Zillow Group (ZG -1.58%) (Z -1.86%)sent shockwaves through the market on Nov. 2 after saying it planned to shut its iBuying operation, a home-flipping venture the company had touted as a pillar of its future. Zillow, best known for its online real estate marketplace, had amped up its iBuying operation this year and last, riding the momentum of the red-hot real estate market. But buying homes, expecting prices to rise for a quick profitable sale, is hard to pull off.

Leading up to the end of Zillow's iBuying

The company initially announced a temporary pause in its iBuying operations on Oct. 18, halting new contracts and stating that strains in the labor and supply markets were proving challenging to keep in synch with its operational backlog. But its latest earnings reveal there is more to the issue.

person typing on laptop with houses in screen

Image source: Getty Images

On Nov. 1, a day before the company's earnings were released, Bloomberg reported that Zillow is attempting to sell about 7,000 homes, hoping to recoup roughly $2.8 billion from institutional investors. According to the article, Zillow has not made a formal statement, and the exact source for the information wasn't revealed. This resulted in a nearly 37% decline from Friday's close. But Tuesday's earnings reports would only made matters worse.  

In the third quarter of 2021, Zillow wrote down $304 million in properties bought within its Homes segment, the department that handles its iBuying operations. It turns out that despite all the market data Zillow collects, it misjudged housing prices and overpaid for properties. Excluding write downs, the company had a net loss of $80,771 per home in the third quarter.

Zillow said future selling prices probably won't exceed its purchase prices, estimating an additional $240 million to $265 million loss in the fourth quarter on homes it expects to purchase.

How did this happen?

iBuying is still a relatively new way to buy or sell homes, and while it seems to be gaining traction with consumers, the model itself is far from perfect. Predicting future values, which is a key aspect of a successful iBuying model, is extremely challenging. Even the slightest pullback in the real estate market -- or having the wrong future valuation, to begin with -- can ruin any and all potential for profit. And as we can see with Zillow's latest news release, it's a hard factor to master. Today, the company's balance sheet has 9,790 homes with an estimated value of about $3.75 billion; two-thirds of the properties are considered underwater. Yesterday, the company reached a deal to sell 2,000 of the homes in its inventory, the Wall Street Street Journal reported, citing unidentified sources.

Will Zillow recover?

Zillow's core business has been and will continue to be its online platform and listing services. iBuying looked like a promising new opportunity for the company but it proved to be a costly error. That said, many investors still believe in the power of its online services, including Premier Agent, Zillow Rental, Zillow Closing Services, and Home Loans, as well as its internet, media, and technology department (IMT). At its core, Zillow is very much the same company it was just three years before the iBuying experiment.

A recovery in the share price will likely take a while. The shares spent most of 2021 sliding from a high of about $200 amid concerns about iBuying, so it will be interesting to see how Zillow pivots from this setback. Rich Barton, Zillow's chief executive officer, had put a lot of emphasis on iBuying being a big part of Zillow's future. Now the company will have to find other ways to grow and to compete in the marketplace despite these losses.