{audio:0:00:01} Bobby, can you provide some history of iBuying and Opendoor?

{audio:0:00:08} Opendoor got started in late 2013, to 2014, so it’s about six or seven years old. It was pretty much the pioneer in iBuying. There were other people buying homes and selling them, at scale. Webuyuglyhouses or products like that, but Opendoor was really one of the ones to say, we give you what is called a fair market value. If your house, on the open market, was around $200,000, maybe you would get $205,000 by listing and maybe you would get $195,000. Opendoor is going to give you that $200,000 or $201,000 and they’re going to do it instantaneously. Within a day or two of submitting a web form, you’re going to have your offer back and it’s going to be that price that is, essentially, a fair market value. You might get more; you might get less. But, essentially, within 24 hours you can sell your home at the click of a button. That was the value proposition. Of course, back then, they started in one market of Phoenix, where the housing stock is similar, where there’s lots of transactions per year. They’ve since expanded to over 20 markets and then pulled back, because of the Covid pandemic.

{audio:0:01:07} Each city is a little different in how they execute. But the simple value is, sell your home instantly, without having to get out of it, do open houses, get your kids out, get your pets out. A seller can have a lot of certainty as they go and seek their next move in life.

{audio:0:01:24} Can we walk through a typical iBuying transaction? So the average value of the house and then we can run through the fees and potential costs?

{audio:0:01:36} Let’s stay at the high level and then you let me know if we’re missing anything. Opendoor, traditionally, and other iBuyers, like Zillow and Offerpad, buy between $200,000 and $500,000, which is called their buy box. If they go above that, it’s very rare and it’s not also in their core area to do, because what they do like is housing stock that is very similar. Usually, these large sub-divisions in Dallas and Phoenix have all been built by one builder. If you build a three-bedroom or a four-bedroom, you can price somewhat algorithmically. That’s what they try to do the most.

{audio:0:02:09} You go on a web form, you enter your address, 100 Main Street, in Austin, Texas. Within a few hours or days, you’ll have an offer back that says – using that $200,000 price example – here’s your home; here’s our estimate, based on the age of the home, it’s a few years old, every house we’ve done requires at least $1,000 in repairs. On your web form, you gave us some more information that the paint or plumbing is in bad shape; we’ve added another estimate of $2,000, based on our previous history of repairs. Then they list, lastly, a fee. You know that if you were to sell this home on the open market, most realtors charge 6%. On $200,000, you’re going to sell it and you’re going to pay that realtor and the buyer-side realtor, 6%, or 3% and 3%, $12,000. Out of your $200,000, you’re going to net $188,000.

{audio:0:03:05} That $188,000 is a little bit of a red herring for sellers, as they start understanding the market, because they have to put in money for repairs and money for their time. Maybe they have to go and rent a different place, maybe they have to pay for cleaners. Opendoor are simplifying that transaction by saying, we’ll take the 6%; in fact, we’ll take a little more. This has been a big debate that we can go into later in our conversation, about what Opendoor should charge for this. Is it a premium service that demands something higher than a realtor? Or is it very comparable to a realtor and if they can be at price parity, or even below a realtor, because of technology and scale, they can offer a lower point, in the same way that, at some day, Ubers became cheaper than taxis. We know that’s not fully played out, but it’s sort of the vision and why would you sell it any other way.

{audio:0:03:55} Just back to the fee question. For $200,000, Opendoor is going to, say, mark up an 8% fee, instead of the 6% fee. So that’s going to be $16,000 instead of $12,000. Then they’re also going to say, we estimate it’ll need these repairs; let’s just say it’s $2,000 on their estimate. So that’s $16,000 plus $2,000, which is $18,000. Then there might be some miscellaneous fees that are less critical that we can walk through, if it matters. Essentially, Opendoor is now saying, it’s $200,000, minus $18,000; you’re going to net $182,000. In that other example, you’re going to net $186,000. The difference is, we’re charging you for the repairs upfront. We’re charging you because this takes 90 days, in places like Phoenix or other towns, before it resells. By the time you’ve put a sign in your yard, you get the mortgage, you get the closing, you get all the banks lined up and you’ll be paying an extra month’s rent, versus moving tomorrow.

{audio:0:04:57} They have experimented with a range of fees below 6%, above 6%. I think that the last research I read is that they’re targeting slightly above, around 7% or 8%. On that 8%, we can do the $16,000, we can do the repair scope of $2,000 to $3,000. Then net, the seller gets that. We can go into some edge cases, but they have made the product more convenient as to whether you want to close in 30 days or 60 days. Whether, afterwards, you want to rent it back for a few days, until you get your new home. So there can be a variety of fees but, essentially, it’s one fee and then repairs are described separately. They’ve experimented with the presentation of that tax, but those are the major costs.

{audio:0:05:37} In terms of the repairs, it’s almost just as important to estimate the repair, as well as the actual bid for the house?

{audio:0:05:50} Yes; this is a significant impact to Opendoor and other iBuyers, on where their margin can be made or lost. Every offer will have a follow-up inspection. This isn’t as simple a model as your typical ecommerce, Netflix, or maybe even Uber, where it’s a low price, $10 price point and the car shows up or the video starts streaming. You’re going to have a lead come in, fill out a web page that takes between 10 and 20 minutes, which is not an insurmountable amount of time, but it is effort, and that’s going to go to a back-end, where an algorithm is going to price it, if it can. A human is going to double check that and it gets sent out. Then they’re going to double check, if you said your paint is in fair condition or good condition. They’re going to send out an inspector and their initial estimate might have been $3,000 of repairs and they may take it to $4,000; or they may say, you were telling it too hard, it’s $1,000. But they really try to nail that down.

