Zillow's $1.6 Billion Dollar Mistake: What NOT To Do

What's up you guys, it's Graham here!

So we all know Zillow. It's the site we go and snoop on to find out how much someone's home is worth. We've all done that. But despite some incredible success, Zillow has recently run into a few hurdles that it might not be able to surpass. So let's go ahead and talk about Zillow, its business model, and why its home flipping business might be more like a home flopping business.

I'm pretty sure that Zillow doesn't need too much of an introduction here, so I'm gonna be saving a minute of my time speaking about it because all of you know what it is. If you don't, just simply go and Google it. But what makes Zillow the topic of this video is its two newest business ventures. The first one is its home flipping business, where Zillow makes direct offers to sellers, much like a car going to CarMax. And the second one is their newest addition, and that is a mortgage company, where all of a sudden, Zillow can originate their own loans.

The concept of this, on the surface, seems absolutely incredible. So why has their stock plummeted, and why could this be seen as a flop? Initially, these two ventures seem to pair perfectly with their existing business model, which is simply congregating real estate listings, compiling data, analyzing trends, and their big moneymaker is advertising.

Alongside every single home that Zillow shows is what's called a Zillow Premier Agent. That is an agent who has paid hundreds, thousands, or often tens of thousands of dollars to appear next to that home, depending on the zip code. Many agents also get quite competitive when it comes to different zip codes, and the way it works is a bidding system. Some agents can simply outbid and pay more than the existing agents, and all of a sudden, they get the spot when the original agent's term expires.

The agent that wins and gets to have their name next to every single home gets the opportunity for buyers and sellers to call their information because their information is displayed. With that, they can turn those clients into buyers or sellers and make a commission. While many agents will often spend anywhere from $10 to over $100 per lead, just making a single $20,000 commission on one home sold can pay for the entire thing plus profit.

The business model here is really simple. It works at an interrelationship perfectly with agents, sellers, buyers, and home data. But naturally, Zillow has poised itself for interstellar domination. In an appreciating market, where they're at the forefront of homes being bought and sold, it makes sense that they take a stab at buying these homes first themselves. I mean honestly, that's exactly what I would do if I had access to tens of thousands of homes before they even come on the market. As soon as people are starting to look, you bet I would be making offers and making propositions to everyone who is even thinking of selling. Just in case a fraction of one percent bites, that could be a great deal.

And that, ladies and gentlemen, is exactly what they did: introducing Zillow Instant Offers. They first started testing this out in two markets: the first one was Las Vegas, Nevada, and the second one was Phoenix, Arizona. The program allows homeowners to submit their home to Zillow, and based on that data and analysis, they can submit an instant cash offer. The CEO of Zillow explained that Zillow gets the opportunity to bid on 15% of all homes sold in Phoenix, Arizona, which is absolutely incredible.

Zillow estimates that within a year, it will buy roughly 300 to 1,000 homes in roughly the $200,000 to $300,000 price point. From there, Zillow will fix up the property, relist it with one of their agents, and then sell it for a profit within 90 days. So why is this potentially a flop? The criticism here comes from both the homeowners and also investor expectations. For the homeowners, the process simply wasn't as fast as they were expecting. For every day a home sits on the market, it’s a home that is losing money. If it takes you an extra week to close on that home, that home has closing costs; that home is costing you money.

So every single day is basically money you are losing. The unfortunate part is that long disclosure times often delay closing longer than expected, and also remodeling a home tends to take longer than expected. This is a very hard business to scale up because it requires you to constantly be fixing up properties, moving on to the next one, flipping them, and then continuing to do that in an appreciating market.

I think it's also the reality that home flipping is a very hard business to scale. Selling it, while surely you could make some money on it, how sustainable is this, and also, is this the best use of resources? The problem for Zillow was that many sellers were using the Zillow Instant Offer as a base to then negotiate from and get higher bids. Much like people going to CarMax and then putting it up on Craigslist a few hours later and say, "CarMax offered me this, but I'll sell it if I just get $500 more." Many homeowners were doing that with the Zillow instant offers.

