The smart money knows that the traditional real estate model is broken and dying. It was designed for a time when information about homes was hard to come by and everyone depended upon their local realtor who relied upon voluminous binders of listings. A dramatic change is long overdue. That’s why new real estate business models seem to be popping up out of nowhere monthly – especially the new ibuyer ventures.
In just the last 3 months two new ibuyer ventures that buy and sell homes directly from and to consumers raised a total of $470 MM. At the end of November one of OpenDoor’s investors announced that they led a $210 MM round that gave the upstart a valuation in excess of $1 B. Then, just a couple of weeks ago, OfferPad announced a $260 MM investment.
Both of these companies have a similar business model where they will quickly buy your home for cash and then they will offer it for sale directly to home buyers. So they are actually inventorying the homes and obviously making their profit off of some kind of spread – and that’s where the rubber meets the road in this business model.
I’ve spoken to people who operate this kind of business model on a smaller scale before and I’m always left scratching my head. Obviously, to make a profit they either have to be buying homes below market value or selling them above market value or some combination of both. Because prospective home buyers are out actively looking at what’s for sale in the market and because they know (presumably) the relative value to them of different features these companies are most likely buying homes below market.
In fact, if you dig around in these ibuyer companies’ FAQs you’ll find out that they indeed have a spread baked into their offer prices. For instance, the OfferPad Web site has a section on their pricing methodology (if you follow that link click on the Pricing Information tab). They are up front in admitting that they take 2 “credits” off the purchase price – a 6% credit that they point out is comparable to a typical real estate commission and a 1 – 7% Risk Metric Score depending upon the characteristics of the home. They don’t really explain the Risk Metric Score but from the name I suspect it’s a cushion to cover their ass if they got the price wrong or if the market tanks on them.
OpenDoor has a similar explanation on their Web site in a section titled How Much Does OpenDoor Charge? The only difference is that their risk discount is 0 – 6%. But the bottom line is that you’re probably going to be selling your home for a little less than you would if you put it on the market – ON AVERAGE. And, of course, both of these companies point out that their process is a lot easier, which is definitely true.
Now, notice that I capitalized ON AVERAGE above. The reason for that is that whatever valuation process these ibuyer companies are using – and I assume from what I’ve read that it’s at least partly automated – there is going to be significant variability around the best price that could be obtained in the market. I’ll call it valuation error. So sometimes they are going to be high and sometimes they are going to be low.
Under these circumstances who is going to be selling their properties to them? I can only think of two types of people: 1) those that aren’t very smart and 2) those that are very smart and know that the ibuyer offer is too high. And don’t forget that most sellers think their home is way above average – i.e. they overestimate it’s value. If I’m right then these ibuyer companies are going to suffer from adverse selection – i.e. on average they are going to overpay for the properties they buy even though some sellers will get screwed. My guess is that they are going to overpay for larger, outdated or cheaply finished homes, possibly with poor layouts, because it’s easier for them to value square footage than immeasurable factors.
So, what is the best way to take advantage of the ibuyers? Talk to one or more realtors about what they would list your home for and what they think it might sell for. Maybe even put it on the market to see what someone is willing to pay. Then quickly get a quote from these guys and if it looks good take the money and run.
OpenDoor is currently operating in Phoenix, Dallas, and Las Vegas while OfferPad is operating in Phoenix, Las Vegas, Salt Lake City, Tampa/ Orlando, and Los Angeles. I’m sure it won’t be too long before they come to Chicago. I can’t wait to get my own free offer.
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Gary Lucido is the President of Lucid Realty, the Chicago area’s full service discount real estate brokerage. If you want to keep up to date on the Chicago real estate market, get an insider’s view of the seamy underbelly of the real estate industry, or you just think he’s the next Kurt Vonnegut you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.