How Zillow could skew housing prices – and push younger homebuyers out of the market

Amid the 2008 housing market crash, NPR's "This American Life," in conjunction with NPR News, produced a special episode explaining the housing crisis. Called "The Giant Pool of Money," it has weathered the past 13 years remarkably well, standing as the foremost national artifact about the cause of the crash.

The crash was brought about by banks doing something they never thought they’d do – making loans to many people who had a strong desire to buy a home and none of the qualifications to do so. Everyone wanted mortgages, and banks and other lenders were more than happy to lend the money.

Then, as mortgage rates and payments rose and adjusted, people stopped paying. It made more financial sense for people to simply walk away from the home in which they were “underwater” than to continue to make payments. Defaults were exponential as compared with expectations, and the global economy practically collapsed as a result.

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Fast-forward to this fall. Though most of us knew about Zillow as a real estate entity, it wasn’t until Nevada real estate agent Sean Gotcher posted a remarkably viral video on social media that most of us became aware of the scope of what Zillow does.

Before then, we assumed that Zillow was harmless. It's the site we often go to when we want to see what $1.2 million will buy in a city in which we’d rather live, because it buys a rat hole in our current city.

Zillow has been driving the phenomenon of “iBuying," which is simply house flipping but done by corporations rather than individuals. The Zillows of the world (which include not only Zillow but also competitors such as Opendoor, Offerpad and Redfin) can flip in a much bigger way, buying and selling homes at scale.

The iBuying flip looks like this: Zillow can use a lot of data points to anticipate its margin on a given transaction. The data it uses is a gift from you. It comes from exactly what all of us do on Zillow – browse the heck out of it.

This data allows Zillow to produce what it refers to as a “Zestimate,” a data-driven but entirely fictitious value of the home. Zillow can look at a property, determine how much it would need to pay for it, how much it would need to put into it and what the eventual selling price would be.

Given how tight the margins are in this industry, Zillow’s success is predicated upon highly accurate number crunching.

The sellers are motivated to accept Zillow’s low-but-fair(ish) offer because it’s clean. They trust Zillow, they don’t have to pay any agent fees (they do have to pay an iBuyer fee) and Zillow can fix up the place and flip it quickly. Again, none of this is based upon Zillow’s feeling as to the value of a property; it’s all extrapolated from Zillow's data.

John Pasalis, a Realtor who founded a data-driven real estate agency and is also a doctoral student in these matters, points out that even the most experienced agents didn’t see this coming: “Many of us really haven’t considered the fact that they can actually start to manipulate the market in this way. Zillow and Opendoor are effectively house flippers – to what end remains to be seen.”

Pasalis agrees that, fundamentally, what Zillow is doing isn’t much different from the signs you see stuck to trash bins and street lamps in big cities: “We pay cash for your home! Call us today to make it happen!” But the capacity of Zillow and its competitors to do this millions of times over has the potential to be disruptive in the same way that creating lending and mortgage products to put unqualified borrowers in a home was 15 years ago.

If those cash buyers didn’t crash the market, how could Zillow?

Zillow puts pause on buying houses

Because what and, more important, how Zillow is doing what it has been doing couldn’t last at the pace it set. In February, Zillow stock was at its highest mark ever, at $212. On Tuesday it closed at $87.20. The reason for this is that Zillow has “paused” its iBuying for the rest of this year, but the true driver of this stock dive might be the fundamental defects in the iBuyer business model itself.

The iBuyer business model is predicated upon Zillow always having the power to manipulate prices. So Zillow buys a lot of homes in an area for slightly less than they’re worth. Then it dramatically overpays for one house.

This allows Zillow to bump up the Zestimate for the entire neighborhood. It's essentially manipulating the market by artificially price setting, and of course it benefits directly from this when it sells those other houses for the higher price.

This is the way real estate works, which is why the old adage is true – it’s smart to own the least valuable home in a great neighborhood, as those other homes will drive up the price of yours.

This is also where the odd realities of the tech and venture capital worlds come into play. Zillow has raised a comparatively small $97 million since its founding in 2006. It did initial public offering 10 years ago and has acquired a dozen companies along the way. But is anything stopping Zillow from raising more money and building a war chest for the iBuyer business model?

Last year, ZIllow raised close to $1 billion through stock and debt offerings. In August, Zillow raised an additional $450 million, according to Bloomberg, from a Credit Suisse bond backed by homes Zillow has bought but not yet sold.

Before the iBuying pause, which Zillow COO Jeremy Wacksman attributed to “a labor- and supply-constrained economy inside a competitive real estate market, especially in the construction, renovation and closing spaces,” Zillow had gambled that it could raise Uber-style unlimited cash to fuel an even more significant bet on this new part of business.

Stakes are high for home buyers

Yet we need to remember that the gamble here is with people’s homes and lives. Unlike Uber, which has raised over $25 billion, if Zillow restarts and goes all in on the iBuying gamble, the stakes are much higher than us simply needing to use taxis again.

Mike Lento, a New Jersey lawyer, points out that there’s nothing in the legal system to slow this down as Zillow and its competitors are doing business in a legal manner: “Even if Zillow is buying and reselling homes in an attempt to drive up housing prices, there’s nothing illegal where sellers are voluntarily selling their homes to Zillow. Absent any fraudulent inducement or any illegality in the buying and selling process itself, Zillow is free to make a low-ball offer on someone’s home and that person is free to accept it.”

While there are logical holes in the notion that Zillow can crash the housing market simply by making iBuying more widespread, there is a greater danger of a different type of housing crash if Zillow finds a way to retool and enter 2022 with a new focus on buying homes.

In many parts of the country, we are already heading down the path where a nation of renters rather than homeowners is possible. So if the Zillows out there own all the homes, you don’t. If the inherent flip nature of iBuying doesn’t work for them in the long run, maybe something more destructive will – like being part of an oligopoly with other similarly situated market players to own a huge percentage of homes.

If someone would have said before this fall that Zillow could be responsible for the next housing crash, would we have paid attention? It’s not going to happen in 2021, maybe not even in 2022, but could it happen? If it does, it will be the perfect storm: a coalescence of technology without morality, real estate jingoism, and the grasping at the rancid bait of a long-soured American real homeownership dream.

A recent Vice article suggested that Zillow isn’t big enough to cause a market crash on its own yet, and while that’s probably true now, things can scale quickly with access to the kind of risk capital that would be interested in Zillow’s play.

Always ahead of the game, investor Chamath Palihapitiya led Zillow’s competitor Opendoor in going public a year ago. The deal valued Opendoor at $4.8 billion, which gets us closer to the Uber stratosphere, and puts iBuying in its proper historical context as to how big it can become.

Pasalis adds: “Zillow’s arguments that this isn’t happening because they only take up 1% of the U.S. market is ridiculous. This phenomenon starts not by taking up 1% of every market but by being major players in certain key markets of their choice, which they are and can be to a far greater extent with more investment. Seen collectively, all of the iBuyers, including Zillow, are taking up a really decent share of those markets.”

What is certain is that while we recovered, at least in part, from 2008, will we even have a chance to recover from this next crash? As things stand, many young people might never own a home.

The notion that we could be creating an obstacle they’ll never be able to get around should give those responsible for housing and monetary policy serious pause.

Aron Solomon is chief legal analyst for Esquire Digital and editor of Today’s Esquire. He has taught entrepreneurship at McGill University and the University of Pennsylvania.

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This article originally appeared on USA TODAY: House prices: How Zillow could skew the market by buying homes