SET UP A CALL NEW
by Roy Dekel
Recently I watched the emergence and rapid growth of iBuyers, an offset of the real estate and technology industries that work to circumvent real estate professionals in the process of buying and selling residential properties. In this new model, homeowners submit inquiries to iBuyer companies, most notably these include Opendoor, Zillow Offers and Offerpad. In turn, these companies make a cash offer to the seller. If accepted, the homeowner sells to the iBuyer who typically turns around and invests ‘X’ amount of capital for minimal renovations and then resells the property. After studying this exciting and modern approach to real estate, I’ve concluded that it is an idiotic business model that is doomed to bankruptcy in no more than three years, and here’s why.
For starters, the iBuyer model operates on razor thin margins, typically 5 – 10%. Long-term profits result from high volumes of transactions. Meaning, any economic hiccup will decimate profits – iBuyers will not pass the financial stress test of an economic downturn.
Which brings me to my next point – what goes up must come down. An economic downturn will occur in the next three years. We’ve enjoyed a strong 10 years, but we are already observing the ultra high-end real estate market slowing down which is almost always a precursor to the slowing down of non-luxury residential real estate markets. It is reasonable to believe that the cycle of life will prevail and there will be a certain slowdown.
So now let’s play the market at a 30% discount wherein a $1 million home is now worth $700,000. Does your formula still work at a 10% margin? Of course not. Even if it’s just a 20% discount to the market, the formulas will still break down. Nowhere is this more evident than with the case of Zillow Offers. I don’t understand anyway they can weather an economic downturn with their slim margins, especially considering that for the last six quarters they have reported both cash and non-cash losses. Given the inability of iBuyers to survive an economic recession, and the inevitability of said economic recession within the next three years, the only conclusion I can make is iBuyers will be bankrupt sooner than later.
At this point you are probably asking why they do it? I have participated in the purchasing of hundreds of residential properties across multiple states and managed hundreds of millions of dollars in real estate transactions. And yet, there are people who are arguably even more successful than me greenlighting these investments, so what gives? Simply put, it’s easier to make these kinds of investments when you are leveraging other people’s money. From my experience, unless you stop to think hard on your investment thesis and reflect on whether or not you would do it with your money, you are significantly biased and blindsided by being superficially rich with cash. It is my position that this superficial wealth is the ultimate blindspot for investors funding iBuyers and will ultimately factor into their inevitable failure.
But what about the homeowner or home buyer who may not care what happens to this industry in the next couple of years if it helps them sell or buy a house in the here and now? The truth is, cutting out real estate agents, brokerages and other professionals from the transactions hurts home buyers and shoppers more than anyone else. iBuyers and other real estate transaction facilitators operate on the thesis that they can do better than the millions of real estate professionals and simply put, they cannot. When you work with a real estate agent, buyers and sellers get better deals and better transactions. At the end of the day, iBuyers are institutional investors working on slim margins. They cannot walk into a house like a normal home shopper and buy emotionally, which means the seller will not get the emotional price point. Home sellers will generally get 10 – 20% less than what they would get from an emotional buyer who will see their kids growing up in that house. On the flip side, buyers will pay full retail because they have much less room to negotiate with investors than if they were working with real estate agents and emotional sellers. It might sound like a good idea to save the 6% compensation by representing yourself in a transaction, but the long term losses will always exceed that initial savings.
I think you can create a lot of technology efficiency around the industry, but the technology cannot completely own the transaction and disown any advisor that is already part of the real estate space. Any attempts to do so will perish under the weight of a fluctuating economy which is why the best business model is to create a hybrid between people and technology. I believe this reality will sink in, especially when we encounter the inevitable economic downturn around the corner. And while iBuyers will succumb to this new economic landscape, we will see the real estate community prevail and the strong survive, as they have during prior recessions.