What is iBuying – and Why is It a Risky Business?

For years, Zillow bought homes from customers who wanted a smooth, fast sale. Eventually, this practice, known as iBuying, caused the internet real estate company to lose hundreds of millions of dollars and lay off a fourth of its workforce. A few similar organizations are still in the game and hoping to net profits. Opendoor claims to have crafted a process non-reliant on valuation models while ignoring the emotional aspects. Will it also fall flat on its face, or succeed by avoiding profit-eating risks?

iBuying - A Primer

An iBuyer is a company that provides an instant cash offer to purchase a home from a seller outright. It buys houses as-is with no contingencies, agent commissions, or closing costs, and avoiding the use of a commissioned real estate agent saves homeowners time and money. It's a win-win situation for sellers if the price is right, but buyers run a higher risk.

Companies like Zillow, Redfin, Offerpad, and Opendoor have unique business and valuation models. In general, the process involves using an algorithm to identify a perfect purchase price for the home. Where does the "i" -- or technological -- side of this enter? The houses are bought sight unseen.

Anyone interested in selling through iBuying must navigate to a buyer's website and fill out a form. Within 24 hours, the company will send its offer to the prospective seller. If he or she accepts, the sale is finalized in just a few weeks.

Zillow Flops

Zillow has been infamous for helping both sellers and buyers estimate the valuation of a property with its "Zestimate." It got into the iBuying game with "Zillow Offers" in December 2019 and bowed out precisely two years later. For the company to make a profit, it had to sell each home for more than what it paid. Sometimes this included putting work into the house, renovating, making additions and repairs.

In February, Zillow Group announced it lost $881 million in its home-flipping business last year. The company shared that it failed to predict movements in home prices accurately. The losses forced it to cut more than 2,000 jobs, one-quarter of its staff. Despite generating $6 billion in revenue, Zillow Offers' spending costs were too high to net a profit. According to most recent data, Zillow still has about 8,600 properties to sell off from inventory. “Mega-landlords” constituted the majority of Zillow’s customers, snatching up homes before the public had a change to tour and put in an offer on a property, and they will continue to do the same with other iBuyers.

What’s a Mega-landlord?

All businesses involved in iBuying are highly criticized for a controversial and misleading practice. The real estate market has thin inventory and high prices. The entire country has seen rent increases, bidding wars, and skyrocketing valuations. It’s a seller’s market but a struggle for buyers. Families are outbidding each other, battling to find a new home, and Zillow and Opendoor’s practices have only made it more challenging.

When these companies can’t easily resell their properties, or if a major player quickly puts in an offer, they conduct an “institutional sale.” The iBuyer sells to investors looking to be “mega-landlords,” which are hedge funds like Blackstone, KKR, and Cerberus. These money-hungry corporations are snapping up homes independently but also flock to grab anything the iBuyers are selling.

What do they do with all these single-family homes? They rent them. When middle-class families cannot purchase an affordable property to call home, they are stuck renting, over and over again. Even the Biden administration is aware of and has criticized the practice. “Large investors' purchases of single-family homes and conversion into rental properties speeds the transition of neighborhoods from homeownership to rental and drives up prices for lower cost homes, making it harder for aspiring first-time and first-generation home buyers, among others, to buy a home,” said a White House spokesperson.

Others Try Their Turn

Other iBuyers are hoping to avoid Zillow's fate. Opendoor's CTO Ian Wong says his company focuses on data from the beginning, and it does not rely solely on valuation assessments. It views pricing as a "holistic process" requiring hundreds of data points from regional trends, the nearby market, and the home's virtual tour.

Before the pandemic, Opendoor sent a human representative to tour, observe, and analyze the property to determine critical flaws and attributes. However, once the pandemic hit and virtual tours became the norm, it pivoted to create algorithms to evaluate every component of these videos and turn them into data points.

Wong believes nearly all homes will eventually be sold and bought online. "We’ve gotten so used to tapping on our phones to order groceries, hail a ride, or even buy a car, sell a car,” he says. But does a home equate to a gallon of milk or even a car? A home is where you raise your children, live with your partner or friends, and make life-long memories. Opendoor relies on information technology and data, ignoring the emotional aspect of purchasing and valuing a house. The future of this business will rely on a seller’s willingness to take the shortcut, when the real estate market eventually crashes, and how many properties mega-landlords are willing to manage.

~Read more from Keelin Ferris.