{audio:0:06:49} I was there, in the early days, when it was in one or two markets, as opposed to 20, and they learned that when you misprice a home, either because you weren’t aware of the repairs or you just thought the market was hotter or colder than it may be, you’re going to hold that home for a lot longer and Opendoor is going to bear the cost.

{audio:0:07:07} So I’d say the two they really try to focus on is pricing and repair scope, which are the two major levers there. The season also matters. It’s easier to sell a home, in most places, in summer than in December, so they charge a higher fee in November, knowing that they’re going to have to wait until the New Year, versus buying it in June and selling it immediately, in July. They have a variety of variables in there. For home repairs, anybody who has done it personally knows that they are usually over-budget and for any of these iBuyers, it’s not just an ecommerce tech funnel; they have to become operationally excellent. They employ hundreds of vendors such as painters, lawn mowers, housekeepers, plumbers, who are employed directly or they have a contractual relationship to manage these repairs. When we talk about a 6% to 8% margin on the product totally, that can eat up a lot of costs. They are putting a lot of scrutiny into those areas.

{audio:0:08:02} You can’t really get scale, especially locally, in markets with that cost line?

{audio:0:08:09} I think scale is an interesting question on how these buyers achieve it. It’s very low efficiency between you having great plumbers in Phoenix and how that helps in Dallas. Maybe there’s a southwestern plumber, or something like that. But you find vendors, locally, in each market. If you can guarantee a plumber in Phoenix that they can do 100 homes per month, instead of 10 homes, they may give you a preferred rate. They may, in fact, give you preferred hours and say, you’ve got a block Monday, Wednesday and Friday; you can schedule me as needed. You can really start to push that. I don’t know what the right number is; 100 homes, 300 homes, before you develop some CL. It doesn’t help you cross-market, but it helps within market. Then the more signs you have in a yard of Opendoor, Zillow, the more other customers will see that and enquire and start developing some scale in acquisition costs. It’s not even a lifetime value to most of these customers. It’s a single purchase. You sell a home every seven to 10 years. Uber you ride multiple times per month, or at least a year. I think they have to think about the economics a little differently from the traditional ecommerce company.

{audio:0:09:21} Let’s say you got $200,000 for the house, $16,000 margin, which is the net revenue for the iBuyer, $2,000 to $3,000 of repair costs; how do you look at the lead generation cost, typically?

{audio:0:09:40} The iBuying space is constantly evolving. Zillow has come in and so how do you get a customer to understand this as most of us are barely hearing about and it’s only in select markets? There has been a lot of advertising by both Zillow and Opendoor. Probably more by Opendoor, who is an unknown brand with a very new product. I think Zillow has done a nice job with what they call their Zestimate which is on every page, of every house, pretty much. We can debate the accuracy of that, but customers were constantly going there to check it. They can click a button next to it that says, sell my home, for this price. I don’t think Zillow can really honor that price, so they have to get better at it. But you can imagine that that is a huge organic source of traffic, for Zillow, with the time they’ve been in market, the brand, what they make in real estate, the type of agents and consumers that go there.

{audio:0:10:34} Opendoor has had to do a little more advertising in traditional CAC channels, like Facebook, direct mail and television and other mediums. But what I would say is, it’s definitely an advantage for Zillow, but it’s not exactly clear in that most people don’t know that Zillow, yet, are engaged in iBuying. Often, you may go and click on that Zillow estimate and go through all these steps, all to say no, because it’s just a convenient lookie-loo tool, which is the way I used my Zestimate for years. But yet, Zillow has to bear all these costs of having somebody in the back-end, verifying the estimate, sending out an inspector, all to hear no.

{audio:0:11:15} So all traffic is not equal. I would predict that Zillow has a lot more traffic but the amount of monetizable traffic, that can be moved into an actual sale is, I think, far less. Most people are going to check out their home and you’re going to be closer to a single-digit conversion versus a 20% to 30% type of conversion, especially with a wide funnel, looking at price.

{audio:0:11:38} Surely Zillow must have an advantage in just the level of organic traffic plus the data they must have, over the years, in pricing and bidding for houses, more efficiently than Opendoor?

{audio:0:11:50} I believe in traffic, but I’m not privy to their exact operations and margin. We know what we’ve seen in their earnings, is that they are losing money per home. You will do that in the beginning, to gain share; you will do that to learn. Did they lose less money than Opendoor first lost when they entered the market? I’m not sure that the competencies that help you make or lose money or even price, are fully applicable. The Zestimate was, not necessarily, designed to be the price to buy the home but more to start the conversation. Developing something that, maybe, more biases recent comps or old comps and even the human element of going in there and inspecting it is not something that Zillow had. It had an advertising sales force; it didn’t have a team of operators and inspectors that are rolling trucks out of facilities. Developing these operational capabilities is very hard.

{audio:0:12:49} Then frankly, everybody is going to make mistakes. The best way for any algorithm to learn is to make mistakes and to relearn. I think that is a little bit about time in market. The Zestimate wasn’t probably as successful if you look at the index that said, how accurate was this when it sold, on the open market. I think Opendoor and Zillow is now incorporating that. Zillow has lots of advantages but I’m not quite convinced that pricing is quite yet what they’ve demonstrated on their earnings, with their margins still being relatively thin and losses, in some case. The data itself and the algorithm still needs tweaking. On traffic, they get a great head start.

{audio:0:13:30} What do you think really does provide a competitive advantage in iBuying?

