Proptech’s big moment

Quick cash, easy sales: iBuyers are grabbing more of the real estate market

Zillow flamed out. Opendoor and Offerpad say their algorithms are working. But ultimately, iBuyers will have to provide more than just an easy home sale.

Proptech Manual 2022: Big Story iBuyers

Homes in a subdivision in McDonough, Georgia. Much of the town sits in one of the ZIP codes where iBuyers are most active nationally.

Photo: Elijah Nouvelage/Bloomberg via Getty Images

The iBuyer model is upending the real estate business, bringing many changes to an industry whose traditional practices have long proved lucrative.

IBuyers, which offer quick, all-cash offers for homeowners with speedy closings, are growing quickly, forcing traditional brokers and real estate firms to move faster and offer better services. The iBuyer market made up a still small but quickly growing $10.6 billion or a record 1.9% of the home sale market in the third quarter of 2021, up from 1% in the second quarter.

While still relatively small, the iBuyer sector could have an outsized impact on the industry, which is currently grappling with a shortage of available homes. Some builders have seen iBuyers as a way to ensure the quick sales of homes. Opendoor has partnered with Lennar, and Offerpad has partnered with Taylor Morrison. If that proves effective, it could help spur more construction.

Meanwhile, to compete with iBuyers, traditional real estate firms and agents will have to look for ways to offer a better selling experience. This could mean offering quicker or more certain closings, new forms of financing to make selling simpler or their own form of iBuying. Some startups are already partnering with agents. Meanwhile, Keller Williams recently hired an executive to build out its iBuyer program and ancillary services. Brokerage giant Realogy also plans to build out its iBuyer program.

The biggest threat to the traditional industry is to agents’ commissions. In markets where iBuyers have gained a larger market share, there has been “downward pressure” on commissions, which could be a growing risk if iBuyers keep expanding nationally, said Jake Fuller, managing director at BTIG.

But their growth hasn’t been smooth. In November, Zillow shocked the market by abruptly pulling out of the iBuyer market, announcing plans to lay off 25% of its staff, about 2,000 people. Zillow had paid too much for homes and bought too many as a hot housing market was cooling. The company also pointed to labor and supply shortages. Ultimately, it was able to make offers to only 10% of customers who wanted one, Zillow CEO Rich Barton said. (Zillow reported last week that it sold off 8,000 homes in the fourth quarter of 2021, at an average loss of more than $27,000 each.)

“Put simply, our observed error rate has been far more volatile than we ever expected possible and makes us look far more like leveraged housing traders than the market makers we set out to be,” he said.

Despite Zillow’s surprising exit, Opendoor and Offerpad seem to be weathering the pandemic storm, and Redfin and a host of startups are also in the market. The reason: Some consumers looking to sell a home like the convenience of quick, reasonably-priced, all-cash offers with quick closings. The traditional process is time-consuming, costly and stressful, and sellers often worry about problems with the buyer’s financing and other impediments to closing.

Opendoor now is the largest iBuyer. Opendoor sold 5,988 homes in the quarter ending in September, up 72% from the prior quarter. That turned into $2.3 billion in revenue, up 91% from the prior quarter. Its home-buying engine isn’t slowing down: It bought 15,181 homes in the third quarter, up 79% from the prior quarter. It had an inventory of 17,164 homes as of the end of the quarter, and more than doubled its local markets in 2021 from 21 to 44. In 2022, it entered the Bay Area.

Smaller rival Offerpad sold 1,673 homes in the third quarter of 2021, up from 749 in the year-ago period. It also ramped up acquisitions, buying 2,753 homes in the quarter, up from 769 a year ago.

Still, the iBuyer model faces risks and isn’t fully proven, according to BTIG’s Fuller. Opendoor’s inventory was expected to be significantly higher at the end of 2021, and its sell-through rate of homes was expected to drop in the fourth quarter. Some think that could be a sign of a Zillow-style problem, Fuller said. Opendoor has said this is a seasonal issue, but there isn’t enough historical data to know for sure until a couple more quarters pass, Fuller said.

“The problem is that we don't know what normal seasonality looks like, and therefore whether a high inventory balance and low sell-through in 4Q are ‘normal’ or a sign of an issue. We think it is more likely the former than the latter,” Fuller wrote in a recent report. Opendoor’s Feb. 24 earnings release could give more clarity on the state of the business.

One longstanding risk of the iBuyer model is that a black swan event will leave iBuyers with a glut of houses that they have to sell at a loss. So far, Opendoor and Offerpad have shown they can quickly adjust to macroeconomic conditions such as the freezing of the housing market in 2020.

Opendoor charges a 5% fee to sellers when it buys a home, compared to a typical 6% fee that is split between the buyer and seller’s agents. With Opendoor, sellers don’t have to deal with staging or buyers requesting repairs or concessions on certain costs, said Ian Wong, co-founder and CTO of Opendoor.

