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Redfin CEO Glenn Kelman at the 2018 GeekWire Summit. (Photo by Dan DeLong for GeekWire)

Redfin and Zillow will face the “first serious test” of their new direct home sales operations in the midst of a slowing real estate market.

RELATED: Redfin predicts big real estate cooldown, with tech hubs like Seattle and S.F. feeling it most

That warning comes from Redfin itself, as part of a series of predictions for the 2019 housing market. The rise of the so-called iBuyer movement, which includes Redfin and Zillow — and also companies like Opendoor, Offerpad and others — presenting sellers with instant offers online and then sprucing up and selling the homes themselves, came within the context of a booming market.

With a continued slowdown expected into the first half of next year, Redfin’s Daryl Fairweather writes that we will soon learn whether the iBuyer movement is here to stay as a permanent part of the real estate market, regardless of its state.

Armed with billions in capital, competitors from Opendoor to RedfinNow to Zillow to Offerpad to Knock have been vying with one another to buy homes from consumers and then sell those properties at a profit, with i-buyers’ combined share of U.S. home sales growing rapidly. The question investors are asking is whether instant offers will now be significantly lower, to compensate institutional buyers for the market’s recent uncertainty, and whether homeowners will accept the offers, just to avoid those same uncertainties themselves. Institutional buyers who made money from nearly every sale in a rising market with low interest rates could start to face losses, or may demonstrate more discipline than other housing investors. In 2019, we’ll find out. If i-buying works in a bear market as well as it has in a bull market, instant offers could become a major, permanent sector within the real estate economy. If it doesn’t, a lot of money is going to sink into the sand.

The CEOs of both Redfin and Zillow have expressed optimism that their programs will work regardless of market conditions. However, both companies have dialed back the aggressiveness somewhat with Zillow Offers and Redfin Now, as the industry waits to see where the market as a whole settles and how buyers and sellers adjust to changing conditions.

Redfin and Zillow, as well as their competitors in the space, are all tackling the same problem from different angles: simplifying the often vexing process of buying and selling homes.

Stephen Lane, CEO of Seattle-based real estate startup FlyHomes, agrees with Redfin’s own analysis that it’s an uncertain time for these programs. FlyHomes is not an iBuyer itself — it does purchase houses directly with cash and then hold onto them until the startup’s buyer clients secure financing — but Lane is tracking the movement closely.

FlyHomes CEO Stephen Lane. (FlyHomes Photo)

The impact of a cooling market on institutional buyers is interesting. On one hand, given their balance sheet exposure and institutional risk – iBuyers will be challenged to maintain volume levels, and I’d expect that their forecast and volatility models will force them to lower their offer prices in order to preserve margin. When a home seller is making a decision on who to sell their home with, iBuyer offers might be too low, and in that scenario a traditional listing agent will win the listing.

On the other hand, the iBuyer model is predicated upon being more efficient than the traditional model, and offers certainty and conveyance for consumers. As the market slows, the inconvenience and stress for sellers and the costs associated with selling a house for listing agents will increase, thereby making the iBuyer model more appealing. If homes are sitting on the market longer, then it costs listing agents more to sell a home. Given the efficiency and scale built into the iBuyer model combined with the rising cost to sell a home, iBuyers should also have a competitive advantage in a cooling market.”

Redfin started testing its direct home-buying and selling operation, Redfin Now, in 2017. In August, Redfin removed the “experimental” tag, doubling down on the program and announcing its intention to staff up Redfin Now and expand beyond Southern California. As part of Redfin Now’s evolution to a long-term business, Redfin started breaking out its quarterly results under a new reporting group called “Properties.”

As part of its most recent financial update, Redfin reported that Properties revenue nearly tripled over the prior year — $11.3 million in the third quarter versus $3.3 million at the same time in 2017. The segment as a whole reported a small loss of about $300,000.

On a call with investors last month, Redfin CEO Glenn Kelman said each of the 24 homes Redfin sold in the third quarter went for more than the company paid for them. Redfin had another 56 homes on its books at the end of the third quarter.

“As Redfin Now grows and the market softens, we don’t expect to sell every single home for a profit as we have to manage a larger number of properties as a portfolio, where the goal is plenty more winners than losers rather than a perfect record,” Kelman said.

Spencer Rascoff
Spencer Rascoff speaks at the 2016 Zillow Premier Agent Forum. (GeekWire Photo / Kevin Lisota)

Zillow Offers debuted in Phoenix in April. Zillow just announced the program’s expansion to Dallas, its ninth known current or future market, joining Phoenix, Las Vegas, Atlanta, Denver, Charlotte, Raleigh, Houston and Riverside, Calif.

In its most recent earnings report, Zillow posted $11 million in revenue from Zillow Offers, and the Homes segment that program falls under reported a loss of $16 million. Zillow purchased 168 homes and sold 36 homes through Zillow Offers in the third quarter.

In October alone, the company bought 130 homes and sold 32, Zillow CEO Spencer Rascoff said on a call with investors last month. It won’t be long, Rascoff said, before the company is buying and selling as many homes in a week as it did in the third quarter.

Zillow expects to generate $30 to $40 million in revenue from the Homes segment in 2018, which is down from earlier projections in May of $125 to $255 million. It expects to hold 300 to 550 homes on its books, down from 300 to 1,000 homes.

On the investor call, Rascoff said the company is still trying to figure out where the program works best, and Zillow wants to be in several different kinds of markets. He said he is optimistic that the program will be even more effective when the real estate market slows.

“Our hypothesis is that Zillow Offers will work even better in a slower market than in a hot market because the certainty and hassle avoidance that our selling process provides to a home seller is relatively more attractive when she has fewer alternatives to selling her home conventionally,” Rascoff said. “And as long as we adjust our offer prices and our fees accordingly, we’ll still be able to build a very meaningful and profitable business even in those slower areas. So diversity of markets is something that we will benefit from as we roll out more cities over the next couple of months.”

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