{audio:0:13:36} This is a new category; this is a new product. It is very hard to build those. I’m sure lots of your listeners have struggled with it; some have succeeded. But it’s not easy, by any means. I would say that a long-term view, capital, a great team, the things that you talk about in a start-up. Let’s walk through some of those things that are different from other start-ups.

{audio:0:14:08} You need operational excellence. This is a 6% to 8% margin business. Just like Amazon and ecommerce, nobody loves that business; they love the cloud business. But Amazon is ruthlessly efficient. It optimizes the way boxes are stacked in its warehouse. If it can remove people for automation, it does. Whether it can ship on Tuesday or Thursday, it is just trying to optimize every dime, every penny, from labor down to the shipping method that gets to your house. It’s still a very thin margin business, so they have to scale.

{audio:0:14:43} But they’ve got a lot of fixed costs, unlike Opendoor, which seems to have a lot of marginal cost?

{audio:0:14:49} Yes, a lot of variable costs that you associate, whether you make a sale or not. When you look at that time horizon, you are going to have to get operationally efficient. You are going to need cheaper rates, which means there is some volume in play with this, in the plumber example we talked about. With enough blue signs in yards and word of mouth, that you’re not paying exorbitant CACs, just to acquire a customer. The last part of it that is critically important would be more a good selection in market choices. You shouldn’t be in San Francisco, where homes are $1 million and a 2% error is not $2,000, it’s $20,000. That’s a lot of engineers’ salaries and other things that are freed up, if you start doing this.

{audio:0:15:46} Opendoor has had a little bit of a learning curve in learning that this market works, this season works, but this doesn’t. Time in market, skills in market, word of mouth, all of those work. I’m of the thesis that this will be the way that people buy and sell homes. It’s just a matter of when, how many homes and who is going to do it. I think this is about execution. I do believe that there are markets where the teams have better management, better operations, better execution, are going to do well here.

{audio:0:16:16} The second piece of the pie that we can talk about is that service is built around the iBuying. iBuying is 6% or 8%. Those following the industry know that, now, Opendoor and Zillow are both offering mortgages. Zillow bought a mortgage company, Opendoor bought a title insurance company. They’re both looking at the resell side of the business, so you don’t have to fully buy the book from the sellers, but then you resell it to folks and you’re making another 3% there, instead of giving it away. It’s a very complex business and I think we’re in the very early innings to say what will matter here or there versus what will matter over the long term. Which start-up executes the best, I think, is key.

{audio:0:16:56} Do you think that’s where the margin is, on these ancillaries? The mortgages, the insurance, the reselling versus the actual iBuying, in the long run?

{audio:0:17:05} Yes; there’s no doubt that’s where the margin is. It’s a higher-margin product. 6% on $200,000 is still a lot of money. Even it’s a low margin, it’s still a meaningful number, where you can have operations. Then mortgage origination and title are going to be lower prices but higher margin.

{audio:0:17:27} But you have to earn the right to get to those ancillaries, by having the scale?

{audio:0:17:31} I think so. I saw a headline, the other day, that Knock, which was a start-up, much smaller scale than Opendoor or Zillow, or even Offerpad, has pivoted away from the iBuying part, if I read it correctly, and moved more towards the mortgage and ancillary services, because they’ve realized how tough a business this can be. Maybe owning one part of the chain would be pretty valuable, but right now, I would say the current piece is around a full stack. What Zillow and Opendoor, the two scale providers, are trying to do is to capture more of the customer value. It makes sense because everybody who buys or sells a home needs title insurance and, usually, nobody can name the vendors they use. The tax rates are going to be particularly high. We talked about no lifetime value, but if you can acquire a home from a seller and then also represent them in their new buy, you’re increasing the value of that single transaction and maybe, again, later on. So I think they are thinking through those ancillary services, as we said.

{audio:0:18:33} Focusing on the iBuying, the way I look at it is, it kind of gives you the right to offer the ancillaries to that customer. It seems as if the seller is really focused on the best price, which means that the iBuyer has to offer the best offer or the lowest commission. So the next question is, what do you think determines getting to the lowest price, for iBuyers?

{audio:0:19:07} I think you’re right. At such an expensive item, it’s more than likely that people are going to price shop. They price shop for airline tickets, they price shop for cars and they rarely choose a car dealer because of the brand; they choose it because the price is better. When people are selling $200,000 or $300,000 homes, they are going to take the time and do the diligence. If Opendoor, Zillow and Offerpad all offer you $200,000 except one is a 6% fee, one is 7% and one is 8%, probably the one with the 6% fee is going to win, most of the time. How you get to the 6% or whatever the lowest one can be is what we call that operational excellence.

{audio:0:19:49} The way they are all going to put together the fee they charge a seller is as a breakdown of their cost. Of that 6%, how much can they keep? We know, when they buy a home and they are charging a 6% or 8% fee, that’s not actually when they recognize the revenue. It will be 60 or 90 days later, when they sell it. When they sell it, the vast majority, a high percentage, are coming in, buying an Opendoor or Zillow home with a broker. That means that when Opendoor bought that house for $200,000 and resold it for, say, $201,000, they now pay another 3% to that buyer’s broker. So their 6% commission has gone down to 3% or their 8% has gone down to 5%, no matter what. That’s just the way the industry works; everybody has to play in that game.

{audio:0:20:43} Opendoor has started its own brokerage and bought a firm called Open Listings and now, if they can represent that broker, they can start capturing some of that margin and have a lower fee structure than Zillow might. If they can make 100 basis points of margin on the mortgage but say, we only want to keep 50 of it; we give 50 back. Then it’s just your flat-out operational excellence. Your plumbers or painters are cheaper; you sell it 10 day faster than your competition sells it, because you have great marketing and you have great networks and great social media. That 10 days of holding a $200,000 loan is going to be meaningful. How do you operate better and get that 6% fee down to 5.5%, or whatever it may be? You’ve got to get this operational excellence; you’ve got to get the ancillary services on there, such that you can be the lowest cost fee provider in town.

