Housing has been incredibly strong in 2020, an abnormality during an economic downturn. That's been great for Zillow Group (NASDAQ:Z)(NASDAQ:ZG), one of the most popular online platforms for buyers, sellers, and renters. Zillow has seen steadily strong interest and high traffic across its websites, making it increasingly appealing to real estate professionals who count on Zillow to find clients. 

But Zillow has steadily put more and more emphasis on so-called iBuying, where it will buy the property directly from the owner, and then attempt to sell it for a profit. As this business grows larger, Zillow is at risk of marginalizing the real estate professionals who are getting cut out of the action, and who still drive the vast majority of the company's cash flows. The biggest risk is that iBuying isn't a big market opportunity, or very profitable at scale, and Zillow ends up burning bridges pursuing a business model that doesn't pan out. 

On the Nov. 6 edition of "The Wrap" on Motley Fool Live, host Jason Hall, Motley Fool and Millionacres contributor Tyler Crowe, and Millionacres editor Deidre Woollard discuss Zillow's pivot, the implications for its business, and the potential risks that could hurt its prospects and in return, investors. 


Deidre Woollard: This has been the strongest quarter for real estate obviously, because the first quarter was a wash, the second quarter was a mixed bag, and the third quarter has just been benefiting from this crazy residential real estate market that we're having. Zillow's consolidated revenue was up to about $657 million. The biggest growth in Zillow is still coming from their core Premier Agent business, which is basically selling leads to real estate agents. They have the most traffic to their sites and apps of any real estate search engine, so they use that power to sell leads to brokers and agents. That business grew 24% to $415 million.

But Zillow, like Redfin (NASDAQ:RDFN), is trying to do that, pivot to iBuying and get the profit out of the iBuying business. They are not there yet partially because they stopped iBuying in April when the pandemic first hit, and then they ramped up again slowly market-by-market. But their homes revenues section was down 51% to $187 million and CEO Rich Barton said that's mostly due to low inventory. In the third quarter, they bought 808 homes and they sold 583 homes. They're still losing money on each home. Right now, they're losing about $2,800 per home through these transactions.

Tyler Crowe: I had a question about the iBuying, it's been something that as you look at a lot of their investor presentations and things like that, they say the margins that they have on it. They think they can get to 4% to 5% margins on iBuying at scale. Have they given any indications on what scale means?

Deidre Woollard: I think nobody's figured out what scale means yet because Zillow and Opendoor, which is going public via SPAC, is they're both in around 25 markets. I think Opendoor is in 20 or 22, maybe. They still don't have enough iBuying sales to really know what scale is or could be. I mean, there's a large addressable market, but so far, it's thousands of homes, low thousands, it's not large yet.

Jason Hall: I think one of the interesting things about that we're going to have to figure out is this is the point, it's how big is that market really, because it's not the entire addressable existing home real estate market. Because let's be honest, buying a home, selling a home is emotionally taxing, it's stressful, and it's complicated as hell in most markets. Frankly, most people want to have a professional that can keep it out of the ditches. They can keep it on the road. Just be there when we feel all the stress to say it's OK, we can deal with this. I think what is going to happen, I think that something like iBuying, I think what it does is it resets to market. What is that service worth and also how many people out there are looking to make it less costly and willing to deal with a little more stress even if it's just perception of stress, Deidre?

Deidre Woollard: Well, one of the things that Rich Barton said on the earnings call is that, and Redfin set a similar thing. They're really trying to build that what they call it like a menu of services. They're really looking at everything to basically run the whole transaction. They see iBuying as just part of that as one path for potential for sellers to go down. But certainly, not necessarily the only way they're going to do it. So both Zillow and Redfin are heavily invested in mortgage and in title and in really trying to control all of the little pieces of a home transaction through one platform and they're not the only ones. There's a whole bunch of start-ups that are trying to do the same thing.

Jason Hall: Well, I think it's pretty clear that Zillow certainly had some network effect benefit. It's so large. I think what they're trying to do is they're walking the line between having this offering and not slaughtering their cash cow. Which is the real estate professionals that use their side as a major marketing platform. I think it has to be like, oh, by the way, if you want to do it, it's here, not you click on the website and then it launches a full-page banner ad, "Sell your house through Zillow." If I'm a realtor that doesn't really satisfy me.

Deidre Woollard: Yes and no, I mean, when they brought out iBuying, they basically told their premier agents, "This is going to be great for you because we're going to sell you these leads and you're going to get these really qualified sellers." But now that they announced last month that they are going to license some of their employees. They get closer and closer to being a brokerage. I know tons of people in real estate who've been saying for like 10 years, "Don't trust Zillow. They're going to be a brokerage, just you watch," and now they're all saying, "Look at us, we were right."

But so far, that hasn't really impacted their premier agent business. But I think it's too soon to tell, just from what I see in the industry, I think we're going to see some major brokerages actually start to pull away from Zillow and just start to rely on those leads less. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.