You wouldn't know it from looking at the stock of Zillow Group (Z +2.30%)(ZG +1.47%), but the U.S. housing market is expected to suffer something between a relatively mild slump and a severe crash.
Even if housing does crash, it's not expected to be on the magnitude of the 2008 financial crisis. But just because something is not as bad as the worst collapse doesn't mean it won't still hurt.
Yet the stock of this real estate marketplace seems blissfully unaware of the gloom hanging over the industry as shares are up 50% in 2023 and some 85% higher over the last 12 months.
But with the stock still some 75% below its all-time high set two years ago, investors need to decide whether Zillow's shares are a fixer-upper or a money pit. Let's find out.
Image source: Getty Images.
Building a worst-case scenario
There's a lot of contradictory information about the state of the housing market. Housing starts and building permits are at their lowest in three years, and mortgage interest rates are at their highest in years. But home prices are still rising, and homebuilder confidence levels are up for two consecutive months.
The St. Louis Federal Reserve says there were 1.7 million housing units under construction in the U.S. at the end of January, just slightly below the record 1.71 million reached last October. The National Association of Home Builders says there are 948,000 apartments under construction, the largest number since 1973.
Yet mortgage delinquencies are starting to rise, up 51 basis points from the third quarter to 3.96%, though still well below the year-ago figure. But the Fed just raised interest rates again, and a hotter-than-expected reading from the producer price index might leave the Fed's governors inclined to continue increasing them.
US housing starts data by YCharts
Hammering home the mistakes
While there are numerous real estate information portals, none has anywhere near the level of mindshare that Zillow does. And for good or bad, its Zestimates -- the online home-value estimates its algorithm creates for every home -- have become the de facto starting point for many.
Yet despite the vast amount of information at Zillow's fingertips, even it wasn't able to parlay that into an effective -- or profitable -- house-flipping business. It was bad at predicting home values in any given market. That led its Zillow Offers program to rack up massive losses that required it to shut down the service (which was completed late last year).
NASDAQ: Z
Key Data Points
But while Zillow is no longer flipping homes, it offers mortgage origination services, title and escrow services, a new instant tour booking feature for renters, a new-construction marketplace, and more. And it still hasn't figured out how to profit from all of them.
In its just-reported quarterly earnings, Zillow said the mortgage division had adjusted losses of $92 million on revenue of $18 million. Rising mortgage rates certainly help account for that, but even during the housing boom two years ago, Zillow reported losses of $9 million for all of 2021.
It also reported $66 million in losses this year for its title and escrow services.
Image source: Getty Images.
A shaky foundation
The affordability of homes remains the primary bellwether for Zillow stock, and despite the run-up in its share price, this is not a market conducive to homebuying.
The Zillow index of home values is declining, showing the average price of a home in the U.S. is over $328,000, down from its peak last August of $333,000. But that's still almost 9% above the year-ago figure and $100,000 more than where prices stood just before the pandemic.
Housing starts tend to be a leading indicator of what's in store for the economy, and for that we're seeing yellow flags waving, if not red ones. This does not bode well for Zillow since it does best when there is a robust real estate market.
The housing market is under pressure, and that's only likely to grow as interest rates rise. With Zillow's stock soaring so high, whatever possible good news there was has been priced into its shares, and any bad economic news will send it tumbling. Just as the Zestimate on your home is heading lower, expect the stock to follow suit.
