The Rise of the Instant Home Buyer Model
An Analysis of Trends and Underlying Success Factors
Instant home buyer companies, often referred to as “iBuyers”, have become one of the most popular PropTech models over the past few years. They offer a compelling customer proposition: sell your home for a guaranteed price, in a short period of time and for cash. For sellers looking to buy their next property the guarantee avoids costly and stressful second mortgages if the first home doesn’t sell before the new home closes. And for busy working families with multiple kids, the speedy process saves a lot of stress, by eliminating the need to keep the house clean for endless showings stretching over several months. In short, home sellers save time and hassle.
In principle this concept is not new and has been around for decades. In the past however offers were made at significant discounts, often as much as 30–40% below market value and only attractive to sellers who were cash strapped. Now, since the launch of US based Opendoor in 2014, the proposition has significantly improved by offering sellers fair market value for their properties. Opendoor in return generates revenue from the service fees it charges (ranging from 6–13%) and from any difference between what it buys houses for and what it sells them for. Whilst the overall fees can be higher than the standard 6% charged by traditional real estate agents in the US, sellers have the certainty around the transaction — a proposition not just attractive to distressed sellers but also for the mass market. 4 years after inception, Opendoor is now on track to acquire homes worth $2.5bn annually which means selling close to 1,000 homes a month. It has raised almost $650m in equity, over $1.5bn in debt and was most recently valued north of $2bn.
Categorisation of Different iBuyer Models
The success of Opendoor and its proposition of allowing home-sellers to close in days instead of months inspired the launch of similar models across the globe. In 2015, Offerpad and Knock followed in the US and Nested in the UK. A couple of years later Homeloop followed in France, Casavo in Italy, ProntoPiso in Spain, Kodit in Finland, evitko in Turkey, IMMO in UK/Germany, Sellable in Australia and Properly in Canada. Even US real estate classified market leader Zillow surprised the market with the launch of Zillow Instant Offers beginning of 2018, underscoring the influence of this model on the market.
Whilst all companies offer sellers transaction security they significantly vary when it comes to pricing, speed of pay-out and nuance of the business model. The different models can also be classified according to the way they finance acquisitions. The following table gives a simplified overview of 3 types of iBuyer groups:
Table 1: iBuyer Business Models
Revenue Split
One of the attractive qualities of the iBuyer models from an investor perspective is the revenue per transaction potential. In the US, iBuyers can make over ~$30k per sale, which is a lot higher than what traditional, online or hybrid estate agents earn. In addition, Buy, Refurb and Resale companies on average achieve more than 5% appreciation of the home value through refurbishment. Below is an illustrative example of a revenue split of a typical North American Buy, Refurb and Resale business:
Table 2: Illustrative revenue per transaction for a US Buy, Refurb and Resale company
In Europe, iBuyer’s revenue per transaction vary, not least because traditional estate agent fees significantly differ per country. They can be as low as 1–2% as in the UK and as high as 7% in Germany. Refurbishments are less important in Europe and generally comprise light touch refurb like brushstroke restoration. iBuyers that specifically target value appreciation achieve those through leveraging price in-transparency in their respective markets. Good examples for such in-transparent markets are Germany, Italy or Spain, less so the UK, where classified sites like Zoopla and Righmove offer consumers pretty accurate pricing tools.
Critical Success Factors
Despite the popularity of the iBuyer model amongst consumers and investors across the globe, it’s an operationally complex business to run. Barriers to entry and success factors are numerous:
- Price Predictability
As previously mentioned, particularly for the Buy, Refurb and Resale Model in North America home value appreciation is one of two major revenue drivers. Homogenous inventory and high transaction volume in conjunction with market data such as the MLS can hereby help to optimise offer and future selling prices. Accurately forecasting prices is critical, also to avoid downturn market corrections. One of the main success factors are therefore proprietary automated valuation models (AVMs), which use market data to predict future property prices. AVMs are also important from an operational efficiency perspective, simply because manual valuations are more expensive.
2. Liquidity and Selection of Inventory
Most iBuyer businesses are extremely selective with the inventory they choose to buy. Opendoor for example has a precise list of criteria, which includes not only the type of homes, but also the year the homes have been built (not before 1960) and a valuation range of $100k to $500k. The restrictions are designed to focus on the most liquid properties. After all, selling homes faster lowers capital cost and frees up capital for more acquisitions.
3. Access and Cost of Capital
Considering that the majority of offers are financed with debt, access and in particular cost of capital are crucial elements of the iBuyer business model. Below illustrative sensitivity analysis show cost of capital per transaction, in aggregate per year, as well as total amount of credit required.
Table 3: Cost of capital / holding cost sensitivity analysis
Table 4: Annual credit requirements in US$ bn
Based on above sensitivities, assuming an average cost of capital of 6%, with average purchase prices of $250k and 90% debt finance, iBuyers spend on average $3.4k interest expenses per transaction (for a 3 month holding period). 1,000 acquired homes a month (12k p.a.) equate to >$40m annual interest expenses. And in order to purchase that many homes, they need access to >$2.7bn in credit lines. To put it in perspective, 12k homes sold with $30k revenue per transaction generates $360m annual revenue.
