Pod Insights Equity Podcast Did Zillow get high on its own supply? About this episode This is our Wednesday episode when we niche down to a single topic, looking to expand our understanding of one particular technology trend or another. This week? iBuying.
Zillow made a decision to get out of the iBuying market, with huge costs hanging over its head and a grip of layoffs to manage. Natasha and Alex were curious what went wrong.
So we brought along Ryan Lawler, one of TechCrunch+'s reporting team, who has covered the space for a chat. Ryan helped us use Opendoor earnings as a comparison point -- it turns out that the iBuying model can work, even if Zillow itself struggled with the model. (Opendoor went public via a SPAC, recall.)
We also talked about what the situation could mean for startups in the real estate market more broadly. It turns out that merely having data is not enough to make money in the housing space.
Equity is back Friday morning with our weekly news roundup, and if all goes well, also back on Saturday with something both special and fun.
And if you haven't given our sister podcast, Found, a listen, check it out!
Credits: Equity is produced by Theresa Loconsolo with editing by Kell. Bryce Durbin is our Illustrator. We'd also like to thank the audience development team and Henry Pickavet, who manages TechCrunch audio products.
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Transcript 0:09 Speaker 00 Hello and welcome back to Equity, a podcast about the business of startups where we unpack the numbers and the nuance behind the headlines. My name is Alex Wilhelm. I'm a reporter here at TechCrunch and I am joined as always by my friend Natasha Moscarenas. Natasha, hello.
0:22 Speaker 01 Hello, hello. Coming at you live for the last time this year in San Francisco.
0:26 Speaker 00 Yes, you are going to Jersey, I believe, for the rest of the year.
0:29 Speaker 01 Next six weeks. Catch me there. Actually, no one catch me there. I'll be home with my parents.
0:34 Speaker 00 I just want to point out that like, it's like 38 degrees on the East Coast right now. So you're leaving California and heading to the tundra, which was an error.
0:41 Speaker 01 Good.
0:42 Speaker 00 Cancel your flights, stay home. Anyway, so we are talking about something very particular today. This is, of course, our Wednesday show where we niche down to a single topic and drill in more deeply. And we have been talking Natasha, quite a lot internally about what the hell happened with Zillow. And essentially, you know, there was a business model change. There's a question of competition. Quite a lot to unpack here. But first, for people who don't get high and look at housing listings, what is Zillow?
1:08 Speaker 01 Yeah, I mean, my parents actually spent a lot of time looking at our neighborhood on Zillow. It is basically a website where you can surf through homes near you, or even in places you want to eventually move and look how much you can't afford them through Zestimates, which is just their fancy way of saying how much that house would potentially sell for based on their algorithms.
1:26 Speaker 00 Which we'll get back to in just a minute, because the news item out there isn't that people like to use Zillow. That's been around for some time. It's not a new company, really. It's public, you know, to give you some reference. But the company had some news in its last earnings report that it is going to give up on its iBuying efforts. And iBuying, if you don't know, is when companies buy up a lot of houses and try to sell them for a profit. And a company like Zillow that has data and has, you know, access to all of our traffic information, you would think would be a great fit for this. However, it hasn't gone according to plan. So what we have done is we have dragged in Ryan Lawler, who's going to help us figure out what's going on in the iBuying world. First of all, Ryan, hello. How are you? Hi, I'm doing well. Good. Folks who don't know, Ryan and I actually go back 1,000 years in the podcasting game because we used to be on Crunch Week together back in like 2000. 2014.
2:11 Speaker 02 Oh my gosh, those were the days.
2:12 Speaker 00 Yeah, I went back to look at the videos and then I realized how much worse I looked and I was like, okay, we're gonna banish these to the ash heap of history.
2:20 Speaker 01 My, my Ryan connection is that he was one of the first people I recognized on Twitter. Like, you know how like when you're first joining tech Twitter, you just like start to see the same names come up a few times? Ryan Lawler was one of the first names that I was like, okay, I think he's important because I see him coming up a lot on my timeline.
