Real estate is one of society's largest, oldest industries and has managed to resist significant disruption for many decades. In recent years, companies like Opendoor Technologies (OPEN -0.61%) have been attempting to improve the homebuying process with iBuying, where companies buy homes and resell them on the market.
Opendoor's largest competitor, Zillow (ZG 2.60%) (Z 2.76%), recently quit iBuying, causing investors to question whether the business model can work. Here is why Opendoor's path could lead to dominance in real estate.
The role of iBuying in real estate
Buying and selling a home isn't known to be an enjoyable process; it's the most significant purchase that most folks will make in their lives. The transaction process has many steps and can take more than two months to complete.
To make things worse, people often need to balance selling their home with buying a new one, which can leave people stuck with two mortgages or no house at all for a while. Roughly 40% of homebuyers have called it the most stressful event in their life.
iBuying is a simple model where a company buys a house with a cash offer and quickly turns around and sells it on the open market in return for a service fee. It's potentially a faster, more straightforward process, and Opendoor generates a net promoter score of 70 out of 100, indicating that the company delivers a positive user experience to homeowners.
A common misconception about iBuyers is that they flip houses for profit, but iBuyers are "market makers," providing homeowners with liquidity -- a quick, easy way to turn their home into cash.
Separating Opendoor from competitors
Three major companies operate in the iBuying space, including Opendoor, Zillow, and Offerpad (OPAD -1.10%). The iBuying business requires large capital investments to acquire houses to sell, and real estate is highly competitive, leaving little room for margins.
Zillow is quitting the iBuying business after aggressively growing it by acquiring many homes to sell. However, it overpaid for a lot of its houses and has had to sell them at losses in many cases.
Offerpad is on the opposite end of the spectrum, being very picky and slow to acquire homes and making sure that it can profitably sell most of the homes it acquires. Here's a comparison of the big three in the space.
|Average acquired price||$395,000||$271,000||$365,000|
|Average sell price||$428,000||$327,000||$403,000|
|Margin on each sale||5%||20.6%||10.6%|
As demonstrated above, Offerpad is generating the highest margins on the homes it sells, but this comes at the cost of slower growth. Offerpad acquired 2,753 homes in its most recent quarter, compared to 15,181 homes for Opendoor in its own most recent quarter.
Opendoor is attempting to strike a balance between growth and profitability. While its margins are less than Offerpad's, Opendoor had positive net income in 2021 Q3, excluding share-based compensation expenses, while growing its inventory much more aggressively.
A nearly infinite growth runway
The company's aggressive pace of acquiring houses reflects the company's efforts to grab market share in a space with nearly limitless opportunities. Each year, roughly 6 million to 7 million homes are sold in the U.S. alone, meaning that even as the most significant player in iBuying, Opendoor hasn't even penetrated 1% of its potential market.
As Opendoor grows larger, its size becomes a competitive advantage because of how much money competitors need to compete in this industry. If it succeeds in growing large enough to establish itself as the Amazon of real estate, the size of the real estate market could comfortably power growth for decades to come.
The stock is priced like it already failed
Despite the potential upside here, the failure of Zillow has spooked investors away from iBuying, including Opendoor. The stock has declined nearly 33% over the past month, but that pessimism might be misplaced.
The company is executing at a high level, rapidly growing beyond the expectations it set when going public via its SPAC merger a year ago. At the time, management had guided the business to do $3.5 billion in revenue this year and grow to $9.8 billion by fiscal 2023.
Instead, Opendoor could finish this year at $7.3 billion, more than twice its original revenue guidance. Analysts expect 2022 revenue of $15 billion, a massive leap that further distances the company's growth from initial projections.
At estimated full 2021 revenue, the stock trades at a price-to-sales ratio of just 1. A lower valuation is reasonable because of the low-margin nature of this business. Still, even a company like Carvana that operates a similar model in the vehicle market trades at a P/S of 2.5, so there could certainly be room for Opendoor to expand its valuation once the market warms up to the iBuying concept.