{audio:0:21:36} Aren’t Zillow just doing this already, given that they have the marketplace business?

{audio:0:21:45} They certainly have perceived advantages, as we said, in customer acquisition, although most people are not going to Zillow for that, so they still have to do some of that. But then, if they buy a home for $200,000, would they be willing to sell it for $201,000 and pay the realtor fee and do all of that? They could and they have a lot of capital and a strong balance sheet to do that, but none of their investors – either public or debt investors – I’m sure are looking forward to them going negative unit economics or margin, on these products. Particularly as a public company, making this transition will be challenging, because it’s a low margin business, which their investors don’t like. They are coming from a high margin advertising business, to a low margin operationally intensive business. Even if they do everything right, they’re still going to misprice and have some homes that lose money.

{audio:0:22:38} I think they need to do this in a thoughtful, profitable way and expand that over time. Whether they have an advantage, or whether Opendoor does, as a start-up, where its financials are more private, where investors have longer timeframes, where the public market doesn’t have to opine on every quarter, I think you can argue that Opendoor may be able to take more risk, may be able to push more on the rope, into new types of services and accelerate the adoption of this. But then again, they have fundraising challenges and, certainly, the markets for start-ups has also changed. I’m not in a position to say one is better than the other and I also think there is plenty of room for more than one.

{audio:0:23:26} We talked about consumers wanting to price shop and I can’t imagine there is a market where only one person who buys your home. I think we’ll see the advantages play out, over time. But I don’t think Opendoor has to say, tomorrow, this big incumbent has launched; we’d better shut down. In fact, Zillow has been in the space for over 18 months, I believe, and it’s still a distant second, in most markets.

{audio:0:23:54} You’re saying that it’s not likely that Zillow has an advantage, necessarily, in actually pricing the risk or pricing the homes or it’s hard to argue that, on aggregate, either of them have an advantage in the marginal cost base they pay to the repairs? It’s more on, strategically, how these businesses are going to evolve and use the ancillaries, financing and long-term focus, to build a business that actually uses iBuying to acquire customers and make the margin, elsewhere, on ancillaries?

{audio:0:24:29} Yes. I’d use the term sustainable differentiation. Opendoor probably has higher competencies in operations, having been in this market for four years. It probably has more data on which neighborhoods it is successfully buying at or not successfully buying at and avoiding those. It has more operational experience in how you schedule inspectors to do a home at 2pm and another one at 5pm and another one at 8pm, because it’s got a scheduling app. It has been in the market for four years and tried to solve a lot of these problems. It’s missed on some and succeeded on others. Zillow has been in the market for 18 months, in less cities, and is going find out, this neighborhood is not good. But over time, they’ll catch up. A plumber is not going to turn down Zillow and Zillow is not going to not pay the rate, over the next two years. But eventually, they’ll either both get to scale or only one will get to scale. My bet would be that this is a powerful enough value proposition that you’ll see more than one and they’ll both have advantages in pricing. The ‘loser’ would be the traditional home-selling process, not each other.

{audio:0:25:32} I think that if they view the world as less zero sum, they can build this category in a much better way than if they view this as a winner takes all world.

{audio:0:25:43} What Zillow does have, in the scale and the organic traffic they drive is that they can actually drive a lot of seller referrals to drive more referral revenue, which can actually subsidize that and lead to, potentially, lower costs, arguably quicker than Opendoor, because of the scale?

{audio:0:26:01} What you’re saying is, Opendoor or Zillow buys homes at $200,000 to $500,000 and of the 100 people that come to Opendoor or Zillow.com, 90 of them aren’t even in that $200,000 to $500,000 buy box. Or they’re in it or they’re in the wrong neighborhood because Opendoor or Zillow are not operating there. Or they’re there, but their home is a condo and it needs to be a single family home. There are a million conditions that these iBuyers exclude. So of their 100 homes that they got and they paid for traffic, 90 they never get to do anything with.

{audio:0:26:38} There are programs on both companies that emerge where they sell or refer these leads, where they are not going to make an offer, to brokers and agents in the local community. That broker loves it. They’re spending their whole time trying to find a customer and now they’ve got a hot lead that wants to sell their home but Opendoor and Zillow can’t. So they can call that seller and say, I’ll do the repairs for you, I’ll get your photographs done and we’ll have this house sold for you. Opendoor and Zillow can take X percentage revenue back from that. I think they’re all figuring it out.

{audio:0:27:15} That’s been a huge boon, I think, particularly for Zillow. When they first entered iBuying it was, oh boy, they have all these agents and now they’re trying to displace agents, because that’s what iBuying was positioned as. Will this not only cannibalize Zillow’s business but actually force brokers into not working with them? I think brokers have not come to this war point with Zillow, because they are fine to advertise, particularly at those higher price points and those markets where iBuying is not popular. Secondly, it puts you in the Zillow or Opendoor network, where they can send you back these leads and say, we’ve worked with this broker. For every one of those leads that Opendoor or Zillow can’t buy, they sell it to a broker and then they collect some revenue back.