2:36 Speaker 02 Well, I wouldn't say I'm important, but that's fine.
2:39 Speaker 00 You're, you're important to us. Now, Ryan, for folks who out there who don't know, can you give us just a little bit of a breakdown of what iBuying is? Past the fact that it's just kind of the mass purchase of homes?
2:48 Speaker 02 Yeah, so the idea behind iBuying, whether Zillow's doing it, or Open Door, Offerpad, or, you know, there's a couple of companies that are in this sector. The idea is that a company, if you want to list your home for sale, a company will offer up an immediate sales price to you. And so you don't have to go through all the rigmarole of listing your house and, you know, having open houses and showing it, you know, the company just buys it. And then they do some repairs, maybe they do some renovations, they turn it around and then they sell it. And the idea is, in theory, that the iBuyer will, you know, pay for it at about or slightly below market value.
3:32 Speaker 02 They'll put some money into it and then sell it for more than they bought it for. The problem that Zillow ran into was that it was making offers on houses above market value and then selling them for less than they bought the houses for, which is-
3:49 Speaker 01 So both ends were kind of messed up.
3:51 Speaker 02 Yeah, both ends were kind of messed up and we can talk a little bit about, about why that is and how that affected the market.
3:57 Speaker 00 I mean, you would think it'd be a great way to build revenue. A lot of startups lose money. I don't get why everyone's being so censorious towards Zillow. I mean, my gosh. I mean, they, they bought so many homes. I don't know, as a growth hack for the top line side of their operations, it's not bad. Okay, but Ryan, what did go wrong? So Natasha brought up this estimate earlier. Everyone's favorite tool to kind of figure out what their house might be worth, in theory- Though now I don't trust it. So what went wrong?
4:22 Speaker 02 You know, what went wrong was that their algorithms were not that good. And whether it was the Zestimate, or I'm sure they have some non-public facing algorithm for pricing homes or estimating what they their value should be. It just didn't work. And so, you know, going into the third quarter, they were buying up lots of homes. They were actually bidding up the prices beyond just what the markets were asking for in certain cities. And then finding out on on the other end of the the sale that the homes weren't worth as much as they had originally paid for them.
5:02 Speaker 00 It's legitimately impressive that in a period in which housing prices seem to have gone up by like a million percent a year, they managed to lose money. And I I went through the Zillow earnings call. And they asked about this investor was like, given the market going up, how did you guys manage to lose money? And they were like fluctuations. I'm like, what fluctuations? This was going up like that. When did it go down?
5:22 Speaker 02 Well, I think that was part of it, right? Is that, you know, as they entered into the third quarter, they had seen, you know, 12, 18 months of really high home price appreciation. And then, you know, they hit the third quarter and started to cool. And so they were still operating under the assumption that home prices were going to continue going up at whatever rate they had been going up, and they just didn't. And so they were caught kind of flat footed. The other part of this that's really interesting is that in the second quarter, they actually decided to be more aggressive in their home buying operation. And I think that was part of the problem as well as that, you know, they had this algorithm.
6:04 Speaker 02 They were missing out on certain bids. They weren't buying as many properties as they wanted to. And so they actually kind of, you know, tweaked it a little bit so that they would be more aggressive. And then they got totally caught flat footed when the market turned just a little bit.
6:21 Speaker 01 Yeah, I mean, I was always curious if like the market cooling down was the stress test these companies needed in order to prove that iBuying was more than a market boom sort of business model. Do you feel like there's other companies out there that are proving that? Or are we still waiting for proof that it's not just a hot market that's making iBuying kind of work for other companies?
