ZG - Zillow Group

[patientcapital]

Has anyone dug into Zillow and the iBuying opportunity?

 

I'm pretty well versed on their legacy businesses (premier agent, rentals, mortgage), but it seems iBuying is both a huge risk and opportunity. Question is: does the reward outweigh the risk.

 

Any thoughts on this business is appreciated.

 

[Broeb22]

I have thought about this some...what massive industries/industry histories are out there that require huge amounts of capital to have scale on the supply side but have low barriers to entry to get in at a small scale?

 

I think the end game for these companies is a few companies will aggregate supply and make the housing market more turnkey than it was before and could reduce the need for realtors big time in the industry, which leads to more efficiency, which leads to them capturing even more economics, and so on.

 

On the flip side, anybody at this point can go out and open up a singe family home-buying operation with a quick website, maybe a million bucks (or some VC capital) and a big line of bank capital (hopefully non-recourse), and take a shot at this.

 

Zillow seems like they’re in a good position to succeed because they can fund this business with the cash flows of their existing business, though at some risk that realtors will figure out what they’re doing at some point and rebel against the Zillow lead-gen platform.

 

Anyways the industries this reminds me of:

 

Perhaps early railroad industry

Early airlines is probably a better fit since the assets are not fixed in place like railroads or cable

Early cable companies although railroads are better fit since technology change continues to drive cable CapEx and likely will continue to

Potentially co-working, where the contingent liabilities in leases somewhat mirror the contingent liabilities  in the debt financing for the homes and improvements; in a downturn how do you clear that home inventory out in a timely manner?

Perhaps more optimistically, you aggregate demand a la Priceline via a merchant model where you are actually buying inventory from hotels (someone correct me if I’m wrong on early Priceline’s business model being like this) and can scale very rapidly but can be almost killed in a recession if you’re not filling all those purchased rooms; interestingly, Priceline has kind of moved away from owning the actual hotel inventory, and earns a lower % of each transaction but actually has less at stake because they don’t own the inventory.

 

Thinking out loud, I think aggregating supply could be destabilizing for the home market in some kind of downturn because instead of individual people simply taking their homes off the market, these larger iBuying companies companies will be sitting on significant hits to their equity capital and will be aggressively liquidating their home portfolios to save as much equity capital as possible. While the long game tells me they may be able to earn equity- returns from capturing some of the 5-6% that goes to realtors today, they may not be getting that today in an effort to scale the business, making them a VC-equity funded home lender (except for Zillow) which is probably more fickle capital than bank deposits (which typically grow during recessions).

 

Just some random thoughts...

 

 

[Spekulatius]

House flipping seems like a risky and low return sort of business. Imagine if they get stuck chuck full with housing inventory in a downturn. They also compete with their main customers (realtors), which I think will quickly become a problem. Redfins model seems like a better one to me, but they are struggling too.

[cameronfen]

While I agree with Spek that this sounds like a kind of bad business, I think what Zillow is thinking is that they have so much data they can make more informed decisions on buying houses than anyone else.  Frankly I’d rather be the guy that sells this decision making capability to other house flippers and ibuying businesses, but I don’t run Zillow. 

[johnhuber]

Some thoughts.... Zillow isn't a good business in my opinion. The business of flipping homes loses money on a gross margin basis even before accounting for all of the company's operating expenses. e.g. they lose money on each house before paying their internal employees and all their other operating costs. There just isn't enough spread between the price they buy the home and what they sell it for to pay two sides of closing costs, including attorneys, appraisers, inspections, carrying costs such as taxes and insurance, cleaning fees, painting, maintenance and repairs, etc...

 

Scale isn't always a good thing. If the price of your product isn't high enough to cover your variable costs, then you're just going to lose more money as you "scale". So scale is like leverage: it can work in your favor but it can also work against you. It's not automatically beneficial.