4. Variable Cost and Pricing
Whilst iBuyers achieve significantly higher revenue on a transaction basis compared to traditional or online estate agents, they also occur higher transaction cost. Those variable cost can be split into the following categories:
Table 5: Example of variable cost of an US iBuyer
Biggest cost item are buyer agent commissions which can make up to 3% and additional buyer concessions of ~2%. Buyer agent commissions are the broker fees iBuyers pay in order to sell the homes they purchased. Buyer agent commission would of course become obsolete if iBuyers were to adapt a marketplace model and allow home buyers to find properties without brokers. It remains to be seen if iBuyers ever make that step, as offering supply naturally adds additional operational challenges.
As highlighted in the previous paragraph, capital cost make up another important part of variable cost and obviously increase the longer inventory remains on the books.
Repairs can be a cost item, if the seller decides to pass these on to the iBuyer. Most common repair work includes items that relate to flooring, roofing, plumbing, and HVAC systems. As they are typically charged back to the seller, I have not included them in above variable cost per transaction. Refurbishment work on the other hand, particularly in the US, is typically part of the offering and therefor included in the cost structure.
Transaction cost vary significantly on a country by country comparison. Germany for example imposes real estate transfer taxes which are exceptionally high and can make up to 3.5–6.5% of the purchase price. They are one of the key reasons why no traditional iBuyer company has successfully launched in Germany yet.
Keeping cost as low as possible is important not just from a profitability perspective but also crucial to remain price competitive with traditional real estate agents.
5. Customer Satisfaction
Delivering a superior customer experience is critical for any company operating in a competitive environment. iBuyers face very particular dilemmas which make it hard to compete with incumbents and produce happy customers. To start with they only accept a specific type of home, the ones that are easy to sell, and therefore need to reject sellers which don’t comply with their tight selection criteria. Rejected customers typically don’t leave positive feedback, so explaining why they have been rejected is crucial to improve NPS. Once approved, the next conflict potential comes with settling on a price. Avoiding any dispute is of course easier in price transparent markets where both customer and company rely on AVMs. In price in-transparent markets iBuyers may want to use external evaluators to avoid appearing subjective and striving for the lowest possible price.
6. Operational Efficiency
End of 2017, PropTech guru Mike del Prete published an interesting comparison between Opendoor and Offerpad’s operations. In his research, Mike shows that Opendoor on average required 13 “prep days” between buying a home and subsequently listing it for sale, it’s closest competitor Offerpad averaged 41. Opendoord’s low prep-time is even more impressive, considering it managed to reduce that number from an average of 20 days a year before. Speed of course matters, not least as as each day a home remains on the books it will negatively affect profitability.
Aside from speed of listing and selling, operational excellence also matters when it comes to numerous other parts of the value chain such as cost efficient customer acquisition, customer service or HR (Opendoor employs over 650 people). Given the decentralised nature of the business, iBuyers need to be able to then manage these best practises not just in their HQ but across different markets in which they operate.
Operational excellence also becomes apparent when launching new products, for example finance solutions and services for property buyers . Efficiently managing these processes can often make the decisive competitive advantage.
Final Remarks
iBuyers remove the friction and uncertainty in a property transaction and make selling a home a commodity. We obviously recognise that that the iBuyer model bears a high degree of market and inventory risk as well as operational challenges. They are also generally speaking, more suitable for markets with homogenous properties that show a high level of liquidity. If I were to predict the way people buy and sell properties 10 years from now, I’d say we will therefore end up with two types of brokerage models:
1. In markets with diverse and heterogeneous homes, where predicting prices and matching buyers with sellers are complex, we will see data driven hybrid models prevail. Data and predictive analytics will become crucial to anticipate, identify and match buyers and sellers efficiently. At the same time, customers will want human input and experience when it comes to analysing the respective data. New York is a good example for such a market: flats in large buildings differ floor by floor, with penthouses, condominiums, studio flats, etc. Refurbishments are less common and homeowners are often financial savvy, typically less worried about speed of the transaction and instead focused on achieving the highest possible price. The classic iBuyer model, in particular Buy, Refurb and Resale businesses like Opendoor, won’t succeed here. Instead we will see software-powered real estate brokerages like NY based Triplemint dominate the market.
2. In cities where homes are homogenous, buying and selling properties should be frictionless and with as little human interference as possible. There won’t be space for traditional estate agents or even online hybrid models anymore. The purchase and the sale of a property will be done by the click of a button. iBuyers will be the dominant form of buying and selling homes. Technology will support customers on these platforms for example with augmented reality for remote viewings. iBuyers will also help home buyers with financing solutions at the click of a button, facilitating even faster turnaround time of the inventory.
Let’s see what the future brings. As in every industry, in the end, it is always the customers who decide which companies succeed.
Loric Ventures is a FinTech & PropTech focused early stage fund and investor in Nested and Properly, as well as Triplemint, all mentioned throughout this post.