{audio:0:28:02} Zillow is probably doing that at higher scale than Opendoor so yes, they have advantage. Again, I don’t think it’s that big of an advantage, where it’s sustainable, where it can’t be overcome. I know Opendoor has launched such programs and it has plenty of leads. Lastly, traffic is not as hard as you would think to get. Serious traffic is hard to get. Even the ones you are referring out to brokers, it’s not as if brokers close on these 100%. I think brokers appreciate really hot leads, as opposed to any lead. I think Zillow has an advantage there. I would just say that it’s in the short term and whether it’s sustainable is a debate.

{audio:0:28:48} How does a referral work, specifically? Let’s say it’s a $200,000 property. I ask for a Zestimate; I don’t like it and Zillow would then resell that lead to an agent. I think the agent fee is normally 3% that they take on that. Does Zillow take a take rate of that or how does that work?

{audio:0:29:13} I’m sure the models differ in different towns but, traditionally, you can say, we were going to get 3% on this home and we were going to buy it for $200,000, but the buyer really thinks they can get $210,000 and they don’t want to deal with us. We’re sending it to agent Jane Doe. Jane is going to call you and when Jane sells your home for $210,000, maybe $220,000, she’s going to collect the 3% and she’s going to give 1% or 0.5% of it back to us. Essentially, that’s how it works. Whatever negotiated rate that works out to, I think is usually how that transaction would work.

{audio:0:29:51} Which is obviously very high margin?

{audio:0:29:54} Yes, for doing nothing, you’re just collecting money. It is hard to believe that these homes that Opendoor or Zillow couldn’t buy with an instant buyer are going to sell quickly or sell in such a profitable margin. Often the buyer will come to the realization that these Zestimates and the Opendoor offers were pretty fair and the good agents may then go, let’s go back; let’s go and talk to them as I have a relationship with them. I know what they think they are going to offer and maybe we can move them up here or there, or we can put in this one repair and then go to them. That agent is also a bridge back to the iBuyer, should the buyer change their mind. It also starts as an introduction of, hey, when I try to sell my home, what is the starting price? We can go and look, but here’s an actual offer from Zillow or from Opendoor saying, they’ll buy it for $200,000 tomorrow. As an agent, I have to beat that or I’m not really worth your while.

{audio:0:30:50} As a buyer, you might appreciate that. As an agent, you set the stakes of what we’re trying to aim for, in a less arbitrated manner. I think these tools, more so than a Zestimate, when it’s an actual commitment to buy, can meaningfully change the relationship between a broker and a buyer to be more healthy.

{audio:0:31:09} It’s almost as if iBuying is a far superior lead gen tool for Zillow, in that sense, in just referring leads at such a high margin, at scale?

{audio:0:31:20} I think so. We’ll find out. iBuying is 5% or 10% of any market. Is it going to be more? We’ll have to see how the product takes off. But yes, Zillow was willing to bet their whole business on it. They put in a new CEO, they pivoted it, they’re taking substantial losses on it, right now. They must think it’s worthwhile. They’ve said, one, existentially, this could be a threat, where Opendoor starts rolling it up and takes it over to the point of lead. Secondly, it actually looks like a better consumer experience, in addition to just being a better lead generation tool. Yes, I think Zillow is smart to move into this, for many reasons. I think it’s more friend than foe, to their existing businesses, as they think about a broader real estate portfolio and ownership point.

{audio:0:32:11} Do they have an advantage in that they can refer the leads to a wider partner network of agents, than Opendoor? Or is there no advantage there, in the referrals?

{audio:0:32:23} I’m not as deep in that. I would say, there is probably some advantage but, again, as Opendoor enters a city, to find out the top realtors in the town, to build a network, is a cost in people and time, but it doesn’t seem insurmountable that brokers would say, we only take leads from Zillow and I won’t take them from Opendoor. Zillow has thousands of agents on its platform that it can contact and say, would you like leads, and then contact the ones that are the best, or if you spend more money with Zillow advertising, you can have more access to more leads, or whatever they do. Clearly, there is an area for them to benefit with their existing businesses.

{audio:0:33:03} What advantage, if any, do the traditional brokers have in iBuying. I see Keller for example, are moving into iBuying.

{audio:0:33:14} Again, you have to start with anybody who is an incumbent, relative to the Opendoors or Offerpads or the new entrants. What they have is, they have a brand and traffic. I believe Keller Williams is one of the largest, if not the largest, brokerages in the States, and has probably been selling homes to customers for decades now. When that customer recalls Keller to say, you helped me sell my home seven years ago; you’re my first call, because I’m not just sitting here looking at ads and following the real estate space. The broker that they worked with years ago will say, we’ve got this new product; do you want to sell it instantly? By the way, we’re a trusted name. Keller Williams, around for decades and when we say an offer, we mean it; we stand by it. We’re not going to go out of business tomorrow.

{audio:0:34:06} Opendoor is getting there but yes, if you were to tell somebody that’s less familiar with technology and markets, would you bet on Opendoor, this start-up? They might say, that feels a little risky to me. I’ve heard of Zillow and I’ve heard of Keller Williams and if they’re all the same price, I’ll take those guys. And I’ve got an agent that can come, talk to me and make me feel good, which is always good when you’re spending hundreds of thousands of dollars. So Opendoor has hired people and built something where you can call a number and they’ll assure you that yes, if you want to close your home in six days or 45 days, there’s no difference. They’ll walk you through the FAQ. Keller has a team of agents that it can train and there’s nothing like human contact versus a phone call, and we know the real estate’s relationship business.

{audio:0:34:53} So a lot of advantages but then we can into the disadvantages. Very new to the space; I don’t think they have a team of hundreds of data scientists or an engineering force that some of the tech companies have. Are those insurmountable? Can they build them? Absolutely.

{audio:0:35:08} How much does that tech and stuff matter?

