Does the iBuyer business model represent true innovation in real estate?

by Alistair Helm in


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Last week, a new listing came onto the market in the US – a property for sale in Chandler, Arizona. A 4 bedroom home with a price expectation of around NZ$600,000. Not that interesting you would have thought given the fact that probably close to 20,000 new homes come onto the market every day in the US.

What makes this home different from tens of thousands of others is that the owner of the property is Zillow. That is Zillow; as in the largest real estate website in the US – a property portal.

Think about that for a moment, this would be akin to Trade Me listing for sale a property owned by Trade Me having been bought by Trade Me from a Trade Me member!

Let’s be clear this is not happening in New Zealand. At least not yet, and to be honest I don’t think it is something that suits the New Zealand market. However before getting into all that, let me explain what is going on here.

A new segment of the real estate market emerged about 4 years ago in the US. The ever optimistic, cash rich and somewhat over-hyped tech sector turned its eyes, and its investment dollars to the real estate industry and asked the question – “why is it so hard to sell a property in the US, and why does it take months?”

The answer, and therein the problem, lies in a myriad of archaic systems for legal title-management and exchange; and the equally complex processes for mortgage origination. Both of these in theory being digital processes, naturally the tech investment sector said they could fix and in doing so create the opportunity for a viable business model to arbitrage residential property. This new segment of the industry that has emerged has been dubbed the iBuyer market.

The pioneer of iBuyer was OpenDoor, with the fast follower – Offerpad  and now Zillow with Instant Offers, who far from limiting themselves to just being a real estate website, sees value in this real estate service which can leverage their expertise and knowledge base around property data and valuation modelling.

The business model for iBuyer is simple. A homeowner looking to sell goes online and enters their property details, in what is a matter of hours in most cases, the company comes back with an offer to purchase the property. The offer is at around market-value based on their proprietary algorithm of an Automated Valuation Model (AVM). The seller can literally confirm acceptance and choose a completion date and the sale is then completed, and payment is made on the allotted date. There are naturally legal conditions and inspections as well as deductible fees, but pretty much this has to be the fastest and simplest way to transact real estate. So in theory, you could decide to move and within a week or so you could be moved, cashed up and onto a new life!

The process then moves into top gear with the company undertaking a fast and efficient cosmetic makeover of the property in order to get it back on the market in a matter of weeks for a price that they (and their algorithm) feel is the right market price.

The business model of these iBuyer operations is to act as the sellers’ agent, and the buyers’ agent, as well as the property developer; with the clear intention of flicking the property as fast as possible with a reasonable margin on the purchase price, this they seem to be doing.

With the full sales commission charged to the seller, as well as their representation as the owner for the on-sale, the business model allows for a satisfactory margin through the process as well as any improvement margin.

The core value proposition for this business model is speed and the associated removal of stress which has universal appeal. Just recently a survey undertaken by the Real Estate Authority here in NZ found that 35% of sellers found marketing of their property involving the open homes, the toughest part of the process. The iBuyer service removes this completely. It is critical to appreciate that the core value proposition is all around adding value; and has nothing to do with saving costs or a lower priced offer (a critique I made recently as to the only other aspiring innovations seeking to disrupt the real estate industry).

Whilst not a perfect analogy, the market for used cars is somewhat similar. If you want to trade for another car you can just sell to the dealer for cash or trade in your car, so in theory this is the process for your house – at least in the US at this time.

There are elements of the iBuyer business model that are a true disruptions of the real estate process enabled by technology:

  1. The automated valuation model has become a commodified capability, here in NZ as well as most every country of the world, empowering these companies with the core market information, historically tightly held by real estate professionals
  2. The financing of the properties that these iBuyer companies take on, is enabled by technology as they can leverage the necessary debt financing through whatever financial market structure that suits and is available at the time, packaging the portfolio of properties on-hand thereby optimising lending options
  3. Marketing directly to prospective sellers through targeted marketing and in so doing capturing the selling agent commission
  4. Utilising Internet of Things (IOT) to revolutionise the home viewing process. Once a property owned by the iBuyer company is put on the market, prospective buyers can register and access the property remotely through an app that allows unaccompanied viewings with remote security monitoring

These collectively add significantly to this technology-enabled improvement to the process of real estate, and at first sight would appear to be threatening to the traditional real estate profession. However these iBuyer companies are smart to ensure that their long term ambitions to establish a viable and significant market position are not jeopardised by off-siding the industry of agents. Their business model engages agents with a seller and buyer-side commission structure, positioning themselves to be seen as a fellow competitor in the market rather than a looming destroyer of the market process.

It is important to note that the Zillow iBuyer model is somewhat different to both OpenDoor and Offerpad in that Zillow are actually not purchasing properties in their own name, they are facilitating the market-making between willing sellers and financial investors. They are operating in much the same way as they do with their core business in market-making between buyer - agents - sellers - agents. In this way they are keen to avoid the accusation that they are competing with their customers - real estate agents, especially as they lay out the option for sellers to choose to turn down an 'Instant offer' and sell through an agent.

So having identified what these iBuyer companies provide in their business solution the next key question is – will they succeed?

I believe the answer is yes, but not in the sense of a massive disruption to the overall market. This is key, and as any investor pitch-deck will show, even a very small percentage share of the real estate transaction market in the US represents a significant business opportunity. The estimated value of this market is somewhere around US$60 billion so a mere one tenth of one percent would be US$60m turnover.

There are 2 key issues that the iBuyer business faces that I believe are going to restrict the market opportunity. Firstly there is an inherent risk related to the the volatility of the property market and the downside risk of an iBuyer company being saddled with a large inventory they cannot sell without taking a loss on sale, should the market turn down.

Then secondly there is the complete reliance on the automated valuation. The business simply cannot possibly scale if they were to rely on an army of inspectors. As a consequence their risk profile means that they will only offer the solution to what can be thought of as homogeneous houses. This is easily seen by the markets in which they currently operate – Phoenix, Las Vegas, Charlotte North Carolina, Atlanta, Nashville as well as couple of others in the case of OpenDoor. These markets have a growing suburban belt of new homes and the typical house managed through OpenDoor is recently-built homes with a price around the median sale price between $300,000 and $600,000. This is smart. These houses are a commodity that has a low risk of not finding a buyer coupled with a high confidence factor for automated valuation.

In the US this subset of the market still represents a sizeable market opportunity of around $10bn a year. For New Zealand the business model is unlikely to offer such a lucrative market opportunity. Firstly, very little of NZ housing stock falls into the category of truly homogenous - whilst there have been large scale new housing developments in Auckland that mirror the chosen US markets that have been the target of OpenDoor; and undoubtedly there will be more built in the coming years. This market segment will be small, too small for a company to achieve scale. Secondly the NZ market does not experience the same pain point that the US market suffers from, as a consequence of archaic and protracted transaction process. A NZ property can be marketed and legal transaction completed within weeks if necessary, certainly legal unconditional-sale is achievable within a month from listing day - something not achievable in the US, until now.

As to the question posed earlier, could Trade Me offer this solution? - they could, especially if they facilitated a market-making environment with verified investors. By following the Zillow playbook they could very nicely then generate a leads-business for agents of ready sellers. That would be a smart solution that might just see Trade Me advertising a property for sale that Trade Me facilitated the agent-sale of, from a Trade Me member to a Trade Me member, financed through a Trade Me member and managed by a Trade Me real estate agent.