What happened
Shares of Opendoor Technologies (OPEN 0.70%) fell a brutal 34.9% last month, according to data provided by S&P Global Market Intelligence. The iBuying and house flipping company put up solid growth in its latest quarterly result, but investors are likely worried about what a potential recession and rising mortgage rates will do to its business model. As of this writing, shares of Opendoor are down 65% year to date (YTD).
So what
Opendoor's business model is to buy and sell houses directly from consumers, becoming a new digital middleman that disrupts the traditional real estate market. This model has brought in a lot of growth for the company. Revenue was $5.2 billion in the first quarter, up 590% year over year. However, gross profit was only $535 million (buying and selling houses has low margins) in the period, and net income was a measly $28 million. And this is while housing prices have soared to all-time highs across the United States, creating a tailwind for Opendoor's financials.
Image source: Getty Images.
However, with the Federal Reserve raising interest rates, this might start moving in the opposite direction. When the Fed increases the price of money, this leads to mortgage rates on homes increasing as well. In the past year or so, mortgage rates have gone from under 3% to approaching 6%. When this happens, home affordability goes down, leading to potentially lower housing prices. It also might trap people in their existing mortgages that they filed over the last few years. If housing prices and mobility both go down, this could be bad for Opendoor's business model. The company makes money when people buy and sell homes, and if fewer people are doing so at lower prices, that will hurt Opendoor's margins. The company is also taking a risk by holding homes as inventory on its balance sheet, at $4.66 billion at the end of last quarter.
So, while a housing downturn hasn't shown up in Opendoor's financials yet, investors are pricing in that increasing potential over the next few years. It is unclear how Opendoor will weather this storm if it occurs, but it likely won't be good for the company's already slim profit margins.
Now what
For investors looking to buy high-quality businesses, it is probably best to avoid buying Opendoor shares, no matter how low the price gets. It has extremely low margins, is taking a big risk by holding homes on its balance sheet, and is beholden to the housing cycle. This makes for a highly unpredictable business and one that has not proven it can generate positive cash flow over a multiyear period.
There are much better options out there for investors right now.
