What Just Happened To Zilllow?
You may have noticed that Zillow was all over the news in the last few weeks, and not in a good way. After first announcing they were pausing their Zillow Offers program (where Zillow buys a home directly from a homeowner and resells it), they quickly followed up announcing the shutdown of the program entirely resulting in a plunging stock price and layoffs.
How it All Started
Zillow was founded in 2006 by former Microsoft executives who had created Expedia, the on-line travel site. The original vision for Zillow was to do to the real estate industry what Expedia did to the travel industry, namely allow the consumer to transact directly on line.
It soon became apparent that using a website to buy a $300 plane ticket or make a hotel reservation, a relatively low cost and routine thing, is very different than buying a home which involves a great deal of money, emotion, and done only a handful of times in most people’s lives. It’s one thing to choose an airline and a flight for a vacation, quite another to choose a neighborhood, a home, and make one of the biggest financial decisions of your life unassisted and on-line, no matter how fancy the website.
Nonetheless, Zillow did a superb job of making the online home search an easy process and succeeded in getting consumer attention as a search destination. A key piece of this was the Zestimate, an automated on-line estimate of any given home’s value. Buyers liked it because it purportedly helped them decide if a home was a good value or overpriced. And homeowners liked to see what Zillow thought their home was worth 24/7.
Soon sellers began wanting their homes to show up on Zillow for added visibility since that’s where buyers often looked. And the more homes that showed up on the site, the more desirable it became as a search portal. A virtuous circle for Zillow.
Show Me The Money!
The question was how could Zillow make money on this? They found two answers. One, the typical way by selling advertising on their site for all sorts of companies. But the other much more lucrative solution was to sell placement on their site to real estate agents to generate buyer leads.
How does this work? Well, when you see a home on Zillow, there is a “contact” or a “schedule a tour” link to contact an agent to learn more or see the home. What most people don’t realize is that the agent Zillow connects you with is almost never the agent who actually listed the home! Instead it’s one of the agents who paid Zillow to send them that lead for a potential buyer. That agent may know nothing about the home at all, and in fact may even want to sell that buyer a different home, perhaps one of their own listings. To find the actual listing agent you have to scroll quite a ways down to see that info and there is no easy “contact” button there.
Picture it this way… “The agent the seller hired to sell their house puts their sign on the front lawn and the Zillow van pops up, a guy hops out, and he spray paints over the agent’s name, the broker’s name, and their phone number. Now by law, you must have the listing agent’s name on the sign. So, he staples a little business card to the bottom where technically you could see it, and then puts a different agent’s name up there on the sign. What this guy has done is hijacked the listing so he can sell potential buyer leads to other agents.”
This approach worked and ironically, the company that launched with the idea of getting rid of real estate agents ended up making nearly all of their revenue by selling those agents buyer leads.
Feeding the Wall Street Beast
While selling leads to agents has been good to Zillow, they are a publicly traded company and like many tech stocks, their stock valuation far exceeds what the money they make would suggest. in fact Zillow lost tons of money for years and years and only just recently turned profitable. So the stock is high because investors have been betting on growth. Therefore Zillow has been searching for ways to do just that. Enter the iBuyer, aka Zillow Offers program.
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What is an iBuyer?
An iBuyer is a company that buys homes almost instantly by relying on technology to determine a market-based cash offer. iBuyers complete the purchase transaction online, often sight unseen, which means the homeowner gets to sell their home in a quick sale while skipping a lot of steps in the traditional home-selling process. Zillow then takes the home and preps it for market, providing light repairs and a sprucing up with the intent to quickly turn around and sell making a profit.
While the pilot program initially utilized local agents, as Zillow expanded it they became a broker themselves and took local agents out of the Zillow Offers program, basically relying solely on their Zestimates to determine the appropriate purchase price as well as a future Zestimate of what the house will sell for spruced up (Note these are generally single family homes which do not need gut-rehabs and are typically in the mid price range in select markets - they really have not done much if anything in the Boston metro area).
