paid to a buyer agent when a house is sold -- is the focus of multiple class action lawsuits. But it turns out that the biggest threat to the traditional structure may be iBuyers, which have been waging a silent, systematic war on buyer agent commissions.

This research study looks at buyer agent commissions offered by iBuyers: 11,500 transactions over two years across four of the largest iBuyer markets (Phoenix, Atlanta, Raleigh and Dallas). 

The data is sourced from the multiple listing systems in each market, which records buyer agent commissions offered for every home listed for sale. The data does not include transactions that occur off-market (sales to REITs) nor to buyers that approach iBuyers directly, without an agent.

A History of Cost Optimization

Since the beginning, an iBuyer's biggest expense has been agent commissions -- specifically the buyer agent fee of around 3 percent when a home is resold. This fee is highlighted as “selling costs” in Opendoor's recent investor presentation.

Like many good businesses, Opendoor has attacked this cost with vigor (acquiring Open Listings, launching "Buy With Opendoor", and offering 1 percent savings when buying with a partner agent). Opendoor isn’t shy about it; the same investor presentation lays out a game plan to profitability which includes a further 0.6 percent “cost optimization” on each home sold.

In other words: Opendoor’s target for selling costs is 2 percent, of which the buyer agent commission is the single largest component.

Systematic Fee Compression

Opendoor has systematically reduced buyer agent commissions in Phoenix, its largest market, over the past 18 months. In early 2019 it started offering 2.5 percent commissions alongside 3 percent commissions (a wonderful A/B test). The results must have been promising, because Opendoor subsequently stopped offering 3 percent commissions in favor of an even-lower 2.25 percent starting in February 2020, well below Phoenix’s average buyer agent commission of 2.8 percent.

The trend and timing is similar in Dallas -- a reflection of a corporate-wide initiative to reduce expenses by lowering buyer agent commissions. At the same time in early February, Opendoor began offering 2.5 percent commissions in place of 3 percent.

Raleigh shows an identical trend with consistent timing. The average buyer agent commission is 2.4 percent, but at the same time -- February 2020 -- Opendoor pushed down its commissions to 2.2 percent.

Atlanta is where things get interesting. Opendoor began offering 2.75 percent commissions in late 2019, before introducing even lower 2.5 percent commissions in early February 2020. However, Opendoor also began testing super-low 1.5 percent commissions in late 2019.

Opendoor appears to be testing how low buyer agent commissions can go before it adversely affects time on market (agents may be less likely to show homes that are offering low buyer agent commissions).

Zillow Follows Suit

Opendoor is not alone in its drive to push down buyer agent commissions. Zillow has the same financial incentive, and has also been offering lower commissions over time in its biggest markets.

In Phoenix, Zillow matched Opendoor and began offering 2.25 percent buyer agent commissions in mid-2020, a significant reduction from the full 3 percent offered pre-Covid.

At the same time -- July 2020 -- Zillow dropped its buyer agent commission to 2.5 percent in Atlanta. The evidence suggests that, like Opendoor, this was a coordinated effort affecting multiple markets simultaneously.

In comparison to Opendoor, Zillow is both later to the party and less aggressive in its testing. Opendoor began reducing buyer agent commissions in April 2019, compared to Zillow waiting until July 2020. But the intent is identical to Opendoor: gradually reducing buyer agent commissions.

According to a Zillow spokesperson, “Agents can feel confident in a smooth, fast and easy sale when advising their client interested in a Zillow-owned home, knowing that some of the major hurdles of a traditional transaction have been taken care of prior to their clients having even toured the home.” For Zillow, the argument appears to be a lower fee for less work.

Offerpad, the third-largest iBuyer, is the outlier. It has not dropped buyer agent commissions in any of its large markets. They are “firmly committed to their agent community,” and “continue to offer buyer agents 3% in commissions,” according to a spokesperson. The data concurs.

Good for Opendoor or Good for Consumers?

Opendoor is effectively doing what consumers cannot: negotiating lower buyer agent commissions. The class-action lawsuits argue that buyer agents should “compete to be retained by offering a lower commission” -- in other words, a free market should dictate buyer agent fees.

While it is difficult for a consumer to negotiate -- and see a direct financial benefit from -- a lower buyer agent commission, it is very easy for Opendoor and Zillow. The iBuyers have the scale, financial muscle, and incentive to challenge the status quo.

Dropping buyer agent commissions has a direct financial benefit for iBuyers. The cost savings are not ending up in consumer’s pockets...yet. But Opendoor, in particular, appears to be indirectly passing some savings on to consumers. In September, it dropped its average service fee to just 5 percent, and has repeatedly stated its intent to further reduce fees.

With 2019 losses totaling over $300 million, Opendoor is highly incentivized to reduce its expenses. Systematically reducing the buyer agent commission is a logical move, but not everyone benefits. It appears that the success of the iBuyer model comes at the expense of the traditional real estate commission structure.

Zillow's Brokerage News and the 2 Megatrends of Real Estate Tech

Zillow recently announced that it was hiring its own agent employees to service its iBuyer business. At face value, the news is a relatively small shift, but is a clear reminder of several megatrends occurring in real estate tech.

An Unsurprising Move

If Zillow's announcement caught you by surprise, you haven't been paying close enough attention. For years, real estate portals around the world -- including Zillow -- have been moving closer to and getting involved in more of the transaction.

Zillow's move is a logical next step in this journey. Bringing agents in-house, as opposed to relying on a network of partners, moves Zillow closer to consumers and closer to the transaction. This megatrend -- which has been slowly occurring for years -- is covered at length in my 2018 Global Real Estate Portal Report. 

Ignore At Your Own Risk

With this latest news, some are suggesting that traditional agents fundamentally ignore it and focus on their own business. In other words, don't worry about the competition -- in this case, Zillow -- and just focus on providing the best service possible to your customers and clients.

That strategy is only half right. Ignoring what Zillow is doing brings its own peril; just ask travel agents and video store owners (both industries that Mr. Barton has had a hand in disrupting).

For the traditional industry, sitting still is not an option. To quote my State of the Industry presentation from January 2020:

The industry is moving so slow you can look around and think nothing is changing (or get caught up in the hype and think everything is changing). That’s why now – more than ever before – is the time to stay informed, understand the scope of change, and react appropriately.

