Flipping homes isn’t like flipping pancakes, folks. Now, Zillow is learning this lesson the hard way.
Zillow first launched its Zillow Offers program in 2018. Under the program, Zillow purchases homes directly from sellers, makes improvements when necessary, and then lists (read: flips) these homes for sale. Sellers working with Zillow are able to select their closing date and receive the benefit of no home showings, a guaranteed price and “hassle-free” closing.
Here in California, Zillow offers has operated in:
- Los Angeles;
- Riverside;
- Sacramento; and
- San Diego.
However, in October 2021, Zillow announced the suspension of new offers through the program through the end of 2021. Focusing on the supply chain disruptions and labor shortages that have plagued the construction and home renovation industries, Zillow intended to catch up while it puts new offers on temporary hold.
But playing catch up was the least of Zillow’s worries.
A few weeks later, when announcing its Q3 2021 financial results, Zillow determined to close the program permanently. The reason? They aren’t as good at predicting home values as they thought, and to continue the program across such a broad range of U.S. markets would put them at a heightened risk of “earnings and balance sheet volatility.”
Further, in Q3 2021, Zillow was forced to write off $304 million due to Zillow Offers purchasing homes for higher than their eventual sales (flip) price to the end user. Zillow expects more losses in Q4 2021 as they continue to sell off their existing inventory.
A flip and a miss
This type of large-scale flipping scheme was bound to fail.
First off, by getting into the buying-and-selling game, Zillow created for itself a massive conflict of interest. One of the features that sets Zillow apart from its competition and makes it so popular for consumers is its controversial Zestimate® which provides estimated home values. Based on an algorithm, real estate professionals have long lamented the Zestimate® as being often off base and misleading for their clients.
In the case of a home Zillow owns under the Zillow Offers program, what happens when their public Zestimate® conflicts with the sales price they need to make a profit?
The answer is unclear, though this appears to be the missing link in Zillow’s calculations. In other words, Zillow put their money where their mouth was… and their home value projections did not end up matching up with the reality of how much buyers are willing to pay in a real-world situation. They overpaid, and are paying the price.
As Zillow has demonstrated, real estate speculation is a tricky business.
A real estate speculator sneaks in between the home seller and the ultimate end user of property, be it a buyer-occupant or buy-to-let investor. Their goal is to purchase the home at a discount and sell quickly for a big profit. They may do some small improvements to boost the home’s value in the interim, but their biggest bet is that market momentum will continue to inflate the home’s value in the interim.
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Speculators can play a vital role in a healthy housing market, especially in the early months of a recovery when home values are near their bottom and end users are cautious about buying. But in 2021, when home prices are already at historic heights, speculation is downright dangerous.
The return of speculators
Looking ahead to 2022, firsttuesday forecasts home prices will decline. The obstacles facing home prices include:
- the expiration of the foreclosure moratorium and the winding down of forbearance programs, which are presently keeping roughly one million U.S. homeowners in their homes;
- the Federal Reserve’s bond taper, which is causing interest rates to inch higher;
- the end of government intervention and a slowdown in spending, as the last individual stimulus payments were delivered in March 2021 and the slimmed-down infrastructure bill will do little to lift the economy out of its malaise or ease inflation; and
- the faltering jobs recovery, leaving just over one million Californians still unemployed as of September 2021, compared to the pre-recession peak.
Rather than purchasing in 2021, real estate investors seeking to make a profit are better off waiting for prices to fall. The best time to buy will follow the growing number of homeowners exiting forbearance and choosing a forced sale over foreclosure. As inventory rises, home prices will fall back, and investors will find greater opportunities to profit.
Most importantly, the most prudent investors focus on their local markets. As has been confirmed through Zillow’s experience, even a fancy algorithm can’t make up for in-depth, localized knowledge of the housing market. Where are the improving schools, where are the streets with the most potential, where are they building that new shopping center — these are all questions that local investors know the answers to, and with those answers can make the best decisions on where to invest.
Keep an eye on your local housing market trends, including local jobs, construction, public policy and demographic trends. A full picture of the local housing market will provide investors — and real estate professionals — the best chance at accurately forecasting home sales in the coming months and years.
