Pulse

[PULSE] Why iBuyers went into self-quarantine during the pandemic

Was it poor planning or a survival strategy?

A lot has been written about the emergence and rapid growth of iBuyers over the past two years, companies that streamline the home sales process by making “instant offers” to home sellers, doing minor repairs to the properties they purchase, and immediately putting the properties back on the market for resale.

The iBuyer phenomenon began with Opendoor and fast-follower Offerpad, and continued with the entrance into the category of major real estate industry players like Redfin and Zillow.

For pure-play iBuyers like Opendoor and Offerpad, there was a very specific value proposition to prospective home sellers: the certainty of a successful sale, and a speedy, efficient transaction. Speed and certainty came at a cost, of course, with iBuyers often tendering below-market offers and charging additional service fees. 

Rick Sharga
Guest Author

Companies like Redfin and Zillow incorporated this direct purchase process into their broader business models, offering an iBuyer-like experience as one possible option to prospective sellers, while also offering a more traditional sales process utilizing a Realtor – directly connecting the seller with a Redfin agent, in the case of the former company, or introducing the seller to a number of interested Zillow Premier Agents in the latter. 

Billions of dollars have been raised or invested by these and a handful of smaller companies, who have taken the traditional fix-and-flip model of residential real estate investing and institutionalized it.

While the overall iBuyer share of the market nationally is still minuscule, the growth of the category between 2018 and 2019 almost doubled. Part of this growth was organic – Opendoor grew so rapidly that it purchased more homes in 2019 than were purchased by the entire group of iBuyers during the previous year. Part of the growth was also due to the entrance of Zillow, which grew to become the second-largest player in the space – doing more than twice the volume of Offerpad and 10 times more than Redfin – in its first full year of buying homes.

With all four of these companies poised for growth and expansion – and with the traditional industry trying to determine if iBuying was a peek into the future of real estate transactions or would always be a niche category for opportunistic investors – the COVID-19 pandemic struck, and every major iBuyer simply stopped buying. 

As the iBuyers withdrew from the market, the industry faced a new question: Would the coronavirus be the death of the iBuyers, or was this simply a shelter-in-place strategy to prevent more serious problems?

Stay at Home Orders

So why did the iBuyers stop iBuying? The answer comes down to basic math and some of the business realities faced by iBuyers. 

First, iBuyers operate in a market characterized by thin margins. They need to make purchase offers high enough to be attractive to prospective home sellers; carefully allocate budget for property repairs; and then price the property at a low enough price to compete with existing inventory.

On top of that, their fees can’t be too much higher than the 5-6% commission that a home seller is used to paying to a Realtor in a typical transaction. Getting this equation right is every bit as daunting as it seems: all four of the major iBuyers reportedly lose money on these transactions. 

This model has been challenging over the past few years even with home prices steadily rising, and homebuyer demand outpacing supply. The disruption caused to the housing market by the COVID-19 pandemic makes the iBuying process – and home sales in general – exponentially more difficult.

Two factors become especially critical right now for iBuyers.

First, “carrying costs” during hold times – essentially the time between property acquisition and the subsequent resale. Carrying costs include financing charges, taxes, insurance, and possibly property management fees among other things. Once an iBuyer purchases a property, it typically takes longer to sell the home than it takes a Realtor in a traditional sale. Hold times for iBuyers ranged from 70-92 days in 2019, compared to the 60 days on average it took an agent to sell a home according to Realtor.com.

To be fair, this is not an apples-to-apples comparison – the iBuyer hold time includes the time needed to execute repairs, while in most cases a property is ready to go to market once it’s listed for sale by a real estate agent.

The bottom line, however, is that the longer it takes to sell the property, the higher the carrying costs. And home sales are expected to plummet during the spring this year due to the pandemic and the shelter-in-place orders executed across most of the country. It simply doesn’t make much sense for iBuyers to add to the inventory of properties they own in a market environment where it’s likely to take longer to sell a home.

Inventory, by the way, is the other factor to consider. The worst-case-scenario for iBuyers since the concept was first introduced is a situation where an iBuyer has a large inventory of homes in its portfolio during a period when home prices fall. In that scenario, thin margins can suddenly balloon into huge losses. For companies losing money even while home prices appreciated, a drop of 5-10% in home values could be catastrophic. 

Given that possible scenario, and the uncertainty about where home sales and prices might be headed due to the pandemic, it would have been an enormous risk for iBuyers to continue acquiring homes at this time, and potentially build up a massive inventory of overpriced assets. 

Ending the Self Quarantine

Although all four of the major iBuying companies have announced that they will soon restart purchasing properties, it’s unlikely we’ll see them return to their aggressive pre-pandemic levels of acquisitions until the economic downturn caused by coronavirus is over, or at least winding down. Price predictability is a critical part of the iBuyer business model, and the housing market is likely to be experiencing quite a bit of volatility over the next few months. 

Ironically, though, once the iBuyers do return to the market, conditions may actually be more opportune for them. Homeowners who “need to sell” versus those who “want to sell” are ideal prospects for iBuyers, where the benefits of certainty and speed may outweigh the desire for these sellers to capture the highest possible sales price.

And it’s likely that we’ll see more anxious sellers at the end of the government’s mortgage forbearance period, for whom a slightly less profitable sale is a far better outcome than losing a property to foreclosure.

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