House-Flipping Raises Too Many Questions for Zillow Group Inc Investors


Granted, the 13% gain Zillow Group Inc (NASDAQ:Z, NASDAQ:ZG) mustered last month made it a relatively easy profit-taking target. But, does the company’s entry into the house-flipping market really mean Zillow stock is worth 6% less than it was before the news was released? That’s what the market said on Friday anyway.

As is always the case, there’s more to the story, and the truth is somewhere in the middle. That is to say, current and prospective Z stock holders have a good reason and right to ask some tough questions about what’s next for the real estate listing company. But, only time will really tell how this all pans out.

For what it’s worth though, more than a few industry experts aren’t exactly thrilled with the new Zillow business model.

The “Yes” Crowd

On the off chance you’re reading this and haven’t yet heard, online real estate listing company Zillow Group — which owns Zillow as well as Trulia — is expanding its so-called “Instant Offers” program to Phoenix and Las Vegas. Made available in Orlando early last year, the company’s arm that outright buys and sells real estate (rather than just listing it for agents and buyers) is expanding in a way that suggests Zillow intends to continue wading into these waters. The aim is to turn a profit by selling these homes for more than the price at which Zillow Group buys them.

It’s certainly a departure from the current Zillow business model, which is selling ads, and selling realtors rights to make for-sale properties “featured” on its websites.

RBC Capital Markets analyst Mark Mahaney likes the move, pointing out “there are data points out there in the market that show on-demand real estate is really starting to pick up. In the Phoenix area we’ve seen it go from 1% to 3% of homes now are being sold now in an on-demand, sale/buy environment.”

John Campbell, analyst with equity research outfit Stephens, said “We are big fans of this pivot as it is a natural synergistic extension and helps Zillow better monetize its position as a category killer in the space.”

And for the record, indirect rival Redfin Corp (NASDAQ:RDFN) is doing something similar with an arm called Redfin Now.

Zillow says it intends to own between 300 and 1,000 houses before the end of the year.

The “No” Argument

Not every analyst is sure this is a new endeavor that will help boost the value of Zillow stock, however.

Craig-Hallum analyst Brad Berning is one of those doubters. He downgraded Z stock from a “buy” to “hold,” saying the move into house-flipping could require an additional $3 billion in (frequently tied-up) capital, translating into a net wash for shareholders.

Attom Data’s Daren Blomquist also has concerns. Though he generally likes the idea, he also points out “Not everyone is going to win with this model. Particularly it’s going to be the industry that loses.” By that, he meant the move could alienate and displace real estate agents, many of which use Zillow’s site to post listings.

Blomquist also made the very valid point that “A lot of what helps is that we’re in another booming housing market cycle,” going on to ask “The one question I have, is will this model work as well when house prices are flat or falling.”

And the crowd entertaining such a scenario may be closer to modest vindication than many investors realize.

March’s 13% advance from Zillow stock was at least partially in response to a well-reasoned suggestion that the housing recovery was far from over. More growth is on the radar.

Some conflicting evidence has surfaced in the meantime though. Namely, as Trulia’s first quarter report pointed out, move-in ready starter homes are increasingly tougher to find as more and more home owners are content to remain in place. And, despite the aforementioned optimism about the state of the industry, rising interest rates and new tax laws could ultimately mean, according to Moody’s analytics, a 4% reduction in home purchase transactions.

It remains to be seen how that would impact ad-driven model, and now, its house-flipping model, neither of which necessarily require lots of home purchases to be viable. The dynamic might even help Zillow, if buyers become even more desperate to find a home — rather than giving up on the idea — they further scour Trulia and Zillow.

If homes are increasingly in short supply, Zillow won’t have any easier time finding affordable houses it can turn around and sell for a profit.

Bottom Line for Zillow Stock

If investors are being completely honest with themselves, the professionals who (on a net basis) see more risk than reward have the better argument … this isn’t exactly a move that offers encouragement.

Perhaps more than anything, it’s a move that reeks of desperation at a time when all seems well for the real estate market… the absolute last thing owners of Zillow stock want to see, particularly right now.  In a more immediate and basic sense, however, the foray into this new venture raises more questions than it answers, and leaves the company vulnerable to housing market volatility. Never even mind the fact that “flipping” is usually a labor-intensive business that at least involves a close look at a specific home, and often times requires physical improvements to a home to make them more marketable to their end-buyer.

It’s understandably just more of a shift than Zillow stock holders can stomach.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

Article printed from InvestorPlace Media,

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