How Phoenix predicted Zillow’s spectacular crash

When the real estate tech company Zillow announced Tuesday that it was shutting down its algorithm-fueled home-flipping operation Zillow Offers, few in Phoenix were likely surprised.

Zillow and a cohort of other tech companies including Offerpad, Opendoor, and Redfin had used the growing city’s booming housing market as a proving ground for their disruptive new approach to buying and selling houses. Dubbed iBuying, the tech companies use their deep pockets to quickly buy up homes directly from sellers, relying on algorithms to determine offers, and then flipping the acquired homes for a small profit. Done at volume, these low-margin transactions could add up to millions in revenue.

 As iBuying activity has grown over the last three to five years, the housing market in greater Phoenix has proven to be a convenient place to bring algorithm-influenced home flipping to the masses. Ever since the 2008 recession left Phoenix scattered with foreclosed housing, a surging population has turned the devastation into one of the country’s hottest seller’s markets. Companies like Zillow were able to tap into that action. “In order to test the R&D side of this you need a lot of transactions. That’s one of the reasons a market like Phoenix was so attractive to these companies,” says Mark Stapp, a business professor at Arizona State University.

That test has failed, at least for Zillow. Last month, the company confirmed a Bloomberg News report that it was overpaying for homes. Due to a tweak in its algorithm, the company had gotten aggressive and paid too much for too many homes, leaving it with a deep backlog of homes to flip and forcing it to take losses on many of those properties. Zillow soon paused all of its iBuying acquisitions to try to work through its inventory for renovation and resale. Within weeks it was reported that the company was trying to offload 7,000 of these homes to institutional investors for about $2.8 billion. On an earnings call Tuesday, the company announced it had lost almost $330 million in the third quarter, a significant drop from its $40 million quarterly profit just one year ago. The company said it will be winding down Zillow Offers and reducing its roughly 8,000 person workforce by 25%.

It’s a high-profile collapse for the iBuying industry, and one that raises questions about the role these companies can and should play in people’s home-buying decisions. These are questions many in Phoenix have been asking since long before Zillow’s downfall.

Phoenix area real estate agent and YouTuber Greg Corbett had been keeping an eye on the local house flipping activity of the iBuyers. He had a hunch that the companies’ computer-assisted buying activity was playing the market by slightly different rules. Word kept coming from clients and fellow agents that the iBuyers were making offers for homes that were significantly higher than offers from non-algorithmic sources, sometimes 10% or 20% over the asking price.

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As these anecdotes became more common, Corbett wondered what effect that was having on the homes coming up for sale in the region. He logged into the Multiple Listing Service real estate portal and ran a search to see just how many listings were coming from iBuyers. Of the thousands of listings in Maricopa and Pinal counties, which make up most of metropolitan Phoenix, he expected iBuyers to account for maybe a few percentage points. The database showed Zillow, Offerpad, and Opendoor owning more than a tenth of listed homes. “To have them at 12%, 14%, that was a surprise to me,” Corbett says. The increasing share of iBuyer-listed homes probably wouldn’t be enough to totally manipulate the market, he concedes, but having algorithms determining home prices could begin to skew prices and push some buyers out of competition.

Tina Tamboer is a senior housing analyst at The Cromford Report, which closely tracks the housing market in the Phoenix area, and she says conditions there have been ripe for home-flipping iBuyers to get a toehold. “We’ve been in a seller’s market since 2015 in greater Phoenix,” Tamboer says. Population growth in Phoenix has outpaced new housing construction every year since 2010, she notes, so housing demand and home prices can be expected to remain high. With their large resources, iBuyer companies have been able to come in and serve that demand.

But the role of iBuyers may be pushing some regular homebuyers out of the market. In September 2020, Zillow bought 27 homes in the region, and Opendoor bought 17, according to The Cromford Report’s numbers. In September 2021, those number jumped up to 321 and 587, respectively. The companies are also spending more on houses, with their median acquisition price going from about $275,000 in September 2020 to more than $435,000 a year later.

Tamboer says this can’t all be attributed to iBuyers, even ones like Zillow that were overpaying for housing. The pandemic has heated the housing market in Phoenix, just as it has across the country. Locally, that has resulted in median sales prices increasing by more than 24% in September compared to one year before. “We’re a little bit on the edge of what’s acceptable affordability for what we’re used to,” Tamboer says.

But the iBuyers have also made an imprint on the local market. By the end of September, according to the latest numbers available from The Cromford Report, Zillow owned 709 unsold homes in Phoenix, and Opendoor owned more than 2,100 unsold homes – signs of a buying spree. The iBuyers “came out guns a-blazin’,” Tamboer says. She expects iBuyers to ease up on the buying going forward, and that the prices of those homes will eventually settle closer to what the market demands.

For Zillow, though, that will all come too late. And the ripple effects of the company’s iBuying withdrawal remain to be seen. Zillow’s experience may just be an outlier, a mis-timed algorithmic over-investment that escalated out of the company’s control. It may also be a sign that software is not quite ready to take over the real estate market.

Stapp, the ASU professor, says that while there are certain circumstances where iBuyer companies serve a role – providing a quick sale to someone facing foreclosure, for instance – their entrance into the housing market may end up serving as an argument for relying less on algorithms and more on the human touch. “When you’re buying a home there’s an emotional component to it. And there’s no substitute for that. When you’re selling you’re also making an emotional decision that’s uniquely human,” he says. “I don’t know how you remove that and say the house is purely a commodity.”

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