The Big Picture
For as long as we can remember, real estate has been dubbed the “largest purchase you will ever make.” That’s a justified title from a dollars and commas standpoint — but real estate is also a staple in the American Dream, whether it’s moving into your dream home or turning a run-down duplex into a cash flow generating machine.
Recently, Zillow has been taking the housing market by storm with little signs of slowing down. Although the actual process of buying and selling a home is very cumbersome and time-consuming, this Seattle-based company is looking to simplify the entire experience all through the seamless integration of technology with its customers. Zillow shareholders have seen extraordinary gains, with ZG shares reaching a high of $203.79 in February.
Is it time to ditch the rental property endeavors and pour your down-payment savings into this stock instead?
The Business
Zillow (ZG, Z) focuses on the U.S. housing market, using home-related information through its mobile and web channels to provide customers with the products and services they need to buy, sell, finance, and construct home improvements.
Zillow operates through three main business lines;
Internet, Media & Tech (IMT). This is the advertising Zillow sells on its platforms to real estate agents, rental property companies, and other professionals. Revenue is generated on a cost-per-impression (consumer sees the ad) and cost-per-click (consumer interacts with the ad). This category accounted for 43.4% of FY20 sales.
Homes. Cash purchases and resale of homes. This is where Zillow puts on its work boots and flips real estate just like HGTV. This category accounted for 51.4% of FY20 sales. Title and escrow services are also included in this segment, which went live in the second half of 2019.
Mortgages. Need a mortgage loan for your new beach home? Zillow has you covered here. Zillow originates then sells these mortgages back on the secondary market. Also includes any advertising sold to mortgage lenders. This category accounted for 5.2% of FY20 sales.
Premier Agent
Zillow’s Premier Agent service helps connect real estate agents to potential buyers across its network of platforms. This program offers performance analytics, a customer relationship management tool, and a personalized website service for agents to utilize and build their branding. Premier Agent has three tiers: Premier Platinum, Premier Gold, and Premier Silver. This service alone produced over 30% of Zillow’s FY20 revenue and is considered more predictable than its other services and products.
Portfolio
Zillow owns several consumer brands in the real estate and rental marketplace including Trulia (acquired in 2015), HotPads, StreetEasy, and Out East. This helps expand Zillow’s footprint in more niche areas such as the NYC real estate market with StreetEasy and the rental property and apartment ecosystem with HotPads.
The company also owns a variety of marketing software and technology solution platforms, including Mortech, dotloop, Bridge Interactive, and New Home Feed. These firms give Zillow additional exposure to innovative industry tools such as listing-data management and automated compliance procedures for real estate transactions.
The Narrative
The genesis of Zillow dates back to 2006 when former Microsoft execs came together to utilize technology to innovate and revolutionize the housing market. At the time of launching, housing data was difficult to obtain. Buyers, realtors, investors, etc. would have to scrape archives throughout the web and search bureau databases for any bits of information they could get — a very time-consuming and exhausting process to say the least. This gap in the consumer experience along with great timing (the housing market was exploding with growth) led to overnight popularity for Zillow.
Over the past few years, Zillow experienced double and triple-digit growth across its business segments (and stock price) thanks to (a) further expansion in the U.S. real estate market, (b) a little help from the Fed lowering interest rates, and (c) the continued boom of the Tech sector. Since 2019, the stock has returned over 300% — most of which occurred during the market rebound in 2020.
Exhibit A: ZG Share Price (2019 - Present)
When looking at the bottom line though, the company has not turned a profit from its business operations in recent years.
Exhibit B: Net Loss (FY17 - FY20)
That said, it’s common for a Tech firm to burn through cash as it expands and invests in projects today with the intention of producing future cash flows. Gotta spend money to make money, but where is this capital being spent?