 

I know the real estate business fairly well, and I'm pretty convinced there is no way for Zillow to profit from the flipping business. The other issue they have: scale actually works against them because the only way to really make money flipping homes is to cherry pick great deals. You can do this as a small operator by being nimble and patient, but if your goal is to have 5% of the "TAM", then you lose the ability to get below market pricing in aggregate. Housing is a commodity and Zillow's ibuying service is a commodity, which means they'll pay market pricing on the way in and the way out.

 

And the worst part is that they are taking on massive amounts of debt to finance these money losing transactions because there core business isn't profitable either so they will continually need fresh cash to grow.

 

My hunch is that they saw the writing on the wall with their core business (which also has issues), and they are making a Hail Mary attempt to find something new. But the something new isn't profitable.

 

One thing I've thought about lately is the simple idea of profitability as a checklist item. If the business is public (and thus is relatively established) and is not profitable, then you have to ask why not? If Zillow has all this valuable data, why isn't it using it to make money now? If flipping homes is a profitable business, why are they losing money on each of the thousands of transactions? I think this general concept applies to a lot of businesses. Amazon is the one giant exception to the rule; but the rule might be: if the company isn't making money now, it's highly unlikely that it ever will be a very profitable business.

 

[Spekulatius]

While I agree with Spek that this sounds like a kind of bad business, I think what Zillow is thinking is that they have so much data they can make more informed decisions on buying houses than anyone else.  Frankly I’d rather be the guy that sells this decision making capability to other house flippers and ibuying businesses, but I don’t run Zillow.

 

Fully agree. If data is the differentiator, the figure out how to monitize the data. This also avoids competing with their customers ( realtors) and stays true to a capital light business model.

[TwoCitiesCapital]

I haven't evaluated the numbers on the home flipping because I think it's impossible at this point. What I've mostly been watching is how many homes they successfully purchase because that pipeline is crucial for determining potential market.

 

Things I know:

 

1) The home buying process is massively stressful, expensive, and inefficient. I went through it in January 2018 and cannot remember a more problematic transaction in my life for someone who had excellent credit and a resources for the down payment. In the future, I'd be very open to the idea of selling to Zillow to avoid the headache and can absilt see the benefit to those who'd like to sell quickly and get money now.

 

2) If Zillows data is quality, they should be able to accurately price homes to ensure they aren't overpaying and have a small margin of error to compensate them for the trouble.They should also be able to anticipate turns in the market because they'll have direct access to sales data, how long things have been sitting on the market, etc all at the local level.  I'm concerned about them getting this right the first time, which is why it isn't a larger position for me, but I am hoping they do.

 

3) Even as their spread will trend towards 0 as their data/risk management gets better, the referral to an agent if you don't want to accept Zillow's price is enormously valuable to agents - they're much more likely to transact than someone random browsing the site AND there's information embedded as to what price they felt was too low to accept. This will help Zillow's legacy business with brokers as well.

 

4) Lastly, Zillow has the opportunity to dramatically improve the buying/selling process while still providing enormously valuable leads AND can make a small spread profit on an enormous potential market to do it. If done successfully, they'll have no problems making it rain for shareholders

 

I have about 2-3% of my portfolio in Zillow and have been accumulating in the low-to-mid 30s on every dip and selling calls at massive premiums on every pop while I wait for more clarity.

 

It's not a proven concept and is enormously risky, but if they get it right they will have successfully disrupted a trillion dollars industry and will collect the benefits that come from that.

 

 

[Gregmal]

I remember a ways back, Zillow was pitched as a long, very simply as owning some very valuable internet real estate. Now it seems they're expanding into real world real estate as well. I think they have something potentially valuable and disruptive on many levels. Of course, this is subjective interpretation. At the same time, its important to remember that all the high level, sophisticated, analysis driven short sellers have been wrong for some time as well. Sure, they fault low rates, bubbles, and all the usual suspects, but maybe theyre just wrong. You dont get multi baggers from things that are easy to understand and consensus with everyone. The TAM for Zillow is huge, and then tangentially related opportunities are even greater. If all they need to bridge that, is temporary funding while they burn cash, well, they market has demonstrated its willing to provide that without crushing the equity...

