Why IBuyers Do Not Scare Me

I have enjoyed with great pleasure this week the headlines that have come out of late with regards to the headlines and stories about the companies who have been in the IBuying area. Many of you, if not most of you reading this, have seen the stories over the course of several days, in particular the story about Zillow losing 100k on house flips per home. Yes, read that sentence again. Zillow lost 100,000 dollars on each house flip that it did as a part of its iBuyer program. Now the optimist might say- well that is fine how many houses did they do? What if I told you that it was a total loss of forty-five million dollars, over the course of 414 homes? Ouch. The definition of insane, is doing the same thing over and over again and expecting a different result, meaning this is the very definition of insanity. 

Okay, lets take a step back here for a second, and walk back several years ago to the real estate crash in the last decade. Say what you will about the last real estate market crash about the cause and effect there, but if you want to speak in plain honest english here it is. Wall Street started to bundle up home loans together, or mortgage back securities, and selling slices of those securities to investors who were gobbling them left and right and Wall Street in turn began to make big money. In turn, Wall Street began to get greedy. They started to push the mortgage lenders for more and more home loans that they in turn could bundle up and sell. First problem, and see if you notice a trend with this later on, greed. The lenders were already exhausting the market of stable borrowers with good credit, so their criteria got lower and lower. Second problem, changing the problem to fit the ready made solution. For the longest time, a quality credit score to buy a home was 620 as well as a downpayment of 20%, by almost overnight it was a minimum score of 520 with zero money down. Main St, or the average person, just assumed that the experts were aware of what they were doing and that there was not anything outrageous going on. Third problem, plausible innocence aka if the banks are willing to lend me money, I therefore must be able to afford it. So the typical person reaches for that American dream of home ownership, and buys that home. The bank on the other hand knows that this mortgage is riskier, but sells it anyway and to protect its downside they started buying up insurance in the case those mortgages failed, or in other words as they expected the borrower could not pay the mortgage, these were called default swaps. Fourth problem, passing the risk to someone else. This was the very essence of the economic collapse of 2008-2009. The banks moved the risks from their books so they could take on more loans, and the larger companies who insured the mortgages were left holding the burning bag at the end of the day. The company who took on more of these default swaps was AIG and they nearly went bankrupt. AIG did this on the assumption that the housing market only goes up. Not the case. So when the market took a small downturn, and when people began to default on the mortgage there was no room left to run, and the global economy and those big banks that had pulling in cash left and right for years were left wondering if each day would be the last day of their very existence. 

So lets fast forward to the present day. What's changed? Actually, very little. Banks have learned the risks about providing riskier borrowers with loans. Wall Street still is looking for mortgages to buy every single day, and looking for ways to grow revenues in anyway it possibly can. Cool. 

Working at Blackstone it is beaten into every single of the employees that all real estate for sale it is just a determination of price and creating a market for such a transaction to fit into. You are trained not to look at property current or book value, you are trained to look into five years down the line and think what that property is worth at that moment in time. It is this exact reason why that companies that were the beginning of the ibuyer/ibuying craze are big bank alumni, most of them are fellow ex-Blackstone folk. 

Most of the ibuying principle is not to control the housing market, or to even cut out the traditional real estate agent of the transactions, rather the purpose of the ibuying programs is to have complete control on the entire home buying process. For those paying attention several years Zillow acquired a national mortgage lending business. Now, bare in mind this only applies to Zillow since it is the only ibuying platform that is a public traded company, everyone else in the space is a private company and therefore does not need to release its numbers in terms of costs, expenses, revenues, and profit. For Zillow it is simply a plus minus game, they will eat the cost of buying and fixing the home up for the revenue gain of being able to sell the home and provide the mortgage for it all in one place. This is not, nor will ever be about companies trying to dominate the residential investing space but rather they will look at it as an opportunity to buy up properties to control the entire ecosystem around a consumer buying a home. If we can supply someone the house and the mortgage does that it turn make the process so much easier?  Doesn't that sound just a little too familiar? 

Greed, wanting to control the whole ecosystem. Changing the problem, we want to get more mortgages to sell but need people so lets buy the homes and package the home and mortgage together. Plausible innocence, our investors will be happy because they just want our revenues to grow, and we are already losing money so what difference does it make. Passing the risk to others, let the investors/shareholders run the problem of losing money overall. 

To me, any company that is in the ibuying program I see a perfectly imperfect system that is incredibly flawed. Is it hard to compete with companies that are offering more money for a property because they are not worried about the buying side? Absolutely. Am I worried about these companies over the long run? Not one bit. First of all, if you want an interesting economic lesson over the course of a year follow the Zillow stock, and read the reports. Shareholders have a weaker stomach for companies who eat through losses time and time again with no end in sight. They will trade short time revenue growth for short term loss, but will not ride the roller coaster if profits do not grow. Zillow has already ousted one CEO this year in Spencer Rascoff, and until that company turns a profit that seat will be uncomfortably warm, and home buying at over market pricing is not the way to do it. For the other companies, yes they will exist but they will be smaller competition in the market, and be prone to the swoons that the rest of us are. However, real estate investors who are getting by on margin heed this warning, change your game or you will be the first to go. Companies that lean in with offering a solution to a ready made problem and are not expecting to get by with just the strength of their checkbook are better positioned over the course of the long run.