Over the last decade, technology firms have been hard at work, trying to disrupt and revolutionize the residential real estate market. One of the most ambitious projects toward that end has been the entrance into the ‘fix and flip’ market by real estate technology industry behemoth Zillow. Well, come to find out, buying and updating used homes for quick resell is a far tougher market to crack than some technologists originally thought.
Recently, in a series of public announcements, Zillow first communicated that it was pausing its home buying business. Then, shortly thereafter, announced that it was closing the business for good. This announcement sent shockwaves through the real estate technology industry and further depressed the company’s stock price. As recently reported in an article in Fortune.com, “one of the biggest real estate brands in the world has seen its stock fall nearly 70% since mid-February. Zillow has gotten hammered after bungling its iBuyer program just three short years after getting into the house-flipping business. The company announced it is shuttering the platform, selling the rest of its housing inventory, and laying off up 25% of its staff.”
Technology and big data have been transforming major global industries for the last three decades. The real estate industry is no different. Companies such as Redfin and Zillow (among others) have democratized access to real estate value information across the country, offering both buyers and sellers access to data that would have been unimaginable twenty years ago. Therefore, it did not seem like a big leap to believe that this same data could be used as an additional revenue stream to the company – by purchasing and quickly flipping homes.
With that goal in mind, over the last several years, Zillow’s iBuyer program was buying a significant number of homes across the country. The strategy was to buy used homes, hire professionals to update the property, then quickly sell the property within a three to six-month timeframe. As detailed in the article, “Zillow’s iBuyer program was predicated on the idea that their home-price algorithm could find houses to purchase, fix up, and sell for a profit. The idea was Zillow could find efficiencies in the system if they could do this at scale on a national level. Zillow wasn’t trying to hold houses for the long term. They were trying to buy and flip them in the short term [3 to 6 months].”1
Unfortunately for Zillow, as we learned over the past several weeks, this strategy did not play out as the company had hoped. Rather than adding a consistent source of new revenue, the iBuyer program required significant amounts of capital (to purchase the homes) and added volatility to the company’s quarterly earnings and balance sheet. Per the company’s communication, in too many cases, homes could not be resold at profitable valuation levels. In the article, Zillow CEO Rich Barton “cited price forecasting volatility as one of the main reasons Zillow has been overpaying for houses. With the price forecasting volatility, we have observed and now must expect in the future, we have determined that the scale would require too much equity capital, create too much volatility in our earnings and balance sheet, and ultimately result in a far lower return on equity than we imagined.”1
To be fair to the company, the last three years have been a unique period for the residential real estate market. Millennials have been entering the market in significant numbers, baby boomers have been actively downsizing, and the pandemic fueled a mass movement away from large cities to both suburban and rural locales. Any of these developments alone would make forecasting real estate prices over a short period of time difficult. All three occurring simultaneously made short-term price forecasts nearly impossible. The price and valuation algorithms simply could not handle these massive changes. As detailed in the article, “The problem with using historical models and algorithms when making buy and sell decisions in something as large and complex as the housing market is that it’s impossible to account for unknown variables. It was widely known millennials were coming into their prime household formation age, but no one could have foreseen how a global pandemic would force so many young people to look for a house all at the same time.”1
At the end of the day, residential real estate continues to be largely driven by local factors. Yes, the market can experience boom and bust cycles on a nationwide scale – as we have experienced over the last two decades. However, over shorter periods of time, local dynamics continue to be the primary drivers of demand, valuation, and price. As mentioned in the article, “Unfortunately for them [Zillow], real estate is local. Value in the housing market is determined by a wide range of factors from location to neighborhoods to taxes to school systems to amenities and much more.”1
Understanding the multiple local value drivers are the key to success in the ‘fix and flip’ market. That is why, at Aloha Capital, we were not too surprised to see Zillow abruptly exit this business. Our primary business is offering lending solutions to local real estate developers operating in the fix and flip market. For us, success is reliant upon partnering with experienced local developers that have intimate knowledge of the dynamics driving their geographies. Deep knowledge of the local market is a core tenet to our strategy.
We have no doubt that technology will continue to revolutionize the residential real estate market. However, data alone will not guarantee success. Relationships and local expertise still matter. As summarized in the article, “Buying and selling homes in the short term with the goal of turning a quick profit may sound intriguing. And there are certainly people out there who can flip homes for a profit. But it is not easy, and it is not guaranteed.”1
Access to accurate and actionable data will always drive advantages. However, we believe that the data is most effective when it is in the hands of professionals equipped with intimate knowledge of the geographies that they are operating in. In other words, the borrower partners who make Aloha Fund an excellent investment.
Chris oversees business development, investor relations, and capital partnerships. With 25 years of experience in alternative investments, Chris has raised $250 million in assets. He’s served as Chief Compliance Officer, co-managed a Fund of Funds, and worked in operations and trading. Chris has been instrumental in growing four companies. Through firms like Sapourn Financial Services, Dekker Capital Management, and Diamond Peak Capital, he’s delivered solid absolute returns across varied market cycles.