 

That said I have no position in Zillow.

[cameronfen]

I haven't evaluated the numbers on the home flipping because I think it's impossible at this point. What I've mostly been watching is how many homes they successfully purchase because that pipeline is crucial for determining potential market.

 

Things I know:

 

1) The home buying process is massively stressful, expensive, and inefficient. I went through it in January 2018 and cannot remember a more problematic transaction in my life for someone who had excellent credit and a resources for the down payment. In the future, I'd be very open to the idea of selling to Zillow to avoid the headache and can absilt see the benefit to those who'd like to sell quickly and get money now.

 

2) If Zillows data is quality, they should be able to accurately price homes to ensure they aren't overpaying and have a small margin of error to compensate them for the trouble.They should also be able to anticipate turns in the market because they'll have direct access to sales data, how long things have been sitting on the market, etc all at the local level.  I'm concerned about them getting this right the first time, which is why it isn't a larger position for me, but I am hoping they do.

 

3) Even as their spread will trend towards 0 as their data/risk management gets better, the referral to an agent if you don't want to accept Zillow's price is enormously valuable to agents - they're much more likely to transact than someone random browsing the site AND there's information embedded as to what price they felt was too low to accept. This will help Zillow's legacy business with brokers as well.

 

4) Lastly, Zillow has the opportunity to dramatically improve the buying/selling process while still providing enormously valuable leads AND can make a small spread profit on an enormous potential market to do it. If done successfully, they'll have no problems making it rain for shareholders

 

I have about 2-3% of my portfolio in Zillow and have been accumulating in the low-to-mid 30s on every dip and selling calls at massive premiums on every pop while I wait for more clarity.

 

It's not a proven concept and is enormously risky, but if they get it right they will have successfully disrupted a trillion dollars industry and will collect the benefits that come from that.

 

Certainly iBuying will become a significant industry, but will the fact that it is a capital heavy low margin business, benefit Zillow and Zillow investors?  As an analogy, it probably doesn’t benefit big pharmaceutical from getting into the manufacturing of genetics, doesn’t mean generic manufacturing doesn’t add value to the customer and someone won’t do it. 

[Guest cherzeca]

I looked at Zillow and Redfin and liked the latter more, but have no positions

[TwoCitiesCapital]

I haven't evaluated the numbers on the home flipping because I think it's impossible at this point. What I've mostly been watching is how many homes they successfully purchase because that pipeline is crucial for determining potential market.

 

Things I know:

 

1) The home buying process is massively stressful, expensive, and inefficient. I went through it in January 2018 and cannot remember a more problematic transaction in my life for someone who had excellent credit and a resources for the down payment. In the future, I'd be very open to the idea of selling to Zillow to avoid the headache and can absilt see the benefit to those who'd like to sell quickly and get money now.

 

2) If Zillows data is quality, they should be able to accurately price homes to ensure they aren't overpaying and have a small margin of error to compensate them for the trouble.They should also be able to anticipate turns in the market because they'll have direct access to sales data, how long things have been sitting on the market, etc all at the local level.  I'm concerned about them getting this right the first time, which is why it isn't a larger position for me, but I am hoping they do.

 

3) Even as their spread will trend towards 0 as their data/risk management gets better, the referral to an agent if you don't want to accept Zillow's price is enormously valuable to agents - they're much more likely to transact than someone random browsing the site AND there's information embedded as to what price they felt was too low to accept. This will help Zillow's legacy business with brokers as well.

 

4) Lastly, Zillow has the opportunity to dramatically improve the buying/selling process while still providing enormously valuable leads AND can make a small spread profit on an enormous potential market to do it. If done successfully, they'll have no problems making it rain for shareholders

 

I have about 2-3% of my portfolio in Zillow and have been accumulating in the low-to-mid 30s on every dip and selling calls at massive premiums on every pop while I wait for more clarity.

 

It's not a proven concept and is enormously risky, but if they get it right they will have successfully disrupted a trillion dollars industry and will collect the benefits that come from that.