Agents as Employees

Zillow's move is a clear reflection of a megatrend in real estate: agents as employees. Hiring agents as full-time, salaried employees (a model pioneered by Redfin) provides a number of benefits, all centered around greater control:

• A consistent consumer experience

• Greater operational efficiency

• Better economics

The benefit is perhaps best illustrated by Redfin's agent efficiency, a metric that consistently stands out among its brokerage peers.

Full-time, salaried agents also lead to higher attach rates for services like mortgage and title. Next-gen brokerage models like Orchard and Homie, which also employ agents, are seeing mortgage attach rates of 80+ percent. This is only possible with an integrated end-to-end experience, powered by employees, and not a loose confederation of independent contractors.

Zillow and Redfin are not alone. Other disruptors like Opendoor and Offerpad are hiring agents for new brokerage services. With the exception of Compass (who is stuck in the matter), all of the largest real estate disruptors are moving in this direction -- that's nearly $35 billion in enterprise value pushing in this direction. It's a megatrend that's possible, but not advisable, to ignore.

Opendoor's Path to Profitability: Attaching Title and Mortgage

Opendoor's path to profitability is paved with uncertainty. A key assumption for long-term success is the ability to attach adjacent services to the transaction, such as title insurance and mortgage. Let's look at the data around Opendoor's traction to-date.

In its investor presentation, Opendoor correlates early success with attaching title and escrow services to long-term margin improvement -- and profitability. The challenge is that title and escrow are the easiest ancillary services to attach by a wide margin, and success in a few markets doesn't mean ALL adjacent services will be nearly this easy.

Title insurance is a complicated business and regulations vary by state. Opendoor is seeing early success, but it's taken years (and an acquisition of a traditional title company) to get to this stage.

The below chart shows title attach rates on the sell side, where Opendoor is the owner and sells a home. When it comes to title and escrow, not all states are created equal, and success in one may not mean success in all.

Title insurance is just one of many adjacent services. The holy grail, from a revenue and profitability standpoint, is mortgage, and it's not nearly as easy to attach. Opendoor has been in the mortgage business for about a year and is seeing much lower attach rates to its mortgage product, Opendoor Home Loans.

Compared to title Insurance, which can simply be added into the transaction by the purchaser or seller of the home (Opendoor), mortgage needs to be sold directly to consumers, which is a much more difficult and complicated proposition.

An Uncertain Road Ahead

It should be noted that what Opendoor is attempting to accomplish is not unique. Traditional real estate brokerages have been attaching title and mortgage services for years (Berkshire Hathaway's HomeServices of America, for example). The field is crowded with large, well-entrenched businesses.

Just because Opendoor is seeing early success with title insurance, the easiest adjacent service to attach (especially when you own the home), doesn't mean it will find similar success with more difficult services, such as mortgage. The evidence suggest a long, difficult, and uncertain road ahead -- in a highly-contested and crowded field of incumbents and disruptors.

Opendoor's IPO: Believing the $50 Billion Playbook

As part of Opendoor's upcoming IPO, it has revealed a strategic playbook that takes it to $50 billion in annual revenue. Achieving this is both aspirational and uncertain. What needs to be true for Opendoor to achieve this goal?

A Plethora of Phoenixes

Phoenix. The birthplace of iBuyers. Opendoor's first market. In many respects, Phoenix is the perfect iBuyer market, and has consistently been the largest iBuyer market in the world (based on sales volume).

In the first three months of 2020, Opendoor's revenue run-rate in Phoenix was $1 billion. To achieve a $50 billion run-rate, Opendoor would need to develop 50 Phoenix-sized markets (or 100 markets of half the size).

Phoenix is a mega-market; it is significantly bigger than any other iBuyer market. It accounts for 25 percent of Opendoor's total revenue, and 20 percent of its total sales volume in 2019.

It has taken Opendoor over four years to build the Phoenix market up to four percent market share and $1 billion in sales volume.

While Opendoor has a number of other large markets, none comes close to the scale of Phoenix. The average sales volumes of Atlanta, Dallas, Las Vegas, Raleigh, and Orlando have remained relatively stagnant over the past 12 months.

Opendoor's IPO documents make the claim, which is true, that market share in new markets accelerates quickly in the first year. However, it is also true that growth slows after the first 12 months. And in the case of some markets (Orlando, Las Vegas, and Dallas) sales volume has declined. 

The growth of new markets is not a straight line up and to the right. In Opendoor's case, new markets experienced initial growth followed by a plateau. This is either a deliberate beachhead strategy, or reflective of a larger challenge reaching scale.

Phoenix: Outlier or Target?

Opendoor's $50 billion plan is ambitious. To achieve it, Opendoor needs to replicate the success seen in Phoenix across 50 other markets (or 100 smaller markets) -- no small feat.

Is Phoenix the outlier or the target? The evidence of the past four years suggests the former; other markets have struggled to achieve and sustain volumes anywhere close to the levels seen in Phoenix.

The path to $50 billion -- growing dozens of new markets to significant volumes -- is far from a straight line, and is quite uncertain. Opendoor's growth is not a simple copy-and-paste of the Phoenix playbook. Launching new markets and growing them to significant volumes -- against the headwinds of competition, consumer demand, and profitability -- remains a key challenge in Opendoor's future.

iBuyer Market Share Plummets, With a Measured Recovery Ahead

Like many businesses, iBuyers took a significant hit during the pandemic. Home purchases dropped 90 percent as the major iBuyers paused their operations, and as they come back to life, the iBuyers are rebounding cautiously and slowly, suggesting a long road to pre-pandemic levels.

Purchases Down 90 Percent

With the pandemic and associated lockdowns earlier in the year, iBuyer purchase volumes plummeted 90 percent. The major iBuyers (Opendoor, Offerpad, Zillow, and Redfin) paused new home purchases in March, citing safety concerns, before resuming operations in May.

With a gradual recovery in purchases throughout the remainder of 2020, total iBuyer purchases for the year could be half that of 2019.

Pausing new home purchases didn't stop the iBuyers from selling thousands of homes in inventory during the lockdown. In May, iBuyers only purchased 200 homes but managed to sell over 1,700, a clear sign they were trying to clear their inventory as quickly as possible. The pandemic stopped iBuyers from purchasing homes, but it didn't stop them from selling homes.

