What Scared Zillow's Management About iBuying?

When Zillow (ZG 3.50%) (Z 3.29%) recently announced its exit from the iBuying business, it wasn't necessarily the decision itself that bothered investors -- after all, when a company exits a losing business, it can be a good thing. The problem is how quickly it appears the decision was made. In this Fool Live video clip, recorded on Nov. 5, Fool.com contributors Matt Frankel, Jason Hall, and Matt DiLallo discuss what might have scared Zillow's management so much that they decided to exit a major growth driver of the company so suddenly. 

Matt Frankel: September 7th, Zillow published an iBuying research report that it did, so that means in September, they didn't know that this was going to happen, or they were wasting money on an iBuying report they knew was going to go nowhere. It's one or the other. They made the point to say that iBuying is growing fantastically, 15,000 houses bought by the iBuying industry in the second-quarter, hit a 1% share of the US market for the first time ever, hit a 5% market share in Phoenix, Charlotte, and Atlanta, three of the hottest housing markets in the U.S. 5% of the houses result to iBuyers. They put this out just in September. Does this make you feel like this is a knee-jerk reaction to one volatile quarter?

Matt DiLallo: I think that's what is so weird about this is they were still pushing it for so long, and then all of a sudden, it was like they woke up to the fact that this is a volatile business. My question is, is this an algorithm problem? Did their algorithm just blow up on them? That was something that was hinted at when I was reading from Offerpad (OPAD 4.03%) and Redfin (RDFN 5.34%). Their CEOs hinted at different things. Offerpad CEO told MarketWatch that their algorithm gets them 90% of the pricing, but it's that boots-on-the-ground 10% that really is what makes a difference between a good offer that's going to be profitable and an offer that's not going to be profitable.

I question whether Zillow was doing this. Were they relying completely on the Zestimate? They've been pushing all these changes on the Zestimate, and I don't know what you guys have noticed on your personal houses, but my Zestimate is just always way off for all the houses I've owned. I don't think that they were addressing that issue. There's just things that data can't show you, and real estate is just such a human-intensive business and I don't think that they got that right, whereas Offerpad and Redfin were talking about part of how you get that right is the boots on the ground, that local knowledge.

It just seem like they realized way into it, they were way over their head, and it was just a little too late and the only thing they could do was to pull the plug. Otherwise, they're just going to continue to blow up a bunch of money.

Jason Hall: Yeah. I think it was two things here. Matt, I think you're right. I think a lot of it was, they realized that the technology they were using to make the majority of these, it was the price, it was a cash offer, was not able to factor in these seasonal shifts. And I think the other thing is that because this is a business that if you're really good at it, you can effectively use debt, and you don't have to hang a ton of cash on every transaction, and the returns on that, the actual capital that you invest can be very good.

The flip side of that is that it can compound the losses. I think they acted so quickly because they didn't want to create a position where those losses were compounded, where the decent margins that they make in the good times were wiped out, plus a lot larger losses by the potential losses of trying to offload too much inventory in the wrong part of the season. By the way, what if there is a sudden slowdown in demand? I don't think that's going to happen just because there's so little inventory in general, but I think they were thinking broadly about some sort of a black swan, something unexpected happening and being caught in this position.

Now, with that said, Zillow has got an incredible balance sheet. It would be able to absorb a pretty tremendous blow without fundamentally damaging the business, to lose a ton of cash, but I'm still just trying to absorb it, I really am. I need to take time and be glacial about acting on this. I don't want to jump in on this being a great opportunity because there's a lot of question marks. I certainly don't think it's right for me to sell because the other part, this is still a dominant business in all of the other things that they do and there is an opportunity to consolidate and continue to grow.