 

Certainly iBuying will become a significant industry, but will the fact that it is a capital heavy low margin business, benefit Zillow and Zillow investors?  As an analogy, it probably doesn’t benefit big pharmaceutical from getting into the manufacturing of genetics, doesn’t mean generic manufacturing doesn’t add value to the customer and someone won’t do it.

 

It's capital heavy, yes, but there is opportunity to recycle the same capital multiple times within a calendar year. Same argument for the low margins. Also, I'd it leads to higher revenues from more qualified leads in the traditional business, that has to be added back here as well as incremental return.

 

Ultimately, it's consumers who win here. You don't always make money by betting on the company who is doing the best by consumers, but it's generally it's not a bad strategy. Also, it's hard to say people are paying dearly for the potential - it's down 40% from it's local highs when the strategy was announced AND the EV is miniscule relative to the potential addressable market.

 

Once again, I'm mostly watching. It's not a huge position for me yet, but I'll be adding as it proves out it's potential or will be selling when it's clear that they've failed to execute.

 

 

 

 

 

[peridotcapital]

So what is the elevator pitch for Zillow's home buying venture? Does it go something like this....?

 

"Once we get good at this we can breakeven (at worst) on the flip itself and then charge a 5% service fee to the seller, which they will gladly pay because its hassle-free relative to the traditional process. 5% isn't a high margin, but the market is so big, 5% of a big number is a big number. With realtor commissions in the US estimated at $75B per year, if we get 20% market share we can net upwards of $7.5B of profit annually, in say, 20 years. Compare that with our current $8B market cap and the stock is a very good long-term buy and hold idea."

[Broeb22]

 

One thing I've thought about lately is the simple idea of profitability as a checklist item. If the business is public (and thus is relatively established) and is not profitable, then you have to ask why not? If Zillow has all this valuable data, why isn't it using it to make money now? If flipping homes is a profitable business, why are they losing money on each of the thousands of transactions? I think this general concept applies to a lot of businesses. Amazon is the one giant exception to the rule; but the rule might be: if the company isn't making money now, it's highly unlikely that it ever will be a very profitable business.

 

While I have a strong bias for profitability, looking at profitability in a vacuum is short-sighted in a world where businesses are investing in different parts of their financial statements than others. Fixed assets get capitalized while intangible assets get expensed immediately.

 

Walmart went public in 1970. They generated positive earnings along the way. But when do you think they went FCF positive? 1997. If you had waited for Walmart to be capable of returning cash back to shareholders, you would have missed multiple hundred-baggers.

 

If I'm running a business that has fewer physical assets, such as software, am I wrong to reinvest the cash flows I generate back into features my customers want, even if the geniuses in accounting tell me that my investments in software programmers and sales and marketing will reduce current profitability? Silicon Valley companies don't have a great reputation for frugality, but conceptually their profitability in a growth phase will be lower than other businesses who invest in fixed assets to grow their business.

 

 

[Gregmal]

So what is the elevator pitch for Zillow's home buying venture? Does it go something like this....?

 

"Once we get good at this we can breakeven (at worst) on the flip itself and then charge a 5% service fee to the seller, which they will gladly pay because its hassle-free relative to the traditional process. 5% isn't a high margin, but the market is so big, 5% of a big number is a big number. With realtor commissions in the US estimated at $75B per year, if we get 20% market share we can net upwards of $7.5B of profit annually, in say, 20 years. Compare that with our current $8B market cap and the stock is a very good long-term buy and hold idea."

 

As I said, Im not long this, but I can very easily come up with an elevator long pitch on Zillow focusing on FB and Google like ability to monopolize a specific high volume segment of the internet and then, at the very least, integrate an advertising platform. Off that, you have the obvious realtor transaction biz, and in addition to this, you could, at least very loosely in theory, make the case that they could also raise money from the public markets in order to acquire opportunistic pockets(recognized by their AI) of residential real estate and then run(or outsource) a property management/rental biz.... I believe Warren Buffet said not too long after the GFC that he would be an extremely active investor in single family homes if he could snap up 250,000 at a clip... if the process becomes automated, or moves that way, Zillow will benefit, and can likely move towards achieving what Buffett said he couldn't.

