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3 Things Zillow CEO Spencer Rascoff Wants You to Know

By Joe Tenebruso – Sep 12, 2018 at 2:00AM

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The online real estate leader is significantly expanding its addressable market. Here's how.

Zillow (Z -1.52%) (ZG -1.55%) CEO Spencer Rascoff cleared up some misconceptions about his company's new homebuying and mortgage origination operations during its second-quarter earnings call. Investors may be underestimating just how large these businesses could become in the years ahead.

Expanding an already huge market opportunity

The second quarter of 2018 marked a major milestone in our company's history. We launched our Homes business and began buying houses directly from homeowners in two cities through our Zillow Offers program. We also announced today that we reached an agreement to acquire Mortgage Lenders of America, or MLOA, a national mortgage lender. The launch of our Homes business, coupled with the proposed acquisition of MLOA, are great examples of how we are executing strategically to become more of an end-to-end provider for housing-related services, with a focus on the massive opportunities ahead.

Real estate agents spend more than $12 billion on advertising every year. Yet even after years of torrid growth, Zillow accounts for less than 10% of that figure. As the largest online real estate marketplace with 188 million users, Zillow should continue to take share of this multibillion-dollar industry in the years ahead.

Yet although its core business should provide Zillow with many years of steady growth, the company is moving aggressively into even larger markets. During the call, Rascoff noted that housing sales generate $1.8 trillion in transaction value with "tens of billions of market opportunities" in ancillary services. He also highlighted the $1.1 trillion of purchase loans that mortgage lenders underwrite each year, generating "tens of billions of dollars in origination and advertising market opportunities." Zillow's new homebuying and mortgage businesses will allow it to compete -- and I believe win -- in these massive markets.

With its online and mobile expertise, Zillow should be able to provide consumers with simpler and more flexible homebuying, selling, and financing processes than are available via traditional means. In turn, Zillow has an opportunity to establish a stronger relationship with its customers through the entire home life cycle. And with its trusted brand and large audience, Zillow should have plenty of demand for its homebuying and mortgage origination operations.

Early results prove this to be true: Rascoff said that homeowners representing as much as 15% of the value of homes sold in its test markets are requesting offers from Zillow. I expect Zillow to quickly become a powerful force in the homebuying and -selling marketplace.

A dollar sign with an arrow-shaped shadow pointing from it

Image source: Getty Images.

An $800 million opportunity in mortgages

The mortgage business provides an opportunity to monetize the Zillow Offers business even further. So just what we intend to do here is, on a Zillow-owned home, when we're reselling that to a consumer, we will provide mortgage origination for a homebuyer of a Zillow-owned home through MLOA, which we'll rebrand post-closing as Zillow Mortgages.

So just to give you some napkin math for a second, about 400,000 homes sell a month in the United States. If Zillow Offers is buying and selling, say, 10,000 homes a month, that's about 2.5% or so of the market. If we're doing that type of homebuying and selling volume, homebuilders typically have a 75% attach rate on their in-house mortgage of homes that they're selling. At a 75% attach rate on 10,000 homes a month at $9,000 in revenue per mortgage origination, that's $67 million a month of mortgage origination revenue, or about $800 million a year.

In addition to the revenue figures quoted above, Zillow expects its new mortgage origination business to help it more quickly sell the homes it buys, thereby further improving the profitability of its Zillow Offers segment. Together, these businesses have the potential to generate over a billion dollars of revenue for Zillow, and perhaps more quickly than many investors currently expect.

Don't call us house flippers

To address the investor concern or media concern about this overall business expansion, I think it is a gross mischaracterization and misunderstanding to call this a "flipping business." Flipping requires distressed homes and distressed sellers, people that are selling their home under duress. And it only applies to a very small segment of the market. You know, most people are not willing to sell their home to a flipper, because their home doesn't meet that type of criteria. They're not desperate. They're not willing to sell it for 20% or 30% below market.

What we're doing at Zillow Group appeals to a much, much broader segment of the market. It appeals to anybody that values speed, certainty, ease, convenience, the ability to sync up the timing of the sale of their home and the purchase of the next home. That is appealing to a much broader swath of consumers. Arguably, most people need to line up the sale of their home with the purchase of the next home. So you can think of it as a service for which we charge a fee. It is not a flipping business.

Rascoff doesn't like it when Zillow Offers is referred to as a "flipping business." Instead, he views it more as a fee-based service business, in which Zillow receives a fee for providing sellers with a guaranteed price and closing date for their home. Zillow likens this process to selling homeowners a put option on the value of their house.

Moreover, Zillow thinks this service will be attractive to a far larger base of home sellers than is typically seen with house flippers. And rather than just distressed homes, a relatively small percentage of the overall housing market, Zillow says it could potentially make offers on as much as half of all homes sold in the top 200 real estate markets -- approximately 2.75 million homes annually. In turn, Zillow sees this as a volume-based business, albeit at lower margins than can sometimes be earned via flipping distressed homes.

Better still, when homeowners request offers that Zillow chooses not to bid on, it's passing those leads on to customers of its Premier Agent program, who can then potentially turn them into listings. Zillow has not yet begun to monetize these leads, but it intends to do so in the future, thereby creating another significant revenue stream.

The way its mortgage business complements its homebuying and selling operations highlights the strength of Zillow's ecosystem, in which many of its services reinforce the others. This helps to further strengthen Zillow's brand, while also allowing it to better monetize its massive audience. And it makes Zillow a force to be reckoned with in the multitrillion-dollar real estate industry.

Joe Tenebruso has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Zillow Group (A shares) and Zillow Group (C shares). The Motley Fool has a disclosure policy.

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