6:41 Speaker 02 Yeah, well, as I said, there are other companies that are operating in the market. And luckily for us, a few of them are actually public. And so Open Door, which has been around since 2014, they recently went public. And, you know, a week after Zillow had their third quarter earnings announcing that they were getting out of the market, Open Door gave their numbers and their numbers actually looked pretty good, really good. Maybe Alex can can walk through those numbers and sees better at it than I have.
7:12 Speaker 00 Before we get into Open Door, I want to just talk about Zillow and the impacts of all this. This isn't just an academic exercise, talking about business models and what makes the most sense, Ryan. There's a real human cost to this, a real human impact.
7:23 Speaker 02 Yeah, so I mean, on the business side, Zillow is going to be writing down more than $540 million on the inventory side, just because they have so many homes that they can't sell. But they're also going to be laying off 25% of their workforce. So cutting about 2,000 jobs. And, you know, these are all people that were in market in various places, whether they were inspectors, or real estate agents, or, you know, people just doing the labor. And so, yeah, it's a it's a huge loss for them, you know, both from a financial perspective and for the employee base.
7:58 Speaker 01 And like, kind of ironically, one of the reasons that Zillow cited when they were talking about leaving the iBuying market was that they were struggling with the labor side of it, the labor side of renovating homes and then bringing them back on the market. That takes a lot of like, human construction work. So I think that's what caused some other companies to slow down their buying. Zillow, obviously, we just talked about, didn't. And that's another reason why they're now having to lay off people.
8:24 Speaker 00 It's kind of amazing how much the macro environment has come up in my conversations with tech companies. Like just for example, I was talking to the CEO of Root, the kind of Neo Insurance Auto Insurance focused company in the US that's now public. And one thing that they've been hit with is rising costs of used cars, thanks to inflation in the current market and the chip shortage and so forth. And also the fact that it is more expensive now to repair vehicles. And so essentially, labor costs have gone up, used car prices have gone up, et cetera, et cetera, et cetera. And that has actually shaken up the auto insurance market so much in the US that advertising is down across the entire sector because no one knows how to price insurance. And so essentially, no one wants to actually bring on new customers because they don't know how to price the coverage. Who would have thought that a chip shortage would lead to Root having gross margin declines or whatever? I mean, it's fascinating to see how
9:06 Speaker 00 it all trickles down into that world and into the iBuying space. It's very interesting to me. Ryan, I have some data for you. Zillow said they wanted to stay within 200 basis points, or 2%, give or take, of break even economics. And then they said later on in their investor letter, that they saw their economics swing in Zillow offers, this particular part of their business, negative 1,200 basis points from Q2 to an expected negative 500 to negative 700 basis points in Q4. I mean, my gosh, that is so embarrassing for a company that has all the data. I mean, I just can't imagine why this got so twisted. Someone's getting fired. And it's not just the 2,000 people. Someone internally [__] up.
9:46 Speaker 02 Well, I think that's part of the story. And I think that that is part of the difference between what Open Door is doing and why they've managed to be successful versus, you know, what happened with Zillow. You know, if you go back a couple of years, Keith Rabois, who is, you know, founder of Open Door, back when Zillow first announced that they were entering this market, he said, if they buy homes at the zestimate price, they'll be bankrupt quickly. And if they don't, isn't the zestimate fraudulent? And so it's just, you know, really early on, throwing shade at the pricing data that Zillow was putting out there in the world.
10:22 Speaker 00 It's especially shocking, given that Keith Rabois is famous for being so moderate and relaxed in his views and, you know, avoiding the strident cheap shot at competitors. I want to point out there that Open Door is doing very, very well. So at least Keith had a directional point back in the day. Ryan, you asked for these numbers, so here you go. So in the third quarter, Open Door had revenues of 2.3 billion, up 91% compared to 2Q of this year. So we're not looking at a year-over-year comparison. We're looking at a sequential quarter differential because 2020 was kind of a mess in the housing market. And so it kind of makes more sense to compare their recent performance to what's going on now versus a year ago. Anyways, what we really care about is houses. How many houses were involved in driving the revenue numbers that we just saw? Well, in the third quarter, they sold 5,988 homes. Okay, fair enough.
11:06 Speaker 00 But they actually purchased 15,181 homes in the quarter and grew their overall inventory balance to 17,164 homes, representing, and this blew my mind, $6.3 billion in value. That's a lot of money. It's they're taking on more risk, Natasha, when we're seeing Zillow run away, which I was impressed by.
11:27 Speaker 01 And I think you can kind of, when you were the early company in the market, Open Door was founded in 2014, and Zillow entered the market of iBuying in 2018. And I think with something like data, being early actually matters versus other businesses. You can just throw a lot of money at the problem and hope you get it right.
11:44 Speaker 02 I think it also depends on the type of data that we're talking about. And so when you talk about, you know, the data that Zestimates is built on, right? It's a lot of like, public data. It's a lot of data that Zillow sees just in in terms of like, what homes are being listed for and what they're being sold for in, you know, a certain neighborhood or a certain market. But, you know, that type of data really is table stakes. So, you know, independent of this story, I talked to a couple of Open Door executives for another story I was working on before the Zillow news even came around. And so they talked me through, you know, some of the different types of data that they collected. And so they have a lot of first-party data that
12:30 Speaker 02 They get through their seller information flow. They have a virtual walkthrough where they basically have sellers like take photos or video of various parts of their house. And so, you know, they've done something like 175,000, maybe 200,000 inspections since they've been founded. And each of those inspections, whether it's in person or virtual, collects like 100 data points. And so that's stuff that, you know, Zillow was not seeing as part of their estimates collection that gives Open Door an advantage.
13:05 Speaker 01 Yeah, I guess it's kind of a reminder of how human eye buying is, even though it has like an I in front of it. Like, there is so much in person, or at least like stuff that you can't scale super fast dynamics at play. And that also actually struck me about Open Door, because I think you assume if it's a fast-growing tech company that they're automating everything, but it sounds like they continue to rely on in-person as part of their model.
13:28 Speaker 02 Well, actually, no, a lot of what they did has moved virtual.
13:32 Speaker 01 Okay.
13:32 Speaker 02 And part of that was just because of the COVID-19 pandemic, right? Before that, they were sending inspectors into people's homes before, you know, they actually decided to buy a property. And then, you know, over the past year, they've moved to a completely virtual flow for acquiring that information, where there's actually an app where if you're a seller, you can, you know, take photos or whatever around the house just to give them, you know, a view of what they would be potentially buying.
14:05 Speaker 01 Oh, damn, okay.
14:05 Speaker 02 Yeah, so it's very much moved digitally as opposed to, you know, in-person, the way it used to be.
14:13 Speaker 00 I want to point out, though, that while obviously Open Door is doing better at eye buying than Zillow did, it's still taking on a lot of risk. And going back to the number of houses they have on the market, like, if we did see a downturn and they have 16,000 homes on their books that they have to service, you know, that they have to hold on to and pay for, there's a lot of risk there. And so there's kind of an inherent optimism about the housing market and the US economy as a whole baked into this, whereas I think Zillow probably has some more downside protection being mostly an internet business, well, now entirely being an internet business again, because software is a little bit easier to tune down and up on a cost basis than real estate, I'd say. Ryan, is that fair, or am I talking out my ass again?
14:53 Speaker 02 I think that's fair. And I think if you look through their numbers and you look at the third quarter and their estimates for the fourth quarter, one thing that they that they did mention is that their contribution margins did shrink because of the home price appreciation slowed down. And they expected that to extend into the fourth quarter. Especially in the fourth quarter, you know, they're they're going to be slowing down their buying because just seasonally, end of year is a bad time to buy and sell homes, generally speaking. But even beyond that, they still expect contribution margins of four to 6%, which, you know, considering the amount of capital that they have to put into it and the amount of inventory that they have to hold over a certain period of time.
