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Zillow Closes The Door on its iBuying Business

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In the spring of 2018, Zillow launched its instant home buying segment of its business, Zillow Offers. The segment offered fair prices on homes and the ability to cut out the middle man by selling directly to Zillow. Zillow Offers bought 3,805 homes in the second quarter of 2021, which was more than double its home purchases in the first quarter of the same year.

The dramatic increases in homes purchased were due to the Pandemic real estate boom that took place. Many believe that this boom was caused by the dramatic shift in the way people live and work — the Pandemic made working from home so commonplace and accessible that employees realized they could move out of crowded big cities and into quiet and tranquil suburbs.

For example, Peter works in finance for a major technology company. He lives in a large metropolitan area with his family so that he doesn’t have to commute from the suburbs to the office. In 2020, the Pandemic hits, and Peter’s world is turned upside down.

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Rather than walking a few blocks to work each morning through the busy city streets, he begins working remotely out of his small apartment. The apartment is crammed — Peter is doing his office work while his elementary and middle-school-aged children sit in virtual classrooms via Zoom, and his wife stays home with the toddler because preschool is closed.

Peter can barely hear himself think. There must be another way. And so, Peter says to himself, “I think it would be best for my family to move to the suburbs, where we can have a more spacious house. Since I’m working remotely, I don’t have to worry about the long distance to the office. What’s faster and more convenient than selling my home to Zillow Offers?”

Peter sells his home to Zillow Offers, and he moves into a larger house outside the city, where he has office space for remote work, where his kids can focus on virtual learning, and where his wife can care for the toddler.

While this is only a fictitious example, it illustrates what a good portion of the American public did during the COVID-19 Pandemic. According to housing market expert Mike DelPrete, the iBuying arm of Zillow grew at such a fast rate that the rest of the company could not keep up.

Zillow Offers had an “inventory write-down of” $304 million in quarter three of this year, a result of, in their words, buying homes for prices that are higher than it thinks it can sell them. Because of overvaluing much of its inventory, the company expects to shed a quarter of its total workforce, a process which is planned on beginning on January 3rd, 2022. As of end-of-day Tuesday, November 9th, Zillow (Z) stock is down 1.88%.

Zillow Offers’ major downfall was its Zestimate

The Zestimate (Zillow Estimate) is a value based on multiple data points.

For example, Bill is attempting to list his home on Zillow. He lives in a one story, three-bedroom, two-bath home. His home sits in a quiet, residential area that is grabbing the attention of prospective buyers. He goes on the Zillow website and enters his address.

Bill finds out that Zillow lists his house at $365,000. How was this value calculated, you ask? Shortly after Bill’s house was built, Zillow obtained information about the home from the local municipal office in the area. However, data may be obtained through user input. So, in this case, if Bill’s house had a previous owner who listed the home on Zillow, that data could be determining the price of the home.

Say, for example, that Sandy, the previous owner of Bill’s house, mistakenly listed the house as having two additional bedrooms and an additional bathroom. This, in turn, makes the Zestimate algorithm think that the house is worth more than it actually is (the Zestimate says the house is worth $365,000 when in reality it is only $225,000). Bill, who is unaware of the incorrect input values for the bed and bathrooms, thinks the price is a steal and sells the home to Zillow Offers.

Now, Zillow has lost $140,000 on the purchase of Bill’s home. As one can see through this example, trusting a business model to a single algorithm has its consequences.

DelPrete also says that it is hard to put a value on a home when so many qualitative factors are in play, such as distance to one’s relatives or length of travel time to and from work. You can’t calculate the price of strong family ties or the predicament of one’s social situation.

How does it impact the iBuying market?

Rather than discrediting the iBuyer business model as a whole, keep in mind that the end of Zillow Offers lies in its incorrect valuation estimate. Other iBuyers such as RedfinNow and Opendoor don’t have the same issue and are riding the wave that is a booming housing market. In addition, with Zillow Offers no longer being in the business of iBuying, larger pieces of the instant buying market “pie” are available for major players to take advantage of. In the past week, Redfin (RDFN) saw stock prices rise nearly 9%, while Opendoor’s stock (OPEN) has risen nearly 40% in the last three months.

The instant home buying market has lost one of its giants due to an unforeseen mistake in its pricing algorithm. However, the business model is still alive and well, and so are we.

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