Since my last quick take on this, I have had more time to investigate, research, and talk to a wide variety of people from the real estate and financial worlds. I am more convinced than ever that iBuyer will return with a roar when this current shutdown is over, and why people in the real estate industry talking as if Opendoor’s layoffs means that iBuyer model is unsustainable are making a huge, potentially dangerous, mistake.
For the TL;DR crowd: I now believe that Opendoor was caught in a major cash crunch between how much it had in the bank and the likely terms of its financing vehicles for its home purchases. That has zero bearing on the iBuyer model, and more importantly, has no bearing on Zillow the new king of the market makers.
Why Opendoor Did What It Did
Let’s be clear right at the outset that I have no special access to Opendoor’s financial information. And even if I did, I would not use such information as that is confidential. Everything here is from publicly available information.
First, there is the critical question of how much cash Opendoor had.
We know that they raised over $1.3 billion in equity, with another $3 billion in debt (for purchasing houses). We also know that the last time Opendoor raised money was in March of last year, when it did a Series E for $300 million. Furthermore, I assume that startups don’t go raising equity capital just for the hell of it: that equity is valuable, after all, especially for a company eyeing a public offering (which Opendoor had to be doing in 2019). They go raise it because they need the money to make it to an exit.
My assumption, therefore, is that Opendoor had slightly more than $300 million in cash in April of 2019.
We also know that Opendoor had more than 1,700 employees prior to its layoffs by doing simple math: 600 layoffs was 35% of the workforce. We also know that Redfin had 3,377 employees at the end of 2019. We don’t know what the burn rate (outside of its core buying/selling activities, which would have been funded out of the debt raised specifically for that purpose) was for Opendoor, but we do know what Redfin’s burn rate was at the end of 2019: ~$15 million a month. Obviously, Opendoor and Redfin are not the same company, but they are similar enough: lots of technology and data people, and a bunch of field people. So let’s say Opendoor was at half of Redfin’s burn: $7.5 million a month.
So 12 months of burn at $7.5 million a month is $90 million. Because Opendoor was expanding so rapidly, far more rapidly than Redfin was, I’m going to throw some capital expenditures, new office space, etc. etc. on top of that and call it an even $100 million from March of 2019 to March of 2020… when COVID hit.
That leaves us with roughly $200 million in cash in the bank. More than enough with a burn rate of $7.5 million a month.
Here’s the problem…
Financing Covenants
Obviously, I have no idea what the terms of Opendoor’s debt financing that it uses to fund purchases of homes are. But because both Zillow and Redfin are public companies, we do have a bit of a clue on what it might have been.
Here’s the language from Redfin’s annual report:
RedfinNow Borrower must repay all borrowings and accrued interest upon the termination of the facility, and it has the option to repay the borrowings, and the related interest, with respect to a specific financed home upon the sale of such home. In certain situations involving a financed home remaining unsold after a certain time period or becoming ineligible for financing under the facility, RedfinNow Borrower may be obligated to repay all or a portion of the borrowings, and related interest, with respect to such home prior to the sale of such home. In instances involving “bad acts,” Redfin Corporation has guaranteed repayment of amounts owed under the facility, in some situations, and indemnification of certain expenses incurred, in other situations.
Let me translate the highlighted portion into plain English for you:
If a home remains unsold for too long, Redfin has to pay the entire loan amount plus interest, immediately.
Here’s language from Zillow’s annual report:
Outstanding amounts drawn under each credit facility are required to be repaid on the facility maturity date or earlier if accelerