Zillow (Z 3.29%) (ZG 4.02%) has taken shareholders on a wild ride in 2018. After climbing as much as 60% by June, shares of the online real estate platform are now close to breakeven on the year.
Investors appear to be losing faith in the company's ability to successfully enter new markets. Yet their pessimism is presenting long-term minded investors with an intriguing profit opportunity. With this in mind, here are two reasons why Zillow's stock could rise sharply in the coming years.
1. Zillow Offers is a misunderstood and underappreciated opportunity
Investors reacted negatively to Zillow's announcement that it's launching a homebuying and home-selling business. Skeptics argue that Zillow's plan to flip homes would tie up precious capital that could be used to fuel the growth of its core advertising-driven business and add an additional level of risk to its business model.
Yet CEO Spencer Rascoff was adamant during Zillow's second-quarter earnings call that it was a "gross mischaracterization and misunderstanding" to call Zillow Offers a "flipping business." Rascoff said that Zillow was not interested in buying distressed homes, which is what's typically required to make a profit when flipping houses. Instead, the company sees Zillow Offers as a service for which it will receive a fee for providing sellers with a guaranteed price and closing date for their homes.
In turn, Zillow thinks this service will appeal to a far greater number of home sellers than offers made by flippers. In fact, Zillow says it could potentially make offers on as much as 2.75 million homes annually, representing about 50% of all homes sold in the top 200 real estate markets.
Moreover, the valuable data Zillow collects on all the homes listed on its platform will inform its decision-making as to which homes to buy -- and for what price. It's therefore more likely to generate consistent profits on the homes it purchases than typical home flippers would, as they don't have access to the same data. As such, investors may be overestimating the risk involved in Zillow's home-buying operations.
All told, the U.S. housing market generates $1.8 trillion in transaction value each year. If Zillow can earn just a small fraction of the profits generated during those sales, the company stands to make a fortune -- one that's far larger than many investors currently expect.
Zillow's data-collection capabilities allow it to know which homes to buy -- and at what price. That gives its new Zillow Offers business a decided edge in a $1.8 trillion market. Image source: Getty Images.
2. Mortgages are another area of strong potential growth
Zillow's acquisition of Mortgage Lenders of America, or MLOA, also was initially met with investor disapproval. Yet here, again, the bears are missing the bigger picture.
Becoming a national mortgage lender will give Zillow another means by which its new Offers business can generate profits. The company plans to provide mortgages to people who buy a Zillow-owned home through MLOA, which it will rebrand as Zillow Mortgages. Management believes that Zillow's new mortgage business can ultimately generate $800 million in annual revenue. Rascoff explained how during the company's Q2 earnings call:
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.
For context, Zillow generated $1.2 billion in total revenue over the past year. So you would think that a brand new $800 million revenue opportunity would be greeted with cheers from investors -- and a rising stock price. That has not yet been the case, but perhaps it will be once mortgage origination profits begin to flow into Zillow's coffers in the quarters ahead.