After announcing a resumption of purchases in May, all of the iBuyers have slowly ramped up their operations -- but at different velocities. In June, Zillow purchased around 50 homes, Opendoor about twice as many, and Offerpad about three times as many. The ramp up in activity is slow.

A Slow and Measured Recovery

iBuyer purchase volumes are recovering much more slowly than the overall markets they operate in. For example, in Phoenix, the overall market has recovered to pre-pandemic transaction levels. But iBuyer market share of that volume is still well below pre-pandemic levels.

The data suggests that iBuyers are taking a slow and measured approach to ramping up purchases. Many U.S. markets are hot: low inventory, massive buyer demand, and rising prices -- not a great environment for iBuyers.

Total iBuyer purchases across their top five markets are still a fraction of what they were earlier in the year.

Strategic Implications

The pandemic has put the iBuyer business model -- along with countless other businesses -- under strain. The past few months has seen them pivot and adapt, by launching traditional brokerage services, increasing agent referral fees, and Opendoor partnering with leading portal realtor.com.

The iBuyers are back to buying houses, but the evidence suggests a more slow and cautious approach. And once the iBuyers prove they can survive the pandemic, they're still faced with the same challenge they had pre-pandemic: profitability.

iBuyers Turning Into Brokers Turning Into iBuyers

The biggest evolution of the iBuyer business model in four years quietly occurred last week: Opendoor and Offerpad launched traditional brokerage listing services. Both companies will now list homes directly, alongside their core instant offer business, underlining the growing convergence of iBuyers and the traditional industry.

The Value of Seller Leads

One of the biggest opportunities in iBuying is monetizing seller leads (consumers that request an offer but don’t sell to an iBuyer). At scale, converting even a portion of these high-intent leads to a traditional listing could be a billion dollar opportunity.

iBuyers only buy a small fraction of homes from consumers that request offers. In 2019, Zillow bought 6,500 houses of the 264,000 consumers that requested an instant offer (about 2.5 percent). The remaining 257,000 homeowners didn’t sell to Zillow, but many -- upwards of 40 percent -- eventually sold via a traditional listing.

Historically, iBuyers have struggled with converting seller leads. Zillow farms these leads out to its Premier Agent network, and Opendoor has a network of Partner Agents.

It’s a difficult process. Connecting consumers who are interested in an instant sale to a real estate agent feels like a bait-and-switch, and because the partner agents are independent contractors, there’s an inconsistent experience and misaligned incentives.

Launching a listing service is an effort to make a sale on every consumer that enters the funnel. It moves from a “take it or leave it” product choice to presenting consumers the illusion of choice (would you like the instant offer or the traditional sale?), a common sales tactic to increase conversion.

The Lines Between Traditional and Disruptor Are Blurring

It’s not just iBuyers that have evolved their business models. Traditional brokerages are adopting new, disruptive models, and making them their own.

Traditional agents and brokers are providing instant offers and “buy before you sell” services alongside their listing services, utilizing start-ups like zavvie and Homeward. A growing list of brokers have raised capital and have launched their own iBuyer programs -- Lamacchia Realty, Matt Curtis Real Estate, and 8z Real Estate -- while industry behemoths have launched programs like Keller Offers, Redfin Now, and Realogy’s RealSure.

Over time, by adding these new tools to their toolboxes, traditional agents are slowly turning into iBuyers themselves -- or at least offering their full range of services. New ideas are not the exclusive domain of start-ups and disruptors; the best ideas are being co-opted by the traditional industry.

Strategic Implications

With this move, Opendoor and Offerpad have achieved feature parity with traditional brokerages. They are no longer an option to be considered as an alternative to a traditional listing; they’re a complete solution for any homeowner.

Both Offerpad and Opendoor are acting as their own listing agents, utilizing salaried employees to list and sell homes (exactly how they currently sell thousands of homes purchased from consumers). In some markets, Opendoor is also using partner agents for this new service.

The tendency of disruptors to utilize internal, salaried agent employees is noteworthy. Employees offer a consistent, controlled experience, which yields higher conversion rates for converting seller leads and ancillary services (which is why Redfin’s agent productivity is exponentially higher than the industry average, and why fixed-fee brokerage Homie has an 85+ percent attach rate on its mortgage product).

Ultimately, this new service -- which is in the early stages and not fully rolled out -- represents a way for iBuyers to make money without having to actually buy houses. After four years and billions of dollars invested into iBuying, it’s a significant adjustment to the core business model.

Opendoor: Down, But Not Out

This week Opendoor announced it was laying off 35 percent of its workforce, or around 600 people. The move, designed to give Opendoor more runway, increases its chances of survival, but comes at a competitive cost -- and is far from the largest layoff the industry will see in 2020.

A Tactical Retreat is Not a Defeat

The biggest mistake anyone can make is confusing this move with the failure of the iBuyer business model. Pausing new home purchases, controlling costs, and reducing headcount are all sensible strategies in the current environment. Common advice to business leaders during uncertain situations is simple: conserve cash.

The strategies taken by iBuyers are signs of a smart business trying to survive a market downturn. Blindly pushing ahead, regardless of a rapidly changing environment, is not a smart strategy. And a tactical retreat to reassess the situation and reallocate resources is not a defeat.

The Biggest Layoffs Have Yet to Come

Massive layoffs are occurring across the real estate industry. The ones that involve full time employees generate press: Opendoor, Redfin, and Compass. But those pale in comparison to the largest “workforce reduction” that will occur in slow-motion over the next six months -- real estate agents.

Real estate agents are independent contractors that work for themselves. They don’t issue a press release when they’re out of work; they simply disappear from the workforce.

In 2019, there were about 1.3 million real estate agents in the U.S., supported by about $70 billion in commissions (that’s $54,000 per agent). If the total number of transactions in 2020 drops as expected -- perhaps up to 50 percent -- there’s $35 billion less in commissions to support those agents. During the financial crisis of 2008, the industry lost about 25 percent -- or 300,000 -- active agents.

Just because Opendoor, Redfin, and Compass are announcing layoffs is not a repudiation of their business models; it’s a reflection of their employment models. Layoffs will hit the traditional industry just as hard; it just won’t be in a press release.

