Zillow Group (NASDAQ:ZG)(NASDAQ:Z) recently surprised investors by announcing plans to exit the iBuying business, despite having promoted it as the company's biggest future growth driver for years. In this Fool Live video clip, recorded on Nov. 9, real estate analyst Matt Argersinger discusses whether the iBuying business itself is in trouble or if Zillow just didn't do a great job with it.
Matt Argersinger: Let's pretend we're still in the world of Oct. 18 and Zillow announced that they're pausing their iBuying program. Immediately the question is, are there deeper challenges to this business? Should we be a little bit worried? Well, maybe not, because at the time, Opendoor (NASDAQ:OPEN) and others said, "Hey, we're not slowing down. Zillow might be slowing down but we're not. We're open for business," as Opendoor said.
The question was, what about the profitability of iBuying? Well, it's interesting. You can make the argument even at the time, looking at second-quarter data, Zillow was not exactly profitable in their iBuying platform. Understandable for a lot of reasons. This is still a nascent growing industry. Opendoor, if you adjust for their, really large, stock-based compensation was profitable as was Offerpad (NYSE:OPAD), which is one of the smaller iBuyers in the marketplace.
From an industry point of view, you could make the argument, well, Zillow's running into some trouble, but maybe it's their own making and the overall industry is doing OK. This dovetails with data from Mike DelPrete who follows the industry really closely. He's got a great blog. He's a little more worried or was at the time. He said the overwhelming majority of profits, even for those iBuyers that are producing profits, it's really coming from the record home price appreciation we're seeing.
You can look at the Opendoor's gross profit margin in the same quarter, huge. Almost double where they were in 2018, but maybe or not maybe, but factually, a lot of that is coming because we've seen a lot of really great home price appreciation and the question is or the question was a month ago, what happens if that rolls over and we don't get to the double-digit price appreciation we're seeing in a lot of markets in 2021? That was a big question at the time. Then you had anecdotal data.
Anthony remembers this, but we shared this with Deidre when we were talking iBuying a few weeks ago on Backstage and this was almost funny at the time, but someone had posted this where this person listed their home for sale for $269,000. I don't remember where it was. It looks like maybe in Georgia somewhere. It went off the market and later Zillow ended up buying it for double-digit percentages above where the person was trying to sell, $305,000. They listed it for sale a couple of weeks later at a little bit of a markup. Not by any stretch, a huge profit margin, but definitely a markup and who knows how much work they put into it in those two weeks, but they ended up selling it in October at a loss of less than what they bought, and of course, the carrying costs, whatever costs they put into it, this was definitely a money loser.
And the question at the time was, is this just anecdotal? Or is this really happening across Zillow Offers? I think the conclusion today, guys, as we get into this, we are getting to Zillow's latest results, this wasn't exactly anecdotal. This might have been a fairly typical transaction that Zillow was getting into and the question is, why did their algorithm or why did their platform suggest that this was a good price to pay for this particular property? That's still an open question.
But if you look at this data, also from Mike DelPrete, it seems like a bit of a pattern. If you look at the median purchase price that Zillow was making in Phoenix, which again, I said was one of the hotter iBuyer markets. In September, Zillow was paying a lot more on the average house or the median house than the market was or Opendoor or Offerpad. It raises the question, not begs, raises the question of whether Zillow was just not very good at this. That's surprising in itself because it feels Zillow has been at this for a lot longer, at least has had data on houses for a lot longer than some of the other iBuyers.
Well, let's finally get into what happened last week. Nov. 2, Zillow announces earnings, but the shocker there was that they announced not only are they pausing iBuying, they're actually going to wind down the Zillow Offers operations completely. Rich Barton, CEO, founder, came out and said, "It's just too risky, volatile to earnings and operations and it's too low return on equity opportunity, at least right now for the business." They admitted, this was maybe a shock, too, they were unable to accurately forecast future home prices.
Anyone who's followed Zillow or been an investor in Zillow, knows about the Zestimate, Ze-estimate, how you want to pronounce it. They've been trying to algorithmically predict what home price's value is for probably over a decade at least by now. It's been a shock that, hey, that Zestimate didn't really help them or at least it didn't play a very smart role in their iBuyer platform. He also mentioned the unit economics deteriorates substantially in Q3. A lot of houses they bought in Q3 are going to be a lot less profitable than the ones they bought in Q2 and they're likely going to see further deterioration in Q4. That's not great. He also mentioned that getting to profitability at scale, it's just going to take too much capital with far too much risk.
Guys, this is coming from a company Zillow that is probably the most well-capitalized of the iBuyers in the industry. It's the largest company, or at least it was and they had the biggest balance sheet and probably the most access to capital markets versus your Opendoors, Offerpads and Redfins (NASDAQ:RDFN) of the world. That again, this is all pretty shocking news.
Rich Barton then said, "We really want to be a market-maker in this business. Instead, we ended up being a leveraged housing trader," and he'd rather refocus and address a wider audience of customers with more "asset-light solutions", what Zillow has been doing really since it was founded, which is very asset-light, really relying on the network effects around their user base and their platform to offer very high-margin solutions to its users. This was all a huge, shocking, big departure and guess what happened? Wall Street hated this.