The bigger they are, the harder they fall. That much is true for housing giant Zillow, which entered a hot and unpredictable housing market as a speculator and got burned.
Zillow Group, Inc. reported a $330 million net loss for the third quarter (Q3) of 2021 in a letter to shareholders, blaming the loss on the failure of their Zillow Offers program.
As a result, Zillow decided to sunset the program entirely.
The program’s rise and fall reveals the chasm in real estate yet to be bridged by technology — and serves as a cautionary tale to speculators in today’s housing market.
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The Offers program first launched in 2017, with a limited test in Las Vegas and Orlando. The program promised quick and easy online home sales — eschewing the traditional but time-consuming negotiations and showings.
Offers used a proprietary automated valuation model which relied on computers to set a listing price. Similar to Zillow’s Zestimate® tool, the valuations on those online listings have generated controversy and scrutiny.
That’s because Zillow’s property estimates are generated entirely by data and algorithms, rather than by real estate professionals licensed to perform appraisals or properly evaluate a home’s fair market value.
Consumers — and real estate professionals — have repeatedly criticized the accuracy of Zillow’s home valuations. Many users find its property valuations misleading. In fact, Zillow has fended off lawsuits by homeowners in recent years over inaccuracies in its pricing algorithm. Similarly, Offers became notorious in test markets for overvaluing homes.
For Offers, the algorithm’s proof (or lack thereof) is in the pudding. The average return on homes sold ran a loss — an average of $25,000 per home, according to Zillow’s Q4 shareholder letter. This figure does not include indirect expenses like sales and marketing, technology and development, operating expenses or income taxes Zillow may have incurred.
To be fair, the program was also snarled by extraordinary circumstances: a global pandemic that fundamentally shifted homebuyer preferences, a supply-demand imbalance resulting from an increasingly constrained for-sale inventory and unprecedented home prices hikes across the country.
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The iBuyer model for home sales
Despite the Offers debacle, this model — known as iBuying (or instant buying) — is part of a growing trend among real estate tech companies.
Opendoor pioneered the iBuyer model in 2014, and today is the largest iBuyer in the U.S., followed by Offerpad in 2015 which is now second-largest. RedfinNow, Redfin’s iBuyer program, launched in 2017 and continues to operate in key California markets. These are just a few of the dozens of iBuyer companies homeowners have to choose from.
Unabated by Zillow’s missteps, iBuyers continue to rely on artificial intelligence (AI), property data and algorithms to make instant all-cash offers.
To sweeten the deal, iBuyers entice homeowners to sell with other perks, including:
- purchasing the home “as-is” without requesting any repairs, upgrades, warranties, closing costs or counteroffers;
- cutting out real estate brokers, agents, and their fees from the transaction;
- making trade ins easier when a replacement residence is required, since the seller can more easily sell their home and buy a new one simultaneously;
- shopping their property to a wider market of buyers; and
- confidence that their home will sell quickly.
Editor’s note — Properties sold with an as-is clause are unenforceable in traditional real estate transactions involving a broker and a principal. An as-is clause states the buyer accepts the property without a full disclosure of known conditions.
When a buyer chooses to purchase a home without discovering the full extent of necessary repairs, such as with an iBuyer here in this case, properties are sold “as-disclosed,” never “as-is.” [See RPI e-book Real Estate Principles Chapter 13]
Related Video: Property is Sold “As-Disclosed,” Never “As-Is”
Click here for more information on California disclosure requirements.
After an iBuyer purchases a home from a seller, the iBuyer ideally makes the necessary repairs, markets and lists the house themselves.
Ka-ching! Easy profit — unless your algorithm is flawed.
Flipping fundamentals
As an iBuyer, Zillow acted as a speculator, flipping properties by targeting growing markets.
A real estate speculator slips into the real estate market, sandwiching themselves between the seller and the end user homebuyer — usually a buyer-occupant or long-term buy-to-let investor. Their goal is to purchase a home at a discount and sell soon after acquiring it for a juicy profit when prices inflate. [See RPI e-book Real Estate Economics Chapter 3.1]
Their gamble is to buy now on the belief home prices will increase by 50% or more in two or three years. All this is a bet a profit can be had, after the cost of acquisition, carrying costs and the cost to sell are factored in.
Speculator activity ramped up significantly in California between 2012 and 2019. Their bet was to make money on market momentum alone, believing home prices would continue rising thanks to the state’s stagnating housing inventory.