{audio:0:35:12} I think it does matter. When you get into these low-margin operation businesses – I like using the Amazon analogy; it’s been successful. Is Amazon a technology company; is it a retailer? Well, it’s both. I think its technology is a really big advantage in keeping that warehouse 1% more efficient, shipping on the right day and having a customer service experience that can do chat, can do talk and can do many things. I don’t think it’s like AI engineering, where you have to do everything.

{audio:0:35:46} But we’re experiencing it in Covid, already, with the pandemic, where virtual showings are more important. Opendoor pioneered this loft, where it opens 9am to 9pm to see a showing. Whereas traditional brokerages had a realtor from 2pm to 4pm on Sunday. Opendoor said, you can come by any time; just come up with a smart lock and your phone unlocks it. We pull analytics on how many times you’re visiting a home. Maybe people that are visiting homes more, we send them emails and help them more. There’s a lot of technology that is now being realized in the pandemic, that used to be fancy bells and whistles, to maybe becoming the norm. How can you now not have a virtual showing of a home?

{audio:0:36:26} Companies like Opendoor and Zillow that have been pushing the technology frontier, to change real estate, even prior to the pandemic are, I think, ahead of the curve. I’m not saying Keller has not innovated, but those companies that have are at a substantial advantage. As the phrase goes, the pandemic has not changed things so much as accelerated them. Zoom video was always going to take off in remote work; it’s just developed much faster. If iBuying was a far superior way to buy, where you don’t have to get out of your home and all that uncertainty, the pandemic may speed it up; I don’t know. It will certainly speed up virtual showings and signing documents remotely and those things, that some of these start-ups have invested in.

{audio:0:37:11} How do you look at the cost structure, per unit? Let’s use the $200,000 house example. There’s $16,000 revenue, say, for iBuyers; $2,000 to $3,000 repair costs, which gives you $13,000 which is gross. How do you look at the other lines of cost that can get you to some kind of gross margin or net margin?

{audio:0:37:40} Let’s just do that math to make sure I got everything right. On $200,000, it’s $16,000 when you see Opendoor and it will say, Zillow, $200,000 minus $16,000 gives you $184,000. Then it will say, repair scope, $2,000, so then it’s $182,000. They’re putting it on top of the fee, usually on top of the 8%. It’s blurry, but that’s my latest understanding. Those repairs, for the extra $2,000, if Opendoor spends $2,500 because the mis-estimated, it eats into their margin. But in most senses, they are trying to be repair neutral and obviously everybody has different strategies. They’re not trying to make money on the repairs. It’s mostly on the fee, because they don’t want to be perceived as a flipper. The worst thing would be that you sell your home for $200,000 and then Opendoor sells it for $220,000 and the buyer would feel robbed. What I think they’re trying to present is, this is a fee of convenience and it’s certainly going to sell for more than we buy it for.

{audio:0:38:39} That’s a long-winded way of saying, we’re starting with that $16,000 and now Opendoor is going to go and relist and let’s say, for argument’s sake, they’re going to list it at $203,000. They’ve put in $3,000 of repairs and they’re trying to get it right back out. Well, now they go and sell it and we’re going to assume that the vast majority of these come back with a buyer broker, who is going to take 3%. For simplicity, I’m just going to say that that’s 3% on $200,000, which is $6,000. The $16,000 you collected at time of acquisition, is now down to $10,000; $16,000 minus $6,000. If Opendoor or Zillow could just do that, they would make $10,000 and it would be done. But it has to hold this home. While it is repairing it, it assumes the cost. Opendoor is buying this with debt and leverage and so they pay an interest fee, just like any homeowner does. They, at scale, like Zillow, get a preferred mortgage rate, but they are paying hundreds of dollars, if not more, per week and month, to hold this home while they try to sell it. So you’re going to eat up some of that $10,000 in there on what we call holding cost.

{audio:0:39:57} Repair overruns, pricing. Sometimes you buy the house for $200,000 and you try to sell it for $203,000 and you do do that. Sometimes you sell it for $205,000 and sometimes you sell it for $201,000. Again, some of these houses make money and some lose money on the price. But just factor in some sort of breakage on that. Then all the costs that go into this. This is a 90-day process, where we talked about Opendoor, essentially, holding a loan against the home. They are also employing lots of people, to come out and look at this home and say the repairs that you stated were fair and accurate or, we have to change the repair scope. They have to have a call center waiting and saying, when are we going to schedule you? At 2pm or 4pm? Or an email to somebody going back and forth. So there is lots of human labor in scheduling, in repairing, in the 90 days where this all happens.

{audio:0:40:53} The at the 11th hour, the seller could say, I just don’t want to do this anymore. Or they could have done all the inspections and then right when it comes, they could change their mind at that point. There’s a breakage of having incurred all these fees, where this transaction still doesn’t go through, even if you did everything perfectly, because the buyer just says, my wife changed her mind and we don’t want to move anymore.

{audio:0:41:19} Out of that $10,000 that you’re playing with, that’s almost the floor. So $10,000 on $200,000 that’s a 5% margin and then there’s a whole bunch that could shrink that down, let alone what it cost to acquire. Maybe they spent $100,000 that month and they got 100 customers and $1,000 per customer cost you’ve got to associate. You’re talking sub single digit areas where they go and, in some cases, negative economics.

{audio:0:41:47} Because you’re probably spending at least 1% or 2% in the interest to hold the property, if you hold it for 90 days. You’ve got 3% of margin to work with, plus these inspections, the pricing risk and then the seller pulling out and stuff like that. It seems very, very tight.

