Opendoor’s Challenges May Mean the iBuying Craze is Coming to an End
Opendoor, the once high-flying PropTech startup, lost money on 42% of its transactions in August according to YipitData. The iBuying company’s performance was even worse in markets where it has a large presence such as Los Angeles and Phoenix. Opendoor lost money on 55% and 76% of transactions in each market respectively in August. Opendoor’s recent lackluster performance has caused the stock to fall by about 85% over the last year.
Opendoor’s struggles are emblematic of the iBuying industry’s perils as interest rates continue to move higher in the U.S. Opendoor’s issues were presaged by Zillow. In November 2021, when the nation’s economy seemed to be on stronger footing and borrowing costs were significantly lower than they are today, Zillow was forced to retreat from the iBuying industry and lay-off 25% of its staff after the division posted a net loss of $421 Million in the third quarter of 2021.
iBuying is a rather nascent industry that has taken off over the last decade on the back of low interest rate fueled easy money that was available. iBuyers are institutionally backed house flippers that use algorithmically fueled software to estimate a home’s value and then buy it directly from owners with no financing contingencies and little-to-no due diligence. On average iBuyers offer about 25 less basis points than fair-market value for a home while charging sellers nominally higher fees, about 1.3% more than a conventional agent would.
Sellers value the ease of transacting with iBuyers, particularly how expeditious the process can be, taking days rather than weeks to sell their home, and that the sale is not dependent on bank financing. For most sellers the frictionless nature of dealing with iBuyers makes the slightly higher fees that they pay on these transactions easier to swallow.
With the federal funds rate projected to peak at around 4.25% in 2023 and consumer sentiment dropping to a 14-year low, the next six-to-twelve months may continue to be an uphill climb for highly levered iBuying companies such as Opendoor. Opendoor funds its purchases at leverage levels of around 80%-90% of the total transaction price. When Opendoor purchases a home, it sits on its balance sheet until the unit is sold. In-spite of recent economic headwinds and financing obstacles, Opendoor has accelerated its purchasing activity. The company bought 14,135 homes in Q2 2022, up 66% from the same period last year.
iBuying is subject to a company acquiring a home, making minor repairs, and then reselling the asset, often within a couple of months. When housing prices are trending up, companies like Opendoor are able to make effortless profits. In Q4 2021, in-spite of Zillow’s struggles, Opendoor was listing homes for an average of 17% more than it paid for them a few months prior to marketing the houses for sale. With the 30-year mortgage hitting a post financial crisis high of 6.7% last week, many potential buyers have put their homeowning aspirations on the backburner for the time being.
In theory, a housing downtown could be a fantastic opportunity for Opendoor to scoop up assets on the cheap, but because of its business model, that proposition is not too straightforward. Not only does Opendoor use high leverage levels to fund its purchases, but the company does not use standard Fannie Mae or Freddie Mac debt. This means that Opendoor’s interest rates are not fixed, leaving Opendoor on the hook if interest rates continue to trickle up as the Federal Reserve attempts to combat inflation.
Another obstacle that Opendoor will have to overcome is that the company generally likes to hold inventory on its balance sheet for a brief period of time, only a few months. This may mean that Opendoor will be forced to sell into an already cascading housing market, exacerbating its financial woes.
A potential solution to help Opendoor make it through whatever the next year may bring in the housing market is to rent some of its inventory out as it waits for interest rates to come back down and housing prices to recover. Household rents have proven to be one of the most resilient parts of the economy, rising 10% from their pre-pandemic levels. While Opendoor is not a traditional single-family investor like American Homes 4 Rent, transitioning to becoming a landlord for a brief period of time in select markets, may assist iBuyers in weathering any short-term economic headwinds.