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ZILLOW ANNOUNCED recently that it would cease its algorithm-driven home buying program. Thus ends its three-year experiment to disrupt the real-estate brokerage business with what’s known as “i-buying.”
Zillow had purchased homes without significant involvement by real-estate agents. Instead, it used its proprietary algorithm—which it calls the Zestimate—to determine a property’s value. It then offered homeowners a percentage of this value, in cash, to buy their houses.
This offer proved appealing to many home sellers. They didn’t have to stage their homes and could be certain of the price they’d get. It also gave them a definitive closing date.
To generate a profit on each home sale, Zillow would keep the commissions usually paid to the seller’s and buyer’s brokers. They would also update the properties cosmetically, when needed.
Ultimately, Zillow erred grossly in anticipating how difficult it would be to turn a profit in the residential real-estate market. There were several problems with its model. Zillow likely discovered what the rest of us already knew—that getting a contractor to show up on time and do a good job is incredibly difficult, and that it’s hard to know whether a house is good value unless you take the time to carefully inspect the property. Of the 1,000 homes Zillow recently listed for sale in its five biggest markets, 64% were being offered for less than the company paid for them.
I wouldn’t fault any company for realizing the error of its ways and pivoting accordingly. What Zillow did, however, was irksome. How so? It announced it was pausing its i-buying program on Oct. 18. But it turned out to be more than a pause. Just two weeks later, on Nov. 2, Zillow admitted defeat and shut down its home buying program, shedding roughly 25% of its workforce in the process.
Zillow stock actually rose after it paused i-buying. But it took a 40% haircut when management surprised investors by terminating the program. Its stock is now down more than 70% from its February high.
Investors have to wonder whether management’s sudden decision was a knee-jerk reaction to its home-selling losses. Or did management know, when it announced the pause in i-buying, that it would kill off the program two weeks later? In other words, is Zillow’s management given to rash decisions—or does it lack integrity?
To be clear, the real-estate business model is anachronistic and, indeed, not every i-buying company is failing. A commission of, say, 6% means that real-estate agents who broker the sale of a $250,000 house earn $15,000. It takes roughly the same amount of work to sell a $1 million home, and yet their take would be four times greater. Make no mistake: This industry is ripe for disruption—but not, it seems, by Zillow.
The other major cash buying companies are continuing to advertise (Offer pad, Mark Spain, Open door). This suggests that Zillow paid to much in order to outbid the competition.
I think part of the problem was that the sellers were self-selected. If your house had a problem that is not immediately obvious, you would have an incentive to offer your house to Zillow. If it was in good shape, then you could get more by selling it to a regular buyers.
So Zillow would get a much higher percentage of defective and hard-to-fix houses than is found in the market as a whole.