Deep Pockets Win

While Opendoor claims it is well capitalized and in a healthy financial position, it’s not in a healthy enough position to completely avoid layoffs (as is the case with arch-competitor Zillow, which outlined cost-cutting measures that didn't include layoffs). 

Opendoor’s move buys it time to weather the storm, but at the expense of weakening the business. Saying goodbye to 35 percent of a well-oiled team puts it at an executional disadvantage to pre-covid Opendoor. And to Zillow.

In my Inman presentation from February 2019, I said that companies with deep pockets will win. Opendoor’s deep pockets allow it to weather the current storm and remain intact (albeit smaller). Zillow’s deeper pockets allow it to weather the storm and keep the team together, giving it a potential advantage in the coming recovery.

Survival of the Fittest: The Real Estate Pandemic Survival Guide

My recent presentations usually start with this message: The industry is moving slowly, but it’s never moved this fast. That has never been more true than today.

International and historical data shows that as the pandemic spreads and more stringent lockdown measures are put in place, the volume of real estate transactions will drop significantly -- up to 90 percent. While the drop is temporary, only the most agile and resilient businesses will survive.

Transaction Volumes Will Drop

The available data from China, South Korea, and Italy shows that the current pandemic will likely cause a temporary, but dramatic, drop in overall real estate transactions.

The following chart shows property transactions in China during the early stages of the outbreak. Transactions dropped significantly -- nearly 100 percent -- during a number of weeks during the crisis, and are now growing again (but still down over 50 percent from last year).

There are similar results in Italy, with a top portal telling me that they expect transaction volumes to be down 20–40 percent in February and 70–90 percent in March. Another source cites that visits to apartments for sale in early March were down more than 50 percent compared to a year ago.

In South Korea, national deal volume was down 80 percent in the first nine days of March, and down 90 percent in the nation’s capital of Seoul.

Zillow’s recent research on pandemics shows a similar trend from Hong Kong during the SARS outbreak in 2003: Transaction volumes fell by 33-72% as customers avoided human contact (“avoidance behavior” like avoiding travel, restaurants, and public gatherings). After the epidemic was over, transactions snapped back to normal.

The drop in transactions is immediate and severe, but appears to be temporary. The data suggests that it may take up to six months (or more) for transaction volumes to return to normal levels.

Virtual Tours Won’t Save Your Business

It’s likely that we’ll see plummeting transaction volumes in other international markets as the pandemic spreads. There will be more than a predisposition for social distancing; it will be a temporary halt to a large portion of the real estate market (as evidenced by the data above).

Virtual tours won’t stop the decline; they are no replacement for an actual in-home visit. If transaction volumes drop by 80 percent or more -- driven by market uncertainty, quarantines, travel restrictions, and shelter in place orders -- no amount of virtual tours or clever online outreach will make up for that decline.

Long Term Consumer Behavior Changes

The pandemic may very well leave behind a number of long-lasting changes that impact the world of real estate in its recovery.

Social distancing may lead to the accelerated adoption of services that facilitate streamlined real estate transactions. Once more consumers experience the benefits of selling a home without dozens of open home visitors, iBuyers may see increased adoption. Once home buyers experience a closing with an online notary, more will expect it next time.

New products and services, including iBuying, online notaries, and virtual tours may become a new customer requirement in a world of increased social distancing. It’s an evolution of consumer needs, not a solution to a pandemic. And those individuals and firms that best meet changing consumer needs generally win.

Survival of the Fittest

Using the data above as a reference, it appears likely that the current pandemic will cause a significant drop in transaction volumes for a period of time, after which activity will resume and approach normal -- but only after many months.

The most important strategy for businesses and agents alike becomes quite simple: make sure you’re around for the rebound.

It’s nearly impossible to pivot to a new businesses model during an economy-shuttering pandemic. Virtual tours won’t save your business when transaction volumes drop 80 percent. The alternative strategy is to weather the storm -- cryogenically freeze yourself -- ready to emerge when the recovery begins.

All real estate businesses will be moving quickly to adapt to the changing environment. It’s those that are able to move the fastest, adapt gracefully, and have the strongest foundation and balance sheet (survival of the richest) that will survive and thrive in the recovery.

The Real Estate Pandemic Survival Guide

With the evidence and hypothesis outlined above, I conclude with the following Real Estate Pandemic Survival Guide.

Step 1: Be Around for the Recovery. There is a temporary period of pain to get through. You must survive. Lower your expenses and conserve cash to give yourself the longest runway possible. Virtual tours won’t save your business.

Step 2: There is No Step 2. Survival is everything.

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The industry -- and the world -- is moving incredibly fast, and I find it difficult to keep up with all of the changes.

Like many of you, I'm working outside of my comfort zone (and in my house surrounded by my family). I have less time to collect data, analyze evidence, and present thoughtful insights -- and I'm doing my best.

I am prioritizing releasing new data and insights as quickly as possible, to help guide us all through these uncertain times. Expect more in the weeks and months ahead.

iBuyers Pause Purchases During Pandemic

The world moves fast. In the past 24 hours, both Opendoor and Redfin announced a temporary halt to their home buying operations.

Pausing Home Purchases

The current pandemic is truly a Black Swan event, and more significant and complex than a housing market correction. The iBuyer model was designed with counter-measures to counteract a correction, including raising fees, slowing purchases, and anticipating a slowdown before it hit.

The current situation is more extreme and uncertain. There are extensive public health considerations at play and varying degrees of lockdown and shelter in place orders, which may make all real estate transactions untenable for a period of time.

Redfin pausing its home buying activity is notable, but not nearly as big of a deal as Opendoor’s announcement. Redfin has many other sources of revenue; Opendoor does not. Opendoor was purchasing about 40 times the number of homes as Redfin.

While iBuying has certain advantages in a world of social distancing, those advantages don’t carry over to a pandemic or mass quarantine.

A Temporary Drop in Transactions

The data available shows that the current pandemic will likely cause a temporary, but dramatic, drop in overall real estate transactions.

The following two charts show property transactions in China during the early stages of the pandemic. Transactions dropped significantly -- 80 to 90 percent -- during a number of weeks during the crisis, but are now growing again.

Zillow’s recent research on pandemics shows a similar trend from Hong Kong during the SARS outbreak in 2003: Transaction volumes fell by 33-72% as customers avoided human contact (“avoidance behavior” like avoiding travel, restaurants, and public gatherings). After the epidemic was over, transactions snapped back to normal. 