 

Again this is all just loose elevator pitch and in some ways takes the current business and branches off in ways I would go if I ran the company, but acting like "gee it loses money and I cant see how it ever justifies the multiple.." is shown to be a money losing approach.

[Jurgis]

Some thoughts....

 

Wow, John Huber. Nice to see you here. Welcome, welcome.  8)

[Guest roark33]

While I have a strong bias for profitability, looking at profitability in a vacuum is short-sighted in a world where businesses are investing in different parts of their financial statements than others. Fixed assets get capitalized while intangible assets get expensed immediately.

 

Walmart went public in 1970. They generated positive earnings along the way. But when do you think they went FCF positive? 1997. If you had waited for Walmart to be capable of returning cash back to shareholders, you would have missed multiple hundred-baggers.

 

If I'm running a business that has fewer physical assets, such as software, am I wrong to reinvest the cash flows I generate back into features my customers want, even if the geniuses in accounting tell me that my investments in software programmers and sales and marketing will reduce current profitability? Silicon Valley companies don't have a great reputation for frugality, but conceptually their profitability in a growth phase will be lower than other businesses who invest in fixed assets to grow their business.

 

 

Really, Wal-mart--it was fairly easy to see WMT was profitable on a store-level basis and even profitable when accounting for SGA, so the negative cash flow was clearly a positive IRR for the company.  Zillow cannot adequately explain why they can't on a gross margin basis earn a profit flipping a house.  The only thing they do is wave the magic words, scale, TAM and and other buzzword to make you think that they can make up the losses on volume.  It's just not profitable at scale, it's probably one of the few businesses that has negative scale economics.  It's tough to see how some fairly smart investors are just getting this so wrong. 

[TwoCitiesCapital]

While I have a strong bias for profitability, looking at profitability in a vacuum is short-sighted in a world where businesses are investing in different parts of their financial statements than others. Fixed assets get capitalized while intangible assets get expensed immediately.

 

Walmart went public in 1970. They generated positive earnings along the way. But when do you think they went FCF positive? 1997. If you had waited for Walmart to be capable of returning cash back to shareholders, you would have missed multiple hundred-baggers.

 

If I'm running a business that has fewer physical assets, such as software, am I wrong to reinvest the cash flows I generate back into features my customers want, even if the geniuses in accounting tell me that my investments in software programmers and sales and marketing will reduce current profitability? Silicon Valley companies don't have a great reputation for frugality, but conceptually their profitability in a growth phase will be lower than other businesses who invest in fixed assets to grow their business.

 

 

Really, Wal-mart--it was fairly easy to see WMT was profitable on a store-level basis and even profitable when accounting for SGA, so the negative cash flow was clearly a positive IRR for the company.  Zillow cannot adequately explain why they can't on a gross margin basis earn a profit flipping a house.  The only thing they do is wave the magic words, scale, TAM and and other buzzword to make you think that they can make up the losses on volume.  It's just not profitable at scale, it's probably one of the few businesses that has negative scale economics.  It's tough to see how some fairly smart investors are just getting this so wrong.

 

It's hard for me to understand why you'd expect they wouldn't be able to make money.

 

Home-flippers make money. Granted, they focus on a much smaller piece of the market (fixer-uppers at steep discounts), but the discount doesn't need to be as steep if Zillow is able to effectively use it's data to get a decent view of value.

 

Other benefits of Zillow are cheaper financing, better data, a much larger audience to sell to, and revenue from referrals that home flippers don't get.

 

I am struggling to understand why this would automatically be a negative scale business? I'm not the traditional growth company investor so am open to being wrong, but the path to potential profitability seems clear to me here which is why I'm in it.