15:39 Speaker 02 That is not bad. And, you know, it's actually a business that you can live on at scale.
15:45 Speaker 00 Yeah. And just to put that into numbers, in the Q3 report, Open Door says contribution profit was 170 million or 7.5% versus 128 million in the second quarter, which was 10.8%. So a really serious decline in that number. That's 33 basis points in 90 days, which I'm not going to do the math out there because we get into sub basis points. But like, it's pretty quick as far as margin erosion goes. It'll be fun to see how that changes up. But let's talk about some other companies. Ryan, there's at least one more public firm inside of our matrix here, and that is Offerpad. Ryan, tell me about them.
16:18 Speaker 02 Yeah, I mean, Offerpad operates the same way that Open Door does. And, you know, they've been around almost as long. They were founded in 2015. So they're a little bit younger. They're a little bit smaller. They're not in nearly as many markets. And generally speaking, you know, their business did about as well as Open Doors did, just on a smaller scale, because they're in fewer places.
16:43 Speaker 00 One thing that hit me is that Open Door had revenues of 2.3 billion, gross profit of 200 million, so just under 10% essentially. And then if you go look at the Offerpad numbers, they had revenues of 540 And gross profit of 53. So again, about 10%. So there seems to be a kind of a an agreed upon range in the market of 10% gross margins, which I, Ryan, you said earlier that the the numbers kind of make sense, but to me, that doesn't seem to be that big, even given the high dollar value of these homes, if the market was less attractive. If the market keeps going up, you always look like a genius. But I wonder what's going to happen to these businesses in a, in a, you know, sustained downturn, which will eventually come. We can't live in this bull market forever. But let's talk about startups. So Ryan, you are the the fintech expert on the show today. So you are going to stay in the hot seat. Are
17:27 Speaker 00 we seeing smaller companies try to get towards the iBuying space? Or is this mostly a playground for the mega wealthy and the large?
17:34 Speaker 02 Yeah, I mean, I think at this point, it's just, it's just really difficult to operate in this market. It there's, it's just hugely capital intensive. And so even just getting started is really difficult, especially when you have companies like Open Door that are in so many places already. And so there are, there are a few smaller competitors out there. Redfin, which also kind of operates like Zillow, they have an iBuying offering. There's a startup called Knock. There's another startup called Door. But generally speaking, just, just.
18:09 Speaker 00 Can they merge? They can be called Door Knock?
18:12 Speaker 01 Was that intentional?
18:15 Speaker 00 And then there's a thing called Window, and there's one called Payne, and one called Roof, and one called Shingle.
18:20 Speaker 01 Names for fintechs, honestly, like all of them make sense.
18:23 Speaker 00 Sorry, Ryan.
18:24 Speaker 02 But I, but, but the bigger point is that really, like, each of them is only in, you know, a few markets, whereas Open Door is in 44 now. They continue to expand. You know, they probably won't expand that much over the winter because, again, seasonally, it doesn't really make sense, especially as, as things get cold. You don't want to launch in that type of an environment. But generally speaking, it's just, it's really, really tough to get into this market. It's really tough to, to do it well. And, you know, as we mentioned earlier, you're, you would be entering into it at a severe disadvantage from a data and capital perspective. So I think it's going to be really tough for anyone
19:07 Speaker 02 else to enter iBuying, at least in the US. And then internationally, frankly, I looked it up this morning, I couldn't really find a lot of iBuying operations around the world. You know, as often happens, if a model proves itself out in the US, then you kind of see copycats in different regions. So I wouldn't rule it out.
19:29 Speaker 01 Yeah, there's a startup idea for anyone listening. But yeah, no, just to go off of what you're saying, Ryan, like it also sounds like iBuying isn't a wedge that startups can use and kind of tiptoe into and use it to gain customers down the road. The same way we see fintechs maybe offering other services like credit cards to eventually get stickier customers and like a lifetime value. I feel like iBuying is way too complicated and particularly a bad idea at all to get involved in housing because it's a market that's just so out of your own control that if you can avoid doing that, why not de-risk yourself a little bit?