The bet became too risky in the second half of 2018, when California home prices fell in reaction to both rising interest rates and months of flat-to-down sales volume. Investors, even impulsive ones, have a hard time justifying purchasing when prices are falling.
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A spectacle of speculation
But in 2020-2021, these falling prices took a turn, and the market conditions of the 2020 recession would once again beckon speculators to housing.
Some of this momentum was sparked by low interest rates. In response to the pandemic-ravaged economy, the Federal Reserve (the Fed) reduced rates to historic lows to weather the weak employment and unstable recessionary economy of 2020.
By May 2020, the 30-year fixed rate mortgage (FRM) rate hit an all-time low, averaging 3.23%. For perspective, the rate a year earlier in 2019 was 4.0%.
Buyer fear-of-missing-out (FOMO) ignited an even greater frenzy for real estate. Individual buyers, sellers and investors alike were driven partly by low rates and partly by psychological factors.
California’s home prices skyrocketed in step with buyer purchasing power, despite significant job losses and volatile home sales. Additionally, foreclosure and eviction moratoriums would help keep inventory artificially low. These conditions set the stage for investors to return in droves.
By Q4 2021, investor purchases comprised 18.4% of U.S. home sales, up significantly from 12.6% a year earlier — and the highest percentage since record-keeping on investor purchases began in 2000, according to Redfin.
Offers be damned — cue the iBuyer frenzy.
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What’s next for Zillow?
Zillow still plans to improve the Zestimate® and rely on it as its bread and butter. It will become Zillow’s premier feature and brand advantage, as stated in their Q3 shareholder letter.
But after being burned with Offers, Zillow is expanding its services, platform, tools and technology to focus on clearing points of friction in the homebuying and selling processes.
Their February 2021 acquisition of ShowingTime, a home touring technology company, signals a recommitment to becoming a one-stop resource for all real estate participants. By relying on its platform, Zillow hopes to connect homebuyers and sellers with industry professionals who know their local market best.
More importantly, Zillow seeks to connect homebuyers directly to agents via its Premier Agent program. This initiative helps address the weaknesses exposed in the Offers program by instead tapping into the tried-and-true market expertise of local real estate agents and brokers.
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The value of a local agent
Zillow’s flipping failure yields a familiar refrain from industry veterans: the value of real estate professionals who know their local market cannot be replicated, automated or replaced.
Zillow Offers championed cutting out agents, brokers, and their fees, but it made a multi-million dollar mess by speculating without them. Seasoned professionals know real estate is a hyperlocal game, yet Zillow’s approach to property values is a generic and non-localized one.
Local agents know their markets and prepare offers based on valuations specific to those market conditions.
Agents also discover all the property defects and enhancements of value after conducting due diligence investigations on the subject property.
Therefore, a buyer’s agent will always be better suited to spot defects and negotiate a more realistic purchase price.
Related Video: Word-of-the-Week: Due diligence
Click here for more information on due diligence obligations.
However, Zillow’s iBuyer program relied on speculation. It applied national estimates to a local market, often for properties with unique characteristics. It waived property disclosures by purchasing the property “as-disclosed.”
Ultimately, Zillow gambled on housing prices going up, up and only up.
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What goes up must come down
Zillow’s pricing algorithms proved flawed, vindicating its many Zestimate® detractors. The company didn’t predict a housing market quite like 2021. In fact, few forecasters did.
Speculators like Zillow who bought at the top are looking at grim sales now, since:
- interest rates are continuing to rise;
- buyer purchasing power continues to decrease;
- the jobs market remains tenuous from the impacts of the 2020 recession; and
- housing supply is keeping better pace with demand as homes that were previously untouched by foreclosure due to forbearance programs begin to steadily add to the for-sale inventory after forbearance protections end.
These factors will all contribute to the cooling of home prices in 2022.
Compared to previous years, those who buy in 2022 will need to hold onto their homes for several years. Not two-to-three like speculators prefer, but more in the range of five-to-ten.
Investors looking for a quick profit may quickly begin to change their focus once FOMO fades and reality creeps back in.
Real estate agents assisting buyers can help their buyers avoid buyer’s remorse by explaining the rapidly increasing price gains in recent years cannot be sustained, and that the home the buyer is seeking will need to be one they are willing to stay and invest in for up to the next 10 years.
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Want to learn more about property disclosures and real estate speculation? Click an image below to download the RPI books cited in this article.
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