Zillow Group's (NASDAQ:ZG)(NASDAQ:Z) surprising decision to exit its Zillow Offers iBuying business left investors with more questions than answers. In this Fool Live video clip, recorded on Nov. 5, Fool.com contributors Matt Frankel and Jason Hall share their takes on what went wrong and why Zillow was so quick to pull the plug on the business they've referred to as a major future growth driver.
Matt Frankel: Why did Zillow make this move? This is the part that I don't really buy. You mentioned it's a low-margin business, and that's true to some extent. The goal is to buy these homes, make minor repairs, and sell them for a little bit more than you paid plus the repair cost.
Zillow also takes, I think, a 7% sales fee on every home they buy. The margin is not that low. When you're talking about an average price of say, $350,000 which is what the average existing home is going for right now, 7% is not nothing. On each transaction and with everything else Zillow offers, mortgages, whatever, there's so much room to cross-sell things. That's the idea that Opendoor (NASDAQ:OPEN) and Offerpad (NYSE:OPAD) are trying to sell is that it's not just the house, it's the sales charges, the mortgage, and selling them title insurance, it's selling them all these other incremental, high-margin businesses on top of it.
It doesn't have to be a low-margin business, but the margins aren't consistent. Zillow said their unit economics, essentially the margin on each house, went from positive 12% in the second-quarter when prices were going up and up and up, to negative 5%-7% in the third quarter. That's a big difference in one quarter, but my reaction to that is, what did you expect? Did you expect home prices to go like this forever and ever and ever and ever, or did you think it was going to repeat the historic pattern of little ups and downs? Which when you're talking about a low-margin business like on the surface, which is what it is, that's going to be your gross margin on each home, there's going to be volatile.
I'm surprised that they were surprised that it was a volatile business. This reason makes sense to me. Zillow said out of all the serious buyers who requested offers on their homes, only 10% accepted them, leaving the other 90% of Zillow customers disappointed. They didn't want to risk alienating the people who use their premier agent services and things like that for the sake of this. I buy that one, but I don't buy the surprise in the fact that this business is volatile.
Jason Hall: Here's the chart I just think it's worth looking at. This is the median price for existing family homes going back over the past decade. The bigger trend is going up, but that seasonal peak through the summer, climbed through the spring into the summer and then fall through the winter, by year-over-year, the prices are higher. But from season to season, that definitely changes, that's a really informative.
Frankel: The volatility is not new, I wouldn't even go so far as to call it predictable in that chart.
Hall: It is. It's a seasonal trend, we know the trend. They made a "this time, it's different" mistake, didn't they?
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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