How to Make Money
There are several key factors at play for Zillow to make money here:
- Ideally they pay less than market price for the home and certainly don’t over pay
- They must be very cost efficient in the improvements, pick ones with the biggest bang for the buck, and do it quickly to minimize carrying costs
- They need to be correct in their estimated future resale value
- They are counting on the market staying stable or better yet, rapidly climbing. And hope interest rates don’t rise.
- And to really make money, Zillow has to do this at large scale since
- 1) the profit on each sale is is not likely to be huge and
- 2) smooth out their risk since some portion of “flips” will end up being a loss and/or to protect themselves from a specific local market perhaps not going the way they expected.
Or Maybe Not Make Money…
Well, as it turns out all of that was problematic…
Buying Low - While there are times when it makes sense for a seller to sell below market value (they need the cash, the loss in sale price is worth it to avoid the effort of a traditional sale, etc.), it’s generally not great for your brand to make money by paying people less than their home is worth on a consistent and large scale basis.
Renovating Quickly and Efficiently - As anyone who has done any renovations knows, doing it fast, well, and cost effectively is a challenge under the best of circumstances. Throw in a global pandemic with soaring demand (and therefore prices) for home improvement, supply chain interruptions, shortages of skilled contractors and you have the perfect storm of soaring costs and delays which can easily wipe out any profits, even if Zillow paid under the market value for the home.
Counting on Zestimates - As one high tech CEO put it “All the artificial intelligence and machine learning in the world isn’t yet up to the task of the complexity of valuing a home in a rapidly changing market, and this move by Zillow is proof,” Baur told GeekWire. “They invented computer home valuation with the Zestimate 15 years ago, and it’s still not accurate after 15 years of refinement and billions of dollars invested.”
Keep in mind that Zestimates often have a margin of error of 5% or more depending on the market and property type.. So even if all the other stars align, if your Zestimate is off by a few % on the buy price, or the expected sell price (or worse yet - both), you are in trouble.
Predicting the Future is Risky and Hard - Nothing proved that more than the pandemic, driving buyers out of the city and flooding the suburbs and especially the close by 2nd home markets (like the Cape, Newport, etc.).
Real Estate is Local - Trying to do all of this efficiently at a national level is a huge challenge logistically as there are differences in laws, forms, and practices from state to state. And while some national trends come into play (interest rates for example), real estate can vary wildly from market to market, even ones that are geographically very close. Hyper local factors can make a difference and while a local expert takes these into account, an algorithm is far less likely to factor those in. And let’s face it, buying hundreds or thousands of properties across the country sight unseen, based on numbers from a computer model, is risky even under the best of circumstances.
Believe your own hype at your own risk
Well, how has Zillow done so far? As we learned recently, Zillow’s faith in their Zestimates and their belief that automation could replace local expert agent knowledge just cost them $338 million dollars this past quarter alone, with an additional $240 million to $265 million expected to come from home purchases already in the pipeline for a total loss of over a half billion dollars. And so, not surprisingly, Zillow had little choice but to shut down the program and sadly lay off 25% of their workforce.
As Zillow founder Rich Barton put it “Our observed error rate has been far more volatile than we thought possible,” Barton said during the call. He later added that “fundamentally we have been unable to predict future pricing of homes to a level of accuracy that makes this a safe business to be in.” In other words, Zillow, the company that built its reputation on telling homeowners what their homes are worth, lost their shirt when they actually counted on the accuracy of those Zestimates.
The moral of the story
When it comes to real estate, we should all learn from Zillow’s half billion dollar mistake. Trust local experts, not algorithms. Work with someone who knows your area, knows it’s quirks, and I can’t believe I have to even say this, has actually been in your house! And work with someone who is a professional offering you real time advice, strategies and proven selling techniques, has an ethical and fiduciary responsibility to take care of you.
When all is said and done, Zestimates may be an interesting data point but they are not infallible. Just ask Zillow…