The drop in transactions is immediate and severe, but appears to be temporary.

Opendoor's Glide Slope

By temporarily pausing the purchase of homes, Opendoor has shut off its only source of revenue; there’s no iBuying without buying. The effect is akin to an airliner losing both engines while in flight.

With no revenue -- Opendoor’s engines -- the company will glide until it either manages to once again generate revenue, or it runs out of money. Opendoor is not alone in this predicament; many businesses across a number of industries face the same challenge.

Opendoor won’t sit still. There are many smart people at the organization that are likely working around the clock to pivot, adjust, and invent new ways of doing business in this rapidly changing environment. When you have a business with over 1,000 employees on the payroll, waiting and hoping isn’t an option.

Unintended Advantages: iBuying in a World of Social Distancing

It’s unlikely a global pandemic is what Opendoor and Zillow had in mind when they launched iBuyer businesses. The core benefits of the model -- speed and certainty -- were meant to improve upon a notoriously long and sometimes painful process. But the iBuyer business model is uniquely positioned to thrive in a world of social distancing, where people are putting a premium on the ability to conduct business while limiting direct human contact.

Unintended Advantages

While iBuying launched with specific consumer benefits in mind, it’s becoming evident that the model has several unintended advantages in a world of social distancing. At its core, the model allows consumers to sell and buy homes with limited human interaction -- a fact that had niche appeal in a normal market, but may become more popular in today’s uncertain market.

Today, those advantages include:

• No Open Homes: Homeowners have the advantage of selling their homes directly to an iBuyer, without needing to hold open homes with dozens of people walking through their house.

• Self-Guided Home Tours: Prospective home buyers can tour homes owned by iBuyers on their own, without an agent present, and outside of a crowded open home.

• No In-House Repairs: Selling to an iBuyer removes the necessity of homeowners having external contractors in a house to conduct pre-sale repairs.

Most importantly, selling a home to an iBuyer provides certainty in a time of uncertainty -- and we are definitely in a time of uncertainty. The advantage of selling a home instantly has never been demonstrated in a more dramatic fashion.

Tracking Fee Changes

Since the day Opendoor launched in 2014, people have wondered how the model fares in a down market. One argument in favor of the iBuying model is that in times of uncertainty, consumers would be willing to pay a higher fee for the certainty that an iBuyer provides.

The data is still coming in, but a quick sample of several dozen iBuyer offers from last week (March 9–13) across 14 markets shows no change in the average fee charged to consumers.

It is likely a fee increase will come, to account for the higher risk and uncertainty in the market (iBuyers generally charge a higher fee when there is more market risk). But for the moment, fees remain low, likely in an effort to keep up purchase volumes so as not to exhaust inventory.

Declining Purchase Activity

In the weeks ahead it will be worth paying attention to overall iBuyer volumes.

There are already early signs of a slowdown in the Phoenix market, the birthplace and epicenter of iBuying. Whether driven by inventory shortages, global market uncertainty, or iBuyers mitigating their risk, significantly less homes are being bought each month in Phoenix.

Total iBuyer purchases in Phoenix for February are down 30 percent year-on-year; Zillow in particular is down 63 percent from the same time last year.

Compared to the previous month, January, purchase volumes are down from 368 to 315, or 14 percent. At the same time, iBuyer home inventories are at an all-time low: at current monthly sales rates, Opendoor has two months of inventory and Zillow just one month. The iBuyers are clearing their inventory quickly by selling almost two homes for each home they purchase.

Implications for iBuyers and the Industry

In the months ahead, I would expect iBuyers to react appropriately to a slowing and uncertain market:

• Raise fees to account for increased market risk and houses potentially taking longer to sell, driven by less overall consumer demand.

• Reduce inventory, by purchasing less homes each month (Phoenix as an example) and continuing to clear existing inventory with appropriate price reductions.

The current state of the market will finally shine a light on how the iBuyer business model reacts to slowing consumer demand. On the one hand, the iBuyer proposition becomes stronger for consumers looking for certainty and to limit direct human interaction. But on the other hand, iBuyers are at-risk in a market slowdown by holding hundreds or thousands of unoccupied homes on their balance sheets.

The Zillow Revenue Growth Fallacy

Conventional wisdom is that revenue growth is good, and is an important benchmark to measure a company’s success. But total revenue and revenue growth are misleading metrics for iBuying; they’re simply a proxy for how much capital the company has available to purchase houses. 

To increase revenue, Uber needs people to request rides, Airbnb needs travelers to book stays, and Netflix needs consumers to subscribe. iBuyers simply need to buy more houses, and the more houses they buy, the more houses they sell. 

It takes no great skill to enter a market with a lot of money and start buying houses. But it takes a great deal of skill to resell those houses and generate a profit.

Zillow is currently losing money on each house it buys and resells. Overall losses in its Homes segment (Zillow Offers) are mounting: a $100 million net loss in Q4 2019, and a $312 million net loss in 2019.

Looking at the unit economics of each home, which includes the purchase price, sale price, agent commissions, interest expense, holding and renovation costs, Zillow lost over $6,000 per home it purchased and resold. That number has fluctuated over the year, but is rising.

(What's driving the loss? Since Q1, the average holding cost per home is up $1,000 and the average interest expense per home is up $1,000 -- both signs that it's taking longer to resell homes.)

After all business expenses are factored in: sales and marketing, technology development, employee salaries, office space -- everything -- Zillow is losing $56,000 for each home it purchases and resells.

Zillow’s entry into the iBuyer market is still in the early stages. The fact that the business is unprofitable should come as no surprise. The hope -- and it is really just hope at this stage -- is that profitability will come with scale and adjacent revenue streams like title insurance and mortgage.

What’s unclear is not Zillow’s strategy nor rationale for being an iBuyer. Rather, it is why Wall Street, or any other investor or media outlet, is rewarding Zillow for “beating” its revenue guidance. Not only is Zillow able to generate revenue at will by buying more houses, it loses more money with each house it buys. In effect, Zillow is being rewarded for losing more money than originally planned.

The Real Story: Premier Agent Growth

What Zillow should be rewarded for is bringing its Premier Agent Program back to growth. After a precipitous decline in 2018 and all growth grinding to a halt earlier this year, the program is back to growth mode -- albeit small. 

