Inflation in the U.S. -- as measured by the Consumer Price Index (CPI) -- hit a 40-year high of 8% in 2022 (annualized). As a result, the U.S. Federal Reserve embarked on a campaign to aggressively hike interest rates, taking the federal funds rate from a historic low of 0%-0.25% in March 2022 all the way up to 5.5% by August 2023.
That rapid increase has crushed the housing market. In January of this year, U.S. existing home sales came in at 4 million annualized units, which was only a slight uptick from the 13-year low of 3.85 million just a few months prior. Companies like Zillow Group (Z 1.68%) (ZG 1.70%), which rely on people buying and selling homes to generate revenue, have struggled throughout this period.
The interest rate hikes have worked, as the CPI fell to an annualized 4.1% rate in 2023. That's still above the Fed's target of 2%, but the central bank estimates it will cut interest rates three times in 2024, which could reignite the housing market.
Zillow has transformed its business model over the last few years, and it's poised to benefit from a real estate resurgence. Its stock is still down 72% from its all-time high in 2021, but here's why now might be a great opportunity to buy.
Zillow is creating a housing "super-app"
Zillow has a dominant online presence in real estate, with an estimated 62% market share in terms of daily active users. It generates three times as much online traffic as Realtor.com, which sits in second place. The company is using that presence to deliver a housing "super-app" to consumers.
Through a combination of in-house services and referrals, users can find homes to buy or rent, sell their existing homes, schedule tours, and even get pre-approved for a mortgage. Zillow also offers a suite of relationship management tools for agents so they can interact with clients from the early stages of the deal right up to loan approval and closing.
U.S. real estate transactions totaled $2.3 trillion in 2023 (sales and rentals combined), and Zillow is eyeing a $187 billion opportunity to provide the services that facilitate them.
It's important to note that this is a major strategy shift for Zillow because in 2021, its largest source of revenue was iBuying. It involved purchasing houses from willing sellers and attempting to flip them for a profit, which works great when real estate prices are constantly moving higher. But the tide began to turn in late 2021, and Zillow started taking losses on its inventory of property. As a result, it closed the segment down.
Zillow is on the road to recovery
Zillow's annual revenue peaked in 2021 at $8.1 billion, with iBuying accounting for 74% of that total. With the iBuying segment now closed, Zillow's 2023 revenue came in at just $1.9 billion, which was flat compared to its 2022 result (due to the suppressed housing market).
While that's a huge hole to fill, Zillow is a much healthier business today. The company lost $527 million in 2021, compared to a net loss of just $158 million in 2023. Plus, Zillow delivered $391 million in adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2023, which was more than double its 2021 result despite generating substantially less revenue.
Simply put, real estate services carry higher profit margins than did practices like iBuying, which relied on making small amounts of money on a high volume of flips.
Image source Getty Images.
Why Zillow stock is a buy now
As mentioned earlier, Zillow stock is down 72% from its all-time high that was set during 2021. The decline is understandable, considering the material drop in revenue with the elimination of iBuying. However, it creates a potential opportunity for investors who buy in today and hold for the long term.
Based on its 2023 revenue, Zillow has barely scratched the surface of its $187 billion opportunity. The company believes (based on internal data) that 70% of real estate transactors already visit Zillow every month, even if they don't directly engage its services.
Around 80% of the 105 million people who visit Zillow online each month do so organically, and when that many potential customers regularly walk through the door unprompted, there is always ample opportunity to convert them into paying customers.
If interest rates do fall as expected in 2023, it could trigger an uptick in transactions, which would greatly benefit Zillow. Normalized housing market conditions will give investors an opportunity to assess exactly how well the company's transformation translates into renewed revenue growth.
Wall Street is optimistic. Analysts' consensus forecast for 2024 points to $2.17 billion in revenue, representing 11.8% growth compared to 2023. While modest, it would be a solid improvement over the company's flat result in 2023, and there might even be an upside to that number if interest rates fall faster than expected.
In any case, Zillow will likely face more favorable conditions over the next few years, which makes its beaten-down stock look highly attractive right now.