The price must be right

Flipping homes is risky and requires buyers to price them very accurately, because if you pay too much, you risk overpaying, and if you pay too little, the seller won’t sell. And if you get it just right? That can mean lower returns, said Tyler Sosin, partner at Menlo Ventures, an investor in competitor HomeLight, which works with real estate agents.

“In order to make this a very mass-market product, you have to get the spreads as close to zero as possible,” Sosin said.

Zillow’s problems showed how difficult it is to price houses, which can be unique in their features and vary enormously between local markets. Designing algorithms for trading homes is far more complex than those for trading stocks or commodities — and Wall Street hires physics Ph.D.s for those.

Opendoor says it thrived in the pandemic due to its pricing system, which uses data that is better than that used in typical industry “automated valuation models.” It also has its own proprietary data. This includes data directly from sellers when they request an Opendoor offer, as well as data gleaned through home inspections.

“We're able to infer property characteristics of a pretty broad swath of housing in each of the markets that we operate in,” Wong said. “So a big part of what enables accuracy in our pricing models is the quality of our data.”

Opendoor also uses humans to jump in at different parts of the pricing of a home. “If an algorithm is uncertain about how to process some input, if there's uncertainty about the outputs, the algorithms are designed in a way to be interpretable,” Wong said. “And they provide guardrails for humans or experts to make a decision on. So in that way, we're able to leverage the best of machines and experts.”

Zillow’s algorithm generated higher profits from flipping homes than it expected in the first quarter of 2021, indicating its algorithm had problems pricing homes, as buyer preferences quickly changed during the pandemic. But in the spring and summer, its algorithm led it to overpay for homes. Zillow also bought too many homes as it was trying to catch up to the pace of rival Opendoor, making its problems worse, according to The Wall Street Journal.

It was particularly embarrassing for a company best known for the Zestimate, a feature that estimates a price for any U.S. home, which it has said is accurate to within 2%.

The answer, the iBuyer market’s survivors say, is better data: both macro and market-level numbers. Opendoor trains and tests its models multiple times a day, which helps prepare it for future crises or to respond to an emerging issue, Wong said.

“Our models are highly responsive to changing macro and changing market conditions,” he said. “We know exactly for a given model how it would perform, not just recently, but actually all the way back in time through the great financial crisis [of 2008] and other periods of volatility.”

While some competitors stopped buying during the pandemic, Offerpad kept buying, said Kyle Rush, the company’s national vice president of Sales.

“We made what we felt was the right real estate decision and we monitored the markets very, very closely to see what was happening in each of our markets across the country,” he said. “And what we were able to do is make decisions quickly. We were able to see the rapid home price appreciation and be able to go and scale in our business. Other competitors in this space stopped buying when the pandemic hit, but for our homebuilder partners and our broker partners, we continued buying.”

Layering on services

While offering quick deals for sellers is a key attraction, over the longer term, iBuyers are looking to offer a broader set of end-to-end real estate services.

That’s what they hope will separate them from the competition. “The real differentiation comes in the end-to-end purchase and sale process, right?” BTIG's Fuller said. “If you can lock in with one provider, and everything is digitized and fairly frictionless, I think that's the magic you’re after.”

Opendoor is trying to offer competitive prices when it buys homes, which means it’s not trying to make a killing on the flip. But it’s also seeking to layer more services on top. This vertical integration strategy includes mortgages, title and escrow. To that end, it bought Pro.com and Skylight for home renovation and RedDoor for home financing. But those services are still a small piece of the firm’s revenue. In 2020, Opendoor made a small fraction of its total revenue in this ancillary revenue, according to Fuller. Opendoor said it does not disclose its ancillary revenue.

“It’s still a very, very early-stage effort,” Fuller said. “The biggest cost for these kinds of products is customer acquisition. So if you have a customer already locked in, and you can move an ancillary product like a mortgage, your incremental margin on that product should be very high.”

Opendoor also has a service for homeowners to sell and buy a house simultaneously so that they don’t have to move into a rental property while buying, do a contingent sale or manage two mortgages. About two-thirds of its sellers are also buyers, Wong said.

Offerpad also has a discount program for customers buying and selling homes or getting a home loan through the company. Its partnership with homebuilder Taylor Morrison lets homeowners stay in the existing home for six months after closing or schedule a closing up to nine months out to line up with a new Taylor Morrison home purchase.

For homeowners, these digital iBuyers may seem refreshing in the paperwork-heavy world of real estate. The tradeoff is not working with a real estate agent they’ve trusted through past transactions. But consumers are voting with their wallets. Residential real estate will only become more digital in the future, especially for homes priced below $600,000, where iBuyers focus, said Vik Chawla of Fifth Wall, an investor in Opendoor.

It’s one more headache for real estate agents, who are also grappling with tight inventories. With many piling into the market as housing prices rose, there are now about twice as many agents as there are listings, which is one more sign of a market screaming for change.

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