Time will tell if Premier Agent growth will continue as Zillow continues to roll out its flex program, but the early signs are encouraging.

Choose Your Data Carefully

Zillow is investing heavily to grow a new business line, and its ability to sustain losses is reflective of how big it sees the opportunity. My hope -- and it is really just hope at this stage -- is that more sophisticated industry observers will stop putting so much emphasis on pure revenue growth as a metric for success.

Do iBuyers Like Opendoor and Zillow Make Fair Market Offers?

This research study addresses a fundamental question in real estate: Do iBuyers like Opendoor and Zillow make fair market offers on the homes they purchase? This has been a point of contention since the iBuyer business model launched, with opponents claiming that iBuyers purchase houses at well below market value, while iBuyers claim they provide consumers fair market offers.

To provide a definitive answer, this comprehensive study is both deep -- reviewing over 20,000 iBuyer transactions -- and broad -- utilizing multiple methodologies to draw insights from the data. The evidence suggests a clear answer to an often confusing question.

Methodology and data

This study uses three methodologies to establish an evidence-based view of iBuyer offers relative to market value:

1. Purchase Price-to-AVM

2. Price Appreciation

3. Rejected Offer vs. Market Sale

The data consists of over 20,000 iBuyer transactions conducted in 2018 and 2019 where an iBuyer purchased and then resold a property. The transaction data is sourced from public records, which are the legally required disclosures on any property transaction. Multiple sources were used to establish consistency, and thanks go to Remine and ATTOM Data for making their unique expertise and data sets available.

The data used is not merely a sample; it is comprehensive, covering over 95 percent of relevant iBuyer transactions. The study includes over 60 different legal buying entities that iBuyers use to purchase homes. While all major iBuyers were tracked, this analysis focuses on the leading two: Opendoor and Zillow, which account for 86 percent of total iBuyer volume.

Method #1: Purchase Price-to-AVM

Purchase Price-to-AVM is a straightforward comparison of the price an iBuyer pays for a house and what an AVM (automated valuation model) determines a house is worth at the time of purchase. This study uses the First American AVM.

A review of the transactions undertaken by Opendoor and Zillow between January and September 2019 reveal a median Purchase Price-to-AVM of 98.6 percent, or $3,800 on a $270,000 home.

(For those interested, transactions in 2018 reveal similar results +/- 0.1 percent. I am focusing on 2019 because in a rapidly changing industry, the most recent transactions best reflect the current practices of each business. Zillow was in start-up mode in 2018.)

The Purchase Price-to-AVM also varies by market, with consumers getting offers closest to AVM in the three Florida markets of Tampa, Orlando, and Jacksonville.

While an AVM is not a definitive proxy for true market value, like a Zestimate, it is a data point and does provide helpful context in determining the fair market value of a house. The outliers are most likely problems with the AVM, rather than an iBuyer purposely over- or under-paying for a house by a significant margin.

Method #2: Price Appreciation

Price appreciation is the difference between what an iBuyer buys and subsequently resells a house for. Each of these “flips” occurs within a short time frame (typically 90 days). The difference between these two numbers reveals clues around the market value for a house.

A review of the transactions where Zillow and Opendoor purchased and then resold a house in 2019 reveals a median price appreciation of 3.3 percent, or $8,900 on a $270,000 house.

In 2019, the average annual home price growth is 3.8 percent, according to Black Knight. Assuming an average holding period of 90 days, that’s 0.9 percent of price appreciation that naturally occurs in the market. Subtracting this from the 3.3 percent median price appreciation leaves 2.4 percent associated with the purchase and resale of the house.

The remaining 2.4 percent price appreciation delta is not solely a discount to market value; it must also account for the improvements made to each home. It’s reasonable for iBuyers to command a premium on the houses they own and resell, in the same way a certified pre-owned car commands a premium. These houses have been through a rigorous repair process with new carpets and paint, and refurbished up to a generally high standard.

Zillow’s per home renovation and repair costs are $12,000 (source: Zillow’s third quarter 2019 shareholder letter). Opendoor’s average average repair cost is between 2–2.5 percent of a home’s value. In each case, a significant amount of money is being invested into each home before resale, which should theoretically and practically lead to a higher home resale value.

Therefore, if we subtract the price appreciation that naturally occurs in the market (0.9 percent) and assume that half of the remaining price appreciation delta is a relative discount to market value when an iBuyer purchases a house, and the other half reflects a resale premium, the actual discount to market value is 1.2 percent (half of 2.4 percent), or $3,200 -- very similar to the 1.4 percent discount derived from the Purchase Price-to-AVM methodology above.

Price appreciation over time

Price appreciation is a fluid metric, and is changing over time and by market. On a yearly basis, the median price appreciation delta has dropped from 5.2 percent in 2018 to 3.3 percent in 2019. And it’s not simply a factor of iBuyers moving into more expensive markets; in absolute dollar value, the median price appreciation dropped from $12,300 in 2018 to $8,500 in 2019.

The trend continues in 2019. On a monthly basis, median price appreciation has dropped a full percentage point between January and September of 2019.

The resulting trend is clear: iBuyers are making less and less money on the “flip” of a house.

There are a number of reasons for this trend. The iBuyers have always publicly stated that they aim to offer consumers a fair deal, with no desire to buy low and sell high. The iBuyers are attempting to make offers as close to market value as possible, and are improving over time.

The change also reflects increased competition in the space. With Zillow launching its home-buying program in 2018, competition is heating up in a major way. Both Opendoor and Zillow are attempting to grab market share as fast as possible, and one way to do that is by offering more attractive offers to consumers. 

Median price appreciation varies by market, and could be an artifact of overall market appreciation, iBuyer market maturity, or local competitive pressures.

Method #3: Rejected Offer vs. Market Sale

Many consumers request an iBuyer offer, but not all accept it. Of those that request an offer, reject it, and then go on to sell their home traditionally, it is possible to track the difference between the original iBuyer offer and the eventual sale price.

A recent Zillow study looked at 3,200 homes where a seller declined a Zillow Offer and then went on to sell traditionally within 120 days. On average, Zillow was offering 99.8 percent of the eventual sale price -- an implied discount of 0.2 percent.

