A lot of people are jumping on the iBuying bandwagon as major iBuyers Redfin (RDFN -1.96%), Offerpad (OPAD -0.68%), and Opendoor (OPEN 0.78%) continue to ramp up scale. In 2021, iBuyers purchased 70,420 homes, double the number purchased in 2019.
This system for instantly buying homes using an algorithm to craft a cash offer and then fixing the home up before listing it at a higher price has gained notable traction among sellers and investors. But there's heavy debate over whether iBuying is here to stay. Despite most companies seeing business grow, here are two reasons I'm still not investing.
1. Flipping ain't easy
As an active investor myself, I understand the challenges involved with successfully flipping a home. Buying low, fixing up, and selling for a profit isn't as easy as it seems. Pricing, including accurately predicting renovation costs and the after repair value (ARV), is a balancing act that requires super careful consideration, something the algorithm hasn't perfected yet.
Comparable properties, which are recently sold, pending, or for sale homes similar in size, age, and condition in the immediate area, are what are used to help derive the ideal buy price and the achievable sale price of a home. Algorithms have gotten incredibly good at automatically considering comps to derive an estimated as-is value, but one thing it's majorly missing is the elimination of false comps, which could overestimate the home's value after repair.
Factors like a flat roof versus pitched, being located on a busy street, or garage conversions are just a few examples that can deduct a property's value, despite nearby comps showing higher prices for properties of similar age, size, or condition. Intricacies like these in addition to the general difficulty and unpredictability of forecasting future home prices can create flawed data within algorithms.
It's the reason Zillow's iBuying business failed miserably, losing hundreds of millions of dollars for the company -- the algorithm overestimated the future value of the homes it bought. Zillow's failed attempt doesn't mean every iBuyer runs the same risks from their respective algorithms as each company has its own sophisticated system. But it is a consideration and risk investors shouldn't overlook.
2. Its business model has yet to be tested
The past two years have been a turning point in profitability across the board for active iBuyers, and understandably so. Home prices growing at a national average of 20% year over year can make almost any flip profitable. Some markets are seeing upwards of 30% year-over-year home price growth. Insane price growth like this allows for greater profit margins for the iBuying business, but it also falsely validates the success of the business model.
RedfinNow generated its first positive gross profit for the full year in 2021, earning $10 million on a mere gross profit margin of 1.2%. Opendoor is in a slightly stronger position, with a gross margin of 9.1% and generating $730 million in gross profit from its iBuying business in 2021 -- although it still operates at a net loss due to operational expenses, sales, and marketing costs, which are nonnegotiable aspects of running an iBuying business. Meanwhile, Offerpad has the strongest financials among its competitors, having earned $207 million, with a gross profit margin of 10%, but these profit margins are still super slim and leave little room for error.
If the market pulls back, even slightly, iBuyers could be left with a lot of inventory on their books and a huge loss for shareholders to endure. The only way to truly know if iBuying will last is for the companies to overcome a market correction and maintain profitability in a balanced market.
The recent tech crash has pushed share prices for all three companies down to record lows, meaning that if you feel the future of iBuying is bright, there has never been a better time to invest. Personally, I want to see how this business model holds up to a real estate market correction before I would consider investing.