Zillow’s original business plan was to create a digital space for housing to connect consumers and professionals; however, Zillow incorporated a real estate play into its business strategy in what management called “Zillow 2.0.” Zillow is shifting its efforts toward the following operations:
Buy. Purchasing homes from Zillow users utilizing its pricing algorithms to determine market value.
Sell. Investing in swift renovations, then flipping the property back on the market to sell at a profit.
Rent. Assisting property owners and renters with the leasing process through a frictionless experience.
Finance. Zillow will also offer financing to qualified buyers.
A very ambitious push to offer more real estate services to consumers, which requires a different set of expertise and skillsets. However, we have seen Zillow make strides to deliver these offerings.
Buy & Sell: Zillow Offers
Launched in 2018, this program has three stages: (1) Zillow provides cash offers to homeowners; (2) Zillow’s renovation team repairs acquired homes; and (3) Zillow lists and sells the home back on the market for a higher price. This service exists in 25 real estate markets and generated $1.7 billion of revenue as of year-end 2020. However, the program has yet to be profitable with a loss of over $303M in 2020 alone.
Rent: Additional Tools
Zillow’s platform offers tools such as online applications for the tenant screening process, e-sign with leases, and digital payments for renters.
Finance: Zillow Home Loans
Zillow acquired Mortgage Lenders of America in 2018 and rebranded the following year to Zillow Home Loans where today the service is available in 45 states. As mentioned earlier, these mortgage originations are sold back on the secondary market. Zillow reported continued revenue growth within this service, which was primarily driven by increased market demand (due to low-interest rates and refinancing activity). However, originating loans continues to be a cash-intensive business.
Workforce Expansion
Zillow wants to expand its employee base by over 40%, equating to over 2,000 professionals and offering either a remote-work or hybrid job approach for the newcomers. This makes sense as the company continues to see expansion in the real estate market and wants to grow its new business verticals.
Competitors
As Zillow releases new product offerings, it also begins to enter new subsets of the real estate market — which means new competition, such as real estate management firms and lenders in the financial services field.
Data as of 3/18/2021
Currently, Zillow trades at a much higher stock price than the likes of RE/MAX, LEJU, FANG, and Redfin. In addition:
Market cap is 5x the size of the nearest competitor (Redfin)
Revenue far exceeds everyone else’s
EPS is in the red (but that’s not uncommon in this industry)
The High-level Finances
Note that all dollar amounts are illustrated in millions.
Revenue
Zillow’s revenue steadily rose over the last several years. The primary reason is the expansion of the Zillow Offers platform, along with the continued growth within its advertising space under IMT.
EBITDA
EBITDA (earnings before interest, taxes, depreciation, and amortization) is a metric used to gauge a company’s operating performance. A company’s operations can appear worse due to certain non-cash expenses, such as depreciation and amortization.
Positive EBITDA performance is mainly driven by its advertising segment within IMT, which has been partially offset recently by the high cost of revenue within its Homes business.
Zillow’s EBITDA was adjusted to account for significant non-cash impairments to the goodwill of the Trulia trade name and trademark intangible assets, resulting in a cost of $71.5 million in 2020. This meant the fair market value of this asset was determined to be less than what was on the books.
Net Loss
Zillow hasn’t been profitable since 2012 (the year after its IPO), but the business looks much different now than it did back then. While revenues continue to expand for all three business units, Zillow may be in the red for a while as the company (a) invests in its newest service offerings and (b) incurs heavy expenses in the Home business.
The Primary Strengths
Housing Market. According to the 2020 U.S. Census Bureau and the National Association of Realtors, the market value of annual home sales was approximately $2.2 trillion. With the Zillow Offers standing at less than 0.1% of this estimated value, there is plenty of room to grow in this space.
The housing market rebounded well since the beginning of the pandemic, as existing home sales are back to double-digit growth figures.
When looking at the mortgage side, a 2020 Mortgage Bankers Association Report states origination revenue represents a $156 billion annual market opportunity in the U.S. With current mortgage rates still at historic lows, incentives are still present for consumers to “lock-in” these rates when purchasing a home.