The Zillow statistic has not been verified by an independent third-party and its comprehensiveness is unclear. Even so, it is a useful data point in this analysis. Opendoor declined to discuss its metric for this study.

Summary of evidence

The evidence in this research study strongly suggests that iBuyers are offering close to fair market value for the homes they purchase. Multiple methodologies based on independent, third-party data suggest a discount to market value of around 1.3 percent -- or $3,500 on a $270,000 house.

It is important to remember that this is the median. In any statistical study, there will be outliers, examples of homes where the discount to market value is higher or lower.

Total cost to the consumer

Whether iBuyers make fair market offers on houses is a different question than if iBuyers make fair offers to consumers. To answer the latter question -- which is not the focus of this study -- all of the associated costs and fees need to be included.

The average iBuyer fee is around 7.5 percent -- 1.5 percent higher than a typical real estate commission. However, the average holding costs for three months (which can range from 1–2.5 percent of a home’s value) shift from the consumer to the iBuyer, making the true cost difference negligible.

Which leaves the discount to market of 1.3 percent, or $3,500 on a $270,000 house, as the primary monetary difference between an iBuyer and a traditional market sale. Ultimately, it is up to consumers to decide whether that discount -- in exchange for convenience, speed, and certainty -- is worth it.

Strategic implications for the industry

So what is revealed about a business that buys and resells houses, but doesn’t make money on the flip? Buying houses is a means to an end. But what is the end, and how will iBuyers make money?

The answer is that it’s not about the house, it’s about the transaction. And iBuyers can make money through ancillary services like mortgage and title, and in Zillow’s case, seller leads. This should concern any mortgage and title incumbent; iBuyers are your new competition. And to maximize consumer adoption of these new services, iBuyers must control the transaction, and the expert advisor in the transaction: the real estate agent.

The results of this study -- that iBuyers are buying homes at close to market value -- is seemingly positive for consumers. But long term, to fulfill their strategies and build a viable business that makes money, iBuyers will need to operate walled gardens under their control: Sell to an iBuyer, buy an iBuyer home, finance with an iBuyer Mortgage, and use an iBuyer Agent. And this exclusive, closed ecosystem will likely have a significant impact on the real estate industry going forward.

Download this research study as a lovely, nine-page PDF.

Transparency And Deception In Real Estate Tech Fundraising

Transparency is the cornerstone of any successful, trustworthy business. But not all real estate tech companies practice transparency; the most egregious example occurs in fundraising. The lines between raising equity and securing debt have been blurred, and numbers are being inflated in an effort to mislead the public. If a business model relies on deception, it’s a bad business model.

Equity vs. Debt

A company raises equity and secures debt.

When a company raises equity funding, it sells investors stock in exchange for capital; investors are buying part of the company at an agreed-upon valuation. When a company secures debt, it is granted a line of credit to access funds when needed, or is given a loan -- both of which need to be paid back, with interest.

With the rise of iBuyers and similar models that involve a strong financial component, such as purchasing homes directly from homeowners, debt requirements are skyrocketing. Many real estate tech companies, some of which are barely a year old, are securing hundreds of millions of dollars in debt.

Debt is not equity

As far back as I can recall, when a company announced that it had raised money, it was talking about equity investment. An investor had reviewed the business pitch, decided the model and the team were winners, and invested money into the venture in exchange for stock.

At some point, things changed. When raising money, it is becoming increasingly common for real estate tech companies to combine equity and debt together into a larger, more impressive sounding number.

Because companies are using debt to finance the purchase of homes, the amounts are absurdly large. In fact, the companies that combine equity and debt are, on average, artificially inflating the amounts raised by 11 times!

This is a deceptive practice meant to trick the public into thinking a company has raised more money than it actually has, and is bigger and more successful than someone may otherwise think.

Debt is not equity. If I get a $500,000 mortgage to purchase a new home, have I “raised $500k to reinvent the home buying process for my family,” or have I simply secured a loan (which must be repaid)?

Best (and worst) practices

Some companies unapologetically combine equity and debt numbers and refuse to reveal the breakdown. Others combine equity and debt as a headline number, but eventually reveal the breakdown later in a press release. Artificially inflating the headline number is still deceptive, but at least they’re not brazenly hiding the truth.

The best practice -- and the most transparent -- is talking about equity as equity, debt as debt, and not inflating the headline number by combining the two.

Transparency in action

Full credit to the two biggest iBuyers, Opendoor and Zillow, for providing full transparency around capital raises. As a public company, Zillow really has no choice other than to play by the rules. Opendoor, as a private company, is not forced to offer the same level of disclosure, but nonetheless chooses to in a commendable effort of transparency.

Ribbon and Knock are two of the worst offenders, with the following big-money, attention-grabbing headlines: “One-year-old Ribbon raises $225M to remove the biggest stress of home buying,” and “Knock Raises $400M To Simplify Home Buying.” Unfortunately, each raise includes massive amounts of debt and neither company reveals the actual numbers (in Knock’s case, public filings later revealed the equity component was $26 million).

EasyKnock, Nested, Flyhomes, Homeward, and Perch are all guilty of combining equity and debt into large headline numbers, and then go on to clarify the figures in the body of the announcement -- but the damage has already been done.

Offerpad used to break out equity and debt, but is now combining both into a large, headline figure and not providing the details. Like the others, the results are impressive headlines that confuse and mislead the public -- especially when compared against peers, like Opendoor, that aren’t inflating their numbers.

Comparing apples and oranges

The issue becomes clear when making comparisons -- often while someone is attempting to make a decision. Whether it’s a prospective customer, a potential employee, or a curious journalist, misleading headlines create unfair and inaccurate comparisons.

For instance, if one compares the headline numbers from Opendoor’s $300 million raise with Knock’s $400 million raise, Knock may appear to be the fundraising winner. However, in reality, Opendoor raised over ten times the amount of equity than Knock: $300 million vs. $26 million! And in total, Opendoor is even further ahead.

Getting noticed

I imagine a number of companies -- many of them run by friends and colleagues -- undertake this practice to appear larger than they actually are. But I also imagine that in real estate, a factor even more important than fundraising prowess is trust. And trust comes through transparency. If your business model relies on deception, it’s a bad business model.

How serious are Zillow and Redfin about iBuying?