{audio:0:42:07} That’s just the variable cost on the person that you talk to, the inspector and then you have a whole bunch of engineers in San Francisco and real estate and operating costs that I’m not even talking about, versus gross margin. It’s a tough business to make and hence why we’ve talked about the ancillary services, the scale, the expertise that you build, over time.

{audio:0:42:26} That’s important, right? Because it seems as if the money is not made to be here. You own the right to offer these ancillaries to the customer?

{audio:0:42:37} I think that’s right. The ancillary businesses seem very important. Or you get to such a position that it becomes almost the default way to buy and sell homes. The volume is so big, you are 30% to 40% of the market. I think that’s what a lot of these start-ups have tried to do. The Ubers, low margin, losing money per ride, but thinking that they could get big enough someday, where the lifetime value of repeat customers and acquisition costs, some sort of tipping point occurs. That economics is not easily playing out, right now, in ride sharing and food delivery. Home selling and buying is probably even tougher, because it’s clearly not repeat purchase; acquisition is much tougher, given the scale of the cost of the business here. Then the timeline and operational intensity are higher.

{audio:0:43:28} But people said that same thing, 25 years ago, with ecommerce; people would say it with healthcare. The bold will try to disrupt and innovate and I think Opendoor and Zillow are going into that ring, willing to do that.

{audio:0:43:44} How much of a risk do you think pricing really is, to these businesses?

{audio:0:43:49} Immense; an immense risk. We have seen some of the early impacts of Covid. Homes didn’t fall by 30% in price, overnight. Maybe in some markets it’s hurting more but even in major urban centers, like New York and San Francisco, you’re not seeing double digit drops yet. Even in 2008, you had big, big drops, but nobody’s portfolio was down half, overnight. That’s because housing is just a more durable good, where people tend to hold on and it’s a tangible thing that you can live in. Usually, it’s not as disrupted. That being said, you cannot sustain losses on every home, for that long. What was going on, prior to the Covid pandemic was, if you were mispricing on high-price homes that are $500,000 or $1 million, that 2% error starts to become very meaningful on your overall P&L, at an absolute level; even on the percentage level that we talked about. That’s just not going to last.

{audio:0:44:57} Hence you saw them say, our buy box is now $200,000 to $500,000. If you go and look at the average price or Zillow or Opendoor, it’s more like $300,000. They’ve figured out a way to get pricing risk down. For example, I’m not sure where they stand now, but it was more difficult to buy in a gated community. Now, when you’re trying to sell a house, the customer has to go through a gate; there’s no realtor to open it for them or give them the code and homes sit longer. Learning all of these pricing errors, such as buying near power lines or this side of the street versus this side of the street, takes a while to figure out. They should ramp their buying as they get the unit economics right. When you get there, you’re going to have a wide pricing problem; when you get to 100 homes, less pricing errors and when you get to 500 homes, even less pricing errors and they figure this out, over time. The longer you hold a portfolio, the more exposed you are. What they thought would be just a normal housing recession, where prices decrease, because of job uncertainty, in this type of recession, you might just be holding the wrong type of inventories. You’re holding suburban versus urban, or homes with backyards do better than condos. Pricing that risk and managing that inventory risk is incredibly complex, especially when demand is not seasonal.

{audio:0:46:21} This is an economics problem that they have to figure out and they are working with and holding the right amount of cash reserves and, very much a fintech start-up in some ways, as well.

{audio:0:46:32} Because even if the average 90-day holding period for the inventory doubles, or even increases by 50%, that shaves another 1% or 2% in your gross margins?

{audio:0:46:46} Remember that Opendoor is buying these with leverage. The lenders are not going to continue to say, sell homes at a loss. The reason Opendoor is being lent money is that they are a good store of capital and if, in the worst case, Opendoor shuts down, that lender on the other side of the transaction still owns the home and the home has inherent value. But if Opendoor buying homes for $200,000 that are now at $190,000, that lender is now under water, tanking on every home. So they have to buy it pretty accurately, for that lender to give it credibility. I’m sure these lenders are auditing and making sure, on an ongoing basis, that the economics work, that the expansion is thoughtful and everything else, otherwise the credit line will shut down.

{audio:0:47:29} Moving on to look at agents and the role of the agent, how have you seen this evolve over the last decade?

{audio:0:47:47} Agents were already starting to experience changes, prior to iBuying and Opendoor. Technology was coming, with virtual listings and Zestimates. This has been the latest change, but I do think it has been helpful in forcing the conversation. Selling is a rough process for an agent. Buying is pretty easy. You go with the buyer, to all the homes, buy it, you sign a contract; it’s kind of fun. Selling is a lot of agony for a seller. Is your home going to sell? Should you cut the price? The buyer wants to buy it but they want you to repair this. A selling agent is almost half therapist, as much as they are advisor.

{audio:0:48:32} Opendoor takes a little bit of that therapy away. But the advising is critical. Are you getting a fair offer? Opendoor can tell you that they are doing that but a human saying, I’ve been in this business for 30 years, this is a fair price, feels a lot better to a lot of buyers. I’ve sold five homes on this street and I’ve got real credibility to tell you that. Oh, you know what, you’re going to need to buy your next home. Let me introduce you to some neighborhoods that are now good because you are selling your home for the kids, or you are getting divorced and you need a home where it’s more singly and urban. Let me also figure out which bank you should get a mortgage from because, with a mortgage, a difference in a quarter point is a lot of money. I work with this guy, at bank XYZ.

{audio:0:49:23} Do you think the agent, historically, has been overearning in the system?

