By Matt Kreamer
The booming housing market of the past near-decade is slowing and there is growing consensus among economists that the second half of 2020 will mark the start of the next recession in the United States. Though most experts do not see the housing market as a likely cause, investors are casting a cautious eye toward it.
Among the questions it raises is how the Zillow Offers business may function in slowing markets or a recession. We believe that the answer lies in Zillow’s unparalleled data. Zillow was founded on its ability to use data to empower consumers, and holds an incredibly comprehensive set of housing data.
Zillow’s economists and data scientists have closely studied housing market dynamics for more than a decade and have applied that depth of knowledge to Zillow Offers, designing a market-making business for homes that can work in many types of markets. One key factor is that Zillow relies on an adjustable fee in exchange for certainty — not market changes or dynamics — to help cover Zillow’s expected costs and drive the business’ profits.
The fee charged to homeowners for the convenience and certainty of selling their home to Zillow varies, but has been running about 7.5%. It takes into account such things as the expected time it may take for Zillow to resell the home, and the home’s expected appreciation or depreciation over that period.
In a down market, the fee likely would increase to account for slightly longer hold times. Zillow believes the service could be especially attractive to sellers who are willing to pay for the certainty of a sale in a sluggish market.
Zillow Offers is now operating in 16 markets, and expects to be in 26 by the middle of next year. In the next three to five years, Zillow anticipates buying a total of 5,000 homes a month and reselling them. Zillow uses computer models to help pick the homes it buys, the price it pays and the fee it charges sellers to cover the costs of selling.
Zillow has an exclusive view of the market: It can combine online and offline insights in a way that no other company could, said Krishna Rao, Zillow’s vice president of Zillow Offers Analytics. And we believe that this provides us with a strategic advantage in any kind of market.
“Online, we can see how people are searching for homes at a certain price point in a certain neighborhood, and we can connect that to live activity on our homes,’’ he said. “We know who’s going in to tour, what fraction of tours are turning into an offer, whether offers are coming in above or below asking prices — we can track these trends and make real-time adjustments.”
As Zillow Offers scales to size, that information “gives us a 360-degree view of housing market activity that will help Zillow predict ever-smaller changes in the market,” Rao said.
How Zillow Offers Works
Currently, when Zillow buys a home, it leverages debt financing from two revolving credit facilities, which provide up to $1 billion in borrowings to fund home purchases. The credit facilities require Zillow to fund approximately 15% of the purchase with equity and the remaining 85% will be funded with debt. The debt is non-recourse, which means it is backed by the homes themselves, minimizing Zillow’s risk exposure. When a home is resold, the credit institution is repaid.
In the second quarter of 2019 Zillow generated a ~1% return on homes before interest expense, but at scale Zillow expects that return can improve to 4-5% per home. In addition to that return, according to Zillow’s second quarter 2019 shareholder letter, Zillow also expects to generate profit from adjacent integrated business lines, such as mortgages and title & escrow.
Zillow uses computer models to predict the demand for a home, the time it will likely take to resell, its likely resale price and overall market conditions. Knowledgeable local experts also are enlisted to price offers.
The real-time computer models allow the company to constantly monitor the risk and adjust pricing as market conditions change, Rao said, and adjust to the early signs of a housing market downturn. Homes purchased in the months before the housing downturn started would have been purchased using overly optimistic assumptions about price appreciation, but we believe that the impact would be short-lived.
Zillow Offers in a Recession
It’s important to remember that housing downturns usually happen slowly. Even in the Great Recession — which was kicked off by a housing crisis — home values nationally never dropped more than about 1% in the worst months, and took 54 months to hit bottom in 2012. In the hardest hit markets, such as Las Vegas, the worst months saw about a 3 percent drop in home values.
Rao said Zillow has run multiple simulations to flesh out various housing market scenarios to evaluate risk. Although those scenarios examined the potential impact of a national recession, Rao said the next recession is not likely to be a national one that hits suddenly.
“The reality is most recessions don’t look like that, especially in housing. They tend to be a little more localized, a lot more intense in certain areas. We will have homes across a large national market, so would have diversified our portfolio and limited our exposure to a local recession.”
This post was originally published July 24.
Forward-Looking Statements. This blog post contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 which involve risks and uncertainties, including, without limitation, statements regarding our long-term business and financial targets for the next three to five years and other future years; the performance of the Homes segment in 2019 and beyond; and the current and future health and stability of the residential housing market. Statements containing words such as “may,” “believe,” “anticipate,” “expect,” “intend,” “plan,” “project,” “will,” “projections,” “continue,” “business outlook,” “forecast,” “estimate,” “outlook,” “guidance,” or similar expressions constitute forward-looking statements. Differences in Zillow Group’s actual results from those described in these forward-looking statements may result from actions taken by Zillow Group as well as from risks and uncertainties beyond Zillow Group’s control. For more information about potential factors that could affect Zillow Group’s business and financial results, please review the “Risk Factors” described in Zillow Group’s Annual Report on Form 10-K for the year ended December 31, 2018 filed with the Securities and Exchange Commission, or SEC, and in Zillow Group’s other filings with the SEC. Forward-looking statements were made based on information available as of August 7, 2019 and are not being affirmed or updated with this communication. Except as may be required by law, Zillow Group does not intend, and undertakes no duty, to update this information to reflect future events or circumstances.
 Please see “Forward-Looking Statements” below for additional information about these long-term targets.
 Return on homes sold before interest expense is a non-GAAP financial measure; it is not calculated or presented in accordance with U.S. generally accepted accounting principles, or GAAP. The most directly comparable GAAP financial measure is per home loss before income taxes. For the three months ended June 30, 2019, per home loss before income taxes was $90,486. Please see the section titled “Use of Non-GAAP Financial Measures” in our second quarter 2019 shareholder letter for more information about our presentation of return on homes sold before interest expense.