In the past year, two of the U.S.'s leading portals, Zillow and Redfin, have launched iBuyer businesses. Zillow's entry was, in part, a response to an existential threat to its business model, and much of the value it may derive is not from buying and selling houses at all, but by generating valuable seller leads (watch my video presentation). Which begs the question: How serious is Zillow about being an iBuyer?

Opendoor's 3x advantage

The best way to compare seriousness is actual market traction and purchase volumes -- putting your money where your mouth is.

In the first seven months of 2019, Opendoor continues to be the clear leader in the iBuyer space as measured by home purchase volume. Opendoor has purchased nearly 10,000 homes, around three times the volume of Zillow.

On average, Opendoor is purchasing around 1,400 homes per month (as an aside, a recent Opendoor commercial stated the company buys a home every 34 minutes -- or around 1,300 per month). Again, this number is about three times the volume of Zillow for the first seven months of 2019.

However, Opendoor's volume advantage is eroding over time as Zillow's activity accelerates. In January, Opendoor purchased 4.7x the volume of Zillow, but that is down to 2.4x in July. Zillow is closing the gap (especially in the last three months).

The magic number in all of this appears to be 3x: year-to-date in 2019, Opendoor is about 3x ahead of Zillow in terms of home purchases. But Zillow is catching up.

Available firepower to purchase homes

Another way to judge a company's level of seriousness about iBuying is how much debt it has available to purchase homes. Each of the major iBuyers has secured massive amounts of debt, but some have secured more than others.

Once again, the magic 3x number appears: Opendoor has three times the debt available to purchase homes compared to Zillow. So it is no surprise that it is purchasing three times the volume of homes.

What about Redfin?

Readers may notice Redfin in distant fourth place in many of the charts, which, again, is an indicator of seriousness about iBuying.

Opendoor has 30x the debt available and has purchased nearly 40x the homes compared to Redfin in 2019. On average, Opendoor is purchasing around 1,400 homes per month, compared to Redfin's 36 homes per month. Redfin is an iBuyer in the same way I'm a basketball player. Both statements are technically true, but neither of us are anywhere close to the big leagues.

Differing strategies and motivations

Opendoor's entire business model revolves around buying and selling as many homes as possible. At scale, it becomes a powerful business. Zillow, on the other hand, may want to moderate its home purchases to achieve a scale where it maximizes seller leads. As I've said before, Zillow has the potential to make more money with less risk by monetizing seller leads.

Zillow's purchase rate (the amount of homes it buys compared to the total number of offer requests it receives) has consistently hovered around 2 percent.

Zillow is expanding fast to catch up to Opendoor, but it may have different motivations in doing so. Zillow's buying activity in Phoenix, for example, has plateaued since January of 2019. Is it taking a well-earned breather, or is 100 homes a month all it wants (or needs) to buy?

The evidence suggests that Zillow is serious about being an iBuyer and a major player in the space. But its motivations, and the question of why it wants to be an iBuyer, may differ significantly from other iBuyers.

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Check out the part of my Inman Connect presentation where I talk about Zillow's pivot to iBuying, and the value of seller leads.

Realtor.com’s slow descent to irrelevancy

With the rise of iBuyers as a powerful new starting point in the consumer journey, realtor.com is yielding the strategic advantage to arch-rival Zillow. Lacking an iBuyer strategy for the past year, realtor.com has fallen further behind in terms of delivering value to consumers and agents. Multiple options to enter the space are available, but the clock is ticking for realtor.com to execute strongly and maintain relevance in a rapidly evolving industry.

Power at the top of the funnel

One of the topics I discussed in my recent Inman Connect presentation was the power companies have at the start of the consumer journey. Real estate portals around the world derive and maintain their dominant positions because they are a consumer's first stop in the home buying and selling process.

In the days before the internet, real estate agents were the starting point. With the launch of Zillow and its Zestimate, portals became the popular starting point for consumers. Opendoor and iBuyers shifted the dynamic by offering instant offers on homes, attracting consumers. Today, a number of iBuyer aggregators and real estate agents are fighting to attract consumers by incorporating instant offer services. I explain further in the quick video clip below.

In some markets, up to 40 percent of serious home sellers are requesting an instant offer before listing their home! Instant offers are becoming the new Zestimate -- the new, natural starting point for determining a home’s value. And because of this, they are also an existential threat to portals.

The value of seller leads

The iBuyer business model generates a ton of high-intent seller leads: consumers who are interested in moving and request an offer, but don’t sell their home to an iBuyer. In the last three months alone, Zillow generated 69,000 offer requests but only bought 1,500 homes. The remaining leads can be distributed to real estate agents -- a valuable source of new business.

Today, Zillow Offers is active in 11 markets. Once it expands to 20 markets, Zillow could generate close to 500,000 seller leads annually -- a number that will increase as its national roll-out continues.

Zillow and realtor.com’s traditional lead generation businesses are built around buyer leads. iBuying has become the holy grail of seller leads: popular with consumers, valuable to agents, and of generally high quality. Over time, these leads will become a valuable source of new business for real estate agents, and an additional revenue driver for Zillow.

Using rough estimates, it's clear that the profit potential of seller leads far outweighs that of buying and selling actual homes, with considerably less risk for Zillow.

Real estate agents partnering with Zillow receive valuable buyer and seller leads. The same partnership with realtor.com yields only buyer leads.

Strategic advantage: Zillow

Each day, Zillow continues building its sustainable competitive advantage by strengthening its leadership position in consumer’s minds as the place to go for an instant offer. Simultaneously, Zillow generates tens-of-thousands of valuable seller leads for its agent customers each month -- a service which realtor.com does not provide.

For a real estate portal’s two most important audiences -- consumers and agents -- Zillow is highly differentiated while realtor.com lags behind.

Realtor.com needs to provide an iBuyer service -- but does not need to buy and sell houses directly -- to compete with Zillow. The logical entry point is a partnership with a national iBuyer (and that iBuyer, by the way, needs an inexpensive source of leads just as much as realtor.com needs an iBuyer service).

Until realtor.com unveils a coherent iBuyer strategy, it will remain at a growing disadvantage to Zillow, and risks further irrelevancy in the evolving battle for consumer eyeballs.

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Check out my entire Inman Connect presentation, "iBuying Disrupted: Battle of the Behemoths."