20:03 Speaker 00 This reminds me of when I was talking to Hippo after one of their earnings calls. They do like homeowners insurance to some degree. And I was like, man, your gross margins took a hit. And they're like, yeah, there was a huge hailstorm in Texas. And I was like, word? They're like, yeah, well, we have, we have a lot of exposure to Texas. I'm like, damn, I have a much easier life than you guys. Sorry, Ryan, you were gonna say something.
20:22 Speaker 02 That goes into a little bit of what's going to be driving Open Door's business going forward is beyond just buying and selling of homes, they're looking to do more value add services. So title insurance, homeowners insurance, you know, all of the other things that go with purchasing a house, they can either sell themselves or they can, you know, act as a cost per action selling for someone else, referring to one of these other businesses.
20:53 Speaker 01 Yeah, I mean, that to me, and I'm sure to investors too, feels a lot more stable of a bet to make. Alex, I guess I'm wondering, like, I know we haven't seen this yet become a profitable business alone. Like iBuying itself isn't profitable, even Open Door is losing money. So how bullish are you on iBuying and what it's gonna look like five years' trip now?
21:13 Speaker 00 Yeah, I'm not that bullish on it. Currently, Open Door is doing a lot of great stuff. Like, I mean, reading through the numbers is very impressive. I covered them when they announced their SPAC deal. Like, you know, I've been tracking this company for some time. But you're right, Natasha, they do lose money. They had negative net income of 57 million in Q3 and negative 144 million in Q2. That's a lot. That's not nothing. Even on an adjusted basis, their adjusted net income is still negative. So, okay, so that's, that's that take. But if Zillow doesn't have the data to make this work and they got high on their own, Zestim's apply, cool. Open Door is the closest profitability, but again, I think the market has to be going up for this. I just, I wonder how this makes money in a less attractive market for homes. So that's my concern. But you know what?
21:58 Speaker 00 It doesn't matter what I think because I do not own Open Door stock. I own index funds. Actually, so I probably do own some minute fraction of an Open Door share somewhere. But it's a model that I find absolutely fascinating and I'll be curious to see if they can bring on more higher margin business lines like Ryan mentioned, title insurance and so forth. And if that's the case, then huzzah. Then the numbers make a lot more sense. I just, certainly the eye buying part of their business can't become gross margin neutral, right? They can't build enough of a business on other stuff that has to make money. I just, I wonder about the overall economics of it long-term, but I'm sure Keith Reboy will have a tweet for us telling us why we're quote, quote, "wrong."
22:38 Speaker 02 Yeah, I forget what he was responding to, but at one point Keith Reboy said there was no way to sell a home before Open Door existed.
22:47 Speaker 00 Wow. It's a good thing that homes have been held in the same hands for tens of thousands of years. This is my cave.
22:54 Speaker 00 You can't have it. Keith hasn't been born yet.
22:56 Speaker 01 For all the startups that are listening that maybe agree or disagree, like, as Ryan said, we're lucky. We have a few companies that give us their numbers because they're public, but this is one of those industries where like actually having revenue numbers matters because so much of it can be smoke. And I think it matters less for some startups at this stage. Matters a lot more if you're in the eye buying space.
23:14 Speaker 00 All right. And listen, we're gonna, we're gonna wrap it up here. We'll have Ryan back on the show as we cover fintech topics here and there. But I just want to say that the real heartbreak, the real catastrophe, the real mess here is that I need to remove our zestimate from our net worth spreadsheet because apparently it's bull. And let me just tell you that it was very convenient to have someone else value this bit of property. All right. That's equity. Ryan, thanks for speaking by. Shout out Philadelphia. Shout out Sixers and equities back Friday morning. Goodbye.
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