How Zillow helped whip house prices higher and got caught with its pants down (AI = artificial idiocy?).
By Wolf Richter for WOLF STREET.
When real-estate-listing-site-turned-house-flipper Zillow announced on October 18 that it suddenly stopped buying houses, it blamed the labor and supply shortages “in the construction, renovation and closing spaces.” That turns out to have been a joke, it seems, as two things have emerged today:
One, Zillow is now trying to dump about 7,000 houses, but not to individual homebuyers as originally planned as house flipper, which is obviously too hard and painful. Instead, it’s pitching these houses to institutional investors, trying to get $2.8 billion in total, according to sources cited by Bloomberg. Zillow is likely to sell the houses to a multitude of investors, rather than selling all of them in a single transaction, the sources said.
I mean, how can a house flipper get stuck with 7,000 houses? I mean, buying houses is easy if price doesn’t matter. And the price didn’t matter for Zillow after it tweaked its pricing algo – the power of AI – to where it was the high bidder in red-hot markets that may have slowed down since then. That was easy. But selling them without losing your shirt is suddenly hard, it turns out.
Two, it overpaid for many houses and is trying to sell at a loss. KeyBanc Capital Markets came out with an analysis of 650 homes owned by Zillow that are currently listed on the market, and found that 66% of them were listed below what Zillow had paid for them, with the average listing price being 4.5% below the purchase price.
Even if it can sell those houses at 4.5% below the purchase price, there are still all kinds of costs involved in flipping a house, and so, even if it can sell at asking price, it would pocket some big losses.
“Zillow may have leaned into home acquisition at the wrong time, and we believe earnings may be at risk due to its current home inventory ($1.17 billion at 2Q21),” the analysts said, cited by MarketWatch.
Wait a minute. Zillow owned $1.17 billion in houses at the end of Q2, after having bought 3,805 houses during Q2, but now it’s suddenly trying to sell 7,000 houses for $2.8 billion?
Didn’t it sell houses in Q3? Did it just buy houses and overpay so much that it couldn’t sell them without losing a ton of money, and it didn’t want to show those losses on its upcoming Q3 earnings report?
Will it book a huge “one-time noncash charge” on those houses that it hopes Wall Street will ignore? With “one time” and “noncash” meaning that the noncash cash was blown weeks and months earlier, house by house, in thousands of one-time transactions?
I cannot wait to see the Q3 earnings report.
According to an analysis by YipitData last week, cited by Bloomberg, Zillow put a record number of homes on the market in September and cut prices on nearly half of them. In Phoenix, Zillow’s roughly 250 listings were priced on average 6% below the price it had paid for them.
By overpaying for thousands of houses each quarter, Zillow helped drive home prices higher. Each time Zillow overpaid, that whole neighborhood got a boost via comparative sales (comps) and housing algos, such as Zillow’s own algos.
If and when those Zillow houses are sold at a lower price, well, those lower prices will then enter into the comps….
Whatever the whole Zillow debacle may say about the broader housing market, it shows how Zillow’s AI (artificial idiocy?) was great at buying houses in that it just paid whatever, becoming the winning bidder on a lot of houses, because the goal was to buy a lot of houses – not to make money flipping them.
Any small-scale house flipper that survived the last housing bust will tell you that they make their money by buying at the right price. No one explained this apparently to Zillow. Or it just didn’t matter to Zillow because making money didn’t matter. Zillow had a net loss every year. And with this debacle playing out, 2021 could fall in line as well.
Class A shares of Zillow [ZG] fell 8.6% on Monday to $97.61 and are down 54% from the peak in February.
Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.