Because of their less than expected prediction, Zillow is slowly scaling back on the homes that they're buying while simultaneously expanding to different markets, and this has investors concerned. The problem with flipping homes is that it's risky. Tying up your assets flipping a house can be risky. Spending your time flipping a home can be a delicate matter, and for what benefit?

The problem lies that this business is entirely dependent on them getting and continuing to get more and more deals to flip, which honestly, I agree, Zillow will continually get new homes to buy and flip. But it also benefits them that the market is going up at the same time as well. If and when the market goes down, the last thing Zillow needs is to be holding on to all of this inventory in all of these homes that if all of a sudden lost 20% of their value, and all of a sudden Zillow is holding this real estate that they can't make any money from.

In my opinion, as some random guy on the internet whose opinion really means nothing, this is a risk that Zillow didn't really need to take. Now Zillow is expanding into a second market, which is, yeah, you guys already know what it is — that is the mortgage business. Oddly enough, when they announced this, the stock continued to drop. Why shouldn't this have been a no-brainer for the company to do? Since basically the very beginning of Zillow, originate loans, sell them, and then profit.

Again, on the surface, to me, this seemed like a really clever and really great idea. But on the other hand, for investors, and let's be real, Zillow is a business that will need to appease to its investors. With this new venture, just comes uncertainty and risk. Getting into the mortgage business at a time where rates have just begun going up again may not have been a risk that was worth taking for Zillow. With investors uncertain about its slowing growth, its high expectations from home flipping, and rising rates, it makes sense that investors would be spooked about anything that company does that isn't its core business, which is advertising.

This is their business. Just like I explained earlier, Zillow makes a lot of money from their Zillow Premier Agents, which pay to advertise next to the homes that are shown. This is a really good business just all the way around. From my perspective, an opinion that means nothing on the internet, is that this business model was basically their goose that was laying the golden eggs. This is the platform I really believe they're strong at; this is the part they should be expanding. Why stop just at Premier Agents? Why not expand to Premier Contractors or Architects? Or why not also link to furniture that you can buy or stage your home with that's shown in the home?

Advertised literally, you can just promote anything that's relevant to any sort of buyer or seller or anything. Promote lenders; have Premier everybody as long as it benefits the people watching and going to Zillow. I think that by expanding their advertising in a way that's beneficial to the consumer, they're going to be able to get the leg up over Redfin, which is slowly been eating away at its core audience.

Zillow has recently been seeing a saturation in their Premier Agents simply because their growth has been slowing. The reality is that prices are rising, competition is getting fierce, and agents are really looking closely at the money that they spend. The ones that can afford to advertise on Zillow will, and the ones that can't won't. But this eventually leads to a saturation where you can only cover so many areas that even just exist. Redfin's 1% listing agents might also eat away at Zillow's Instant Offer because why would you accept a Zillow Instant Offer when you could simply pay a 1% commission for listing on Redfin and have access to the open market and have an agent showing your property?

It's this uncertainty and risk that could either be Zillow's downfall or their saving grace. The way I see it, originating loans makes sense, and it's a good business model. Anything you could do to streamline the process as much as possible and any service you offer that helps this, in my opinion, is simply just a good idea. Is this the right time to do that as their growth has slowed and also as interest rates are going up? That one, I'm not so sure about, but I don't really see any downside of them doing this and really just trying it out and seeing what works.

But I really believe their core focus should really be advertising and proving that and expanding on that, and then everything else second. Continuing to grow the advertising platform in a way that benefits the people going on the website, in my opinion, would just be an easy win. But again, what do I know as just some random guy's opinion on the internet?

So anyway, what's the takeaway here, and what's the lesson for anyone who wants to incorporate any of this stuff into their own business? Well, simply put, the way I see it is just not to deviate too far away from what is already working. If you have something that's working really well, great, just replicate that and expand on it; add to it, improve it, and just make it better.

I wouldn't necessarily take the risk, especially if you have one endeavor that's working so well that you can simply just optimize a little bit better. So take away from this whatever you want, but that's at least the way that I see it.

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