Brand Name. According to a 2020 Google Trends report, the word ‘Zillow’ was searched for more than ‘real estate’! You must be doing something right if you are more popular than the industry you serve. Zillow is also the most visited brand in real estate with over 9.6 billion mobile app and website visits in 2020 across its Zillow, Trulia, and StreetEasy platforms.
Big Data. “Data is the new oil.” The core of Zillow is its unique database of over 135 million U.S. homes, which enables the firm to produce real-time models (e.g. Zestimate, which gives both the estimated home value and rental value of a property). These models have been growing for over 15 years, creating ample opportunities for Zillow Offers’ pricing algorithms.
The Primary Risks
Unproven operations. Although Zillow Offers has seen rapid growth since launching in 2018, the jury is still out on whether Zillow can execute on the purchasing, repairing, and selling of homes in a timely manner and for profit. Zillow Offers’ business results are difficult to predict at this time, which may mean Zillow operates at a loss within this segment for a while as it navigates semi-uncharted waters.
Home valuations. In-person evaluations and proprietary algorithms are used to value the properties Zillow Offers buys and sells; valuation factors include: (1) estimated time between purchase and sale of the home,(2) renovation, closing, and holding costs, (3) resale profits based on market conditions. Incorrect assumptions or inadequate due diligence (see what we did there?) could lead to undiscovered construction defects or surrounding environmental hazards, impacting the value of home inventory and resale ability.
Liquidity. Buying homes with cash and originating mortgage loans for consumers are very capital-intensive ventures — along with the fact they can yield lower margins. Zillow currently utilizes debt financing to fund these operations, which will impact the company’s liquidity and capital resources throughout the growth of these newer ventures.
Competition. Zillow is not the only one in the real estate game — and there are many more experienced players in the newer areas Zillow is pursuing. Gaining market share will be a challenge, as thousands of real estate brokerages and mortgage lenders already exist across the country.
Concentrated. Zillow is solely reliant on the housing market for its business model. Any unexpected negative impacts to the health of the US real estate market (such as lower levels of consumer confidence or illiquidity in the residential market) would directly impact Zillow’s business.
The Street’s Opinion
Overall, the analysts are “Overweight” when it comes to Zillow’s rating. Out of 23 ratings, 14 analysts labeled Zillow a “Buy.” Further, the company’s average stock price target stands at $203.8, as of March 18.
The Street is bullish and expects this stock to climb another 40% when comparing their target pricing to ZG’s current price.
Recent News
Time to Close the Deal?
It’s safe to say Zillow transformed the real estate industry. The fact that you could sell your current home and buy your next dream house all through an app is, well, quite remarkable considering how complex the process actually is. But Zillow isn’t resting on its laurels, as the company undertakes new endeavors via the “Zillow 2.0” initiative.
The company’s future success will depend on its ability to execute this strategy and continue driving more traffic to its online channels. And, of course, Zillow’s operations still rely on the growth and sustainability of the U.S. real estate market. Although COVID’s impact on housing is still uncertain, we believe the sector has made it through the hardest parts of the pandemic and recovered well considering continued growth in home sales.
With the recent surge in ZG’s share price, we aren’t the only ones encouraged by Zillow’s growth and optimistic of Zillow’s new strategy toward home trading and mortgage origination — ARK’s Innovation ETF has Zillow in its top 10 holdings alongside companies such as Tesla, Spotify, and Zoom. These new fields require a different set of expertise beyond Tech, so Zillow will have its hands full for a while as it grows into the asset management and financing arms of the real estate business. Despite the challenge ahead, Zillow does have the brand recognition and online traffic to effectively bring these services to market.
Keep an eye on (1) upcoming business performance of Zillow’s Home segment; (2) further expansion of its Mortgage lending unit; and (3) interest rate movement as this will have a significant impact on the funding and profitability for both lines of business.
Sources
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