{audio:0:49:29} I think for some agents. In some cases, there hasn’t been an alternative for a buyer. On a condo that is fully managed and brand-new, one year old, that is not going to have a high repair, that the person is leaving town, why should they get charged the same price as a house that needs a lot of repairs, that has a lot of complexity, that is low-value selling? We have had no price discrimination between that. The agent usually takes 3% for a hard home or an easy home; a hard seller or an easy seller. In some cases, yes, I think there has been an arbitrage for agents, with easy sellers. I’m sure agents also, sometimes, work way harder. They do all the work; they don’t sell and they get nothing in commission. Therein lies the risk in the occupation. But I think in this one, the agent can almost take away the selling risk, because they now have an offer, or the seller themselves, if they choose not to.

{audio:0:50:28} I believe a meaningful number – not the majority – of transactions, with Opendoor or Zillow, still have an agent, even on the selling side. Some person has listed with an agent, waited three weeks, doesn’t feel good about it and says, let’s just get an instant offer and then that agent is their advisor in saying, Opendoor is reputable and this is a good price and they work out the economics maybe a little differently. But yes, if you are new to town, how do you find out the best school district? Think about how much people pay and invest in their children’s education and if you don’t know anybody around or you don’t know that this sub-division has had a lot of floods and then, six months later, you’re dealing with a home that has a flood or something, that’s invaluable. I definitely believe in agents. Certainly, at the higher price, it looks as if they are going to remain around. LA, San Francisco and Chicago have plenty of homes over $500,000, where their service will still be necessary. The best agents will distinguish themselves in their advice, in their expertise, in their networks, in their psychology of working with folks and in a variety of other ways that we can talk about. I’m not of the opinion that agents go to nothing. I’m not of the opinion that they are useless. But I think, for a lot of transactions, there’s probably a lot of fat on it that can be eliminated, through using iBuying.

{audio:0:51:52} How has the way that Opendoor has worked with agents evolved?

{audio:0:51:58} It has evolved dramatically and will continue to evolve. Opendoor and other iBuyers had already learned a lesson from a few of the other start-ups trying to challenge some of these established places, like Uber in cities, with taxi drivers, in a way that there was such a hostile environment around that. Airbnb which seems, at least, nicer to play with but has had a lot of battles with cities on housing affordability and what this does. I think this has been less controversial from cities and regulations, that this is going to destroy home ownership in the way we know.

{audio:0:52:38} The agent community has been watching it carefully and saying, are you friend or foe, with Opendoor, since the beginning.

{audio:0:52:46} Didn’t they buy a broker?

{audio:0:52:50} They bought a brokerage, called Open Listings, which was, if I have it right, a Y Combinator start-up that was also probably challenging the way that agents worked, but still employing them. Again, I think that signaled a little more pro-agent, although maybe our agents, employed by us, instead of your agents. Everybody is trying to interpret their futures here. But as I said, it’s only a number in single digits that buys direct. So in the resell side, Opendoor has been working with agents in 90% plus of these type of transactions and, in that case, they’ve had to work with agents.

{audio:0:53:35} On the seller side, I think it’s a little more interesting where agents are saying, well look, being a selling agent was pretty awful. You have to go through this 90-day battle, walk your seller through the psychology of price drops and repairs. They still make money so I’m sure they don’t want that business to go away but I think Opendoor and others have said, why don’t you come and get our instant offer and know that that is a floor for you to walk back to and educate your buyer or seller on this. It’s been friendly that way and with the referral program. Actually saying, we’re going to use brokers and we’re not in all buy boxes, has started to make the conversation more friendly.

{audio:0:54:18} There’s a lot of moving parts there and there’s a little bit of tension. Ultimately, the iBuyers are, effectively, taking their seller customers?

{audio:0:54:26} I think that’s right. I do think there is a time when we say, what does the agent provide? It had better be a lot of expertise, often on the buying side, on the right neighborhood, on the right school district. Is the inspection you got legitimate? Did they really look for this thing or that thing, that’s unique to this neighborhood? Over time, these homes may become more transactional. Again, ecommerce is 20 years in, with Amazon, and a lot of retail is still done in brick and mortar. Amazon is only brick and mortar and Opendoor or Zillow will employ agents. So I don’t think one model goes away.

{audio:0:55:09} If we’re talking 10 years from now, and agents are still 95% of transaction and iBuying is only single digits, then it will be news to me, because iBuying failed and agents were worth more or some other type of regulatory event didn’t allow that to happen. By no means should we expect agents to be the same percentage of share, a decade from now.

{audio:0:55:30} What’s the advantage of vertically integrating with brokers versus partnering?

{audio:0:55:37} I’ll look at that in terms of vertical integration, in general. Why not just refer mortgages and collect a bounty on that, or title or agents, and just be this consumer funnel and then dice it out to all these high-margin products? I think there are some folks that will do that; it’s a reasonable strategy, I should say. But I believe what Opendoor and others are trying to do is not only change the business, but change the experience, to a customer experience that is much more pleasurable, for lack of a better word.

Opendoor versus Zillow Group

iBuying transaction process, fees, and costs

Importance of optimizing capital structure and operations to maintain margins

Drivers of a 5% gross margin and the cash flow profile for iBuyers

How Zillow could have an advantage due to organic traffic and lead gen scale

How and why Opendoor vertically integrated with agents and potential advantages over partnering with agents

Opendoor versus Zillow Group

Former Director FP&A at Netflix & Former Head of Strategy & Finance at Opendoor

inpractise.com/articles/opendoor-zillow-ibuying

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Executive Bio

Bobby Tulsiani

Former Director FP&A at Netflix & Former Head of Strategy & Finance at Opendoor

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Opendoor versus Zillow Group(July 20, 2020)

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