[Spekulatius]

Home flippers make money because they cherry pick deals and they are doing value add to the houses. I think it’s much harder to do in corporate setting  (Mt Melrose anyone?).

 

The successful  flippers I have seen also exit the market when it becomes risky. Turns in the market can be hard to predict and when they happen, they occur suddenly. from what I have seen in CA during there downturns is that single home markets can turn illiquid virtually overnight. I am not sure analytics will help with thwt - they might, but if they are really become the large players they want to be they sort of have to dance as long as the music is playing. I just see small upside, large downside in this business, the opposite of what one would want. I guess we will see.

[Guest roark33]

Another reason home flippers make money is they do a lot of the labor themselves, they paint the house, they fix a few cracks here and there.  They do some landscaping, etc.  And if they outsource stuff, they are very hands-on in the process to make sure it is done right.  This can't happen in a "scalable" model.  It just doesn't work.

[maybe4less]

 

 

It's hard for me to understand why you'd expect they wouldn't be able to make money.

 

 

Also, don't forget about adverse selection. Zillow is basically offering a discount so you don't to deal with the hassle of traditionally selling your home. Who's the most likely to sign up for that? Maybe someone with a significant problem that doesn't show up in Zillow's model?

[Gregmal]

Another reason home flippers make money is they do a lot of the labor themselves, they paint the house, they fix a few cracks here and there.  They do some landscaping, etc.  And if they outsource stuff, they are very hands-on in the process to make sure it is done right.  This can't happen in a "scalable" model.  It just doesn't work.

 

This is probably the majority of the equation. The other element is obviously a hot market. Without either, you simply can NOT make any money flipping homes. Everything is so expensive, the only way you ever get anywhere is having super cheap and super reliable ways to get the labor done. Either yourself, or a great connection. Otherwise, quarterly property taxes, mortgage and financing cost, and then the 6% realtor fee...yea good luck.  You basically need to be generating 30% return in under a year for it to be worthwhile. Those dont grow on trees and the random tree that does pop up gets pruned quickly.

 

Most of my research has lead me to believe flipping homes is only profitable for the people selling the seminars that teach you how to do it.

[MrB]

Question I'm pondering is whether Zillow is trying to be a market maker rather than a flipper of houses? Market making is a proven business model. Concern is that market making died off, but did it not just move to the high frequency traders? In other words did the business not just move to those who now has the info and efficiency edge? Will value not accrue to those who have a) the information edge (clearly Zillow) and b) who's the most efficient (Zillow's plan)? On b) consider that this year Zillow only invited it's top agents to Zillow Unlock (used to be open to everyone). Message was.... If you want to clear the most inventory in real estate then you need to get on this train. 

 

In an illiquid market, such as a downturn the value of a market maker goes up as the spreads blow out. If they're the best at clearing inventory then the bulk of the value will accrue to them. From memory they only have to stay within a 4% spread if they can clear inventory within 3 months (on average); believe 4% was the worse depreciation over 3 months in recorded US real estate. Seems doable.

 

[TwoCitiesCapital]

Question I'm pondering is whether Zillow is trying to be a market maker rather than a flipper of houses? Market making is a proven business model. Concern is that market making died off, but did it not just move to the high frequency traders? In other words did the business not just move to those who now has the info and efficiency edge? Will value not accrue to those who have a) the information edge (clearly Zillow) and b) who's the most efficient (Zillow's plan)? On b) consider that this year Zillow only invited it's top agents to Zillow Unlock (used to be open to everyone). Message was.... If you want to clear the most inventory in real estate then you need to get on this train. 

 

In an illiquid market, such as a downturn the value of a market maker goes up as the spreads blow out. If they're the best at clearing inventory then the bulk of the value will accrue to them. From memory they only have to stay within a 4% spread if they can clear inventory within 3 months (on average); believe 4% was the worse depreciation over 3 months in recorded US real estate. Seems doable.

 

 

My take is the market making opportunity. They only have to earn enough spread from flipping to compensate them for the risk they're taking - not the double-digit returns that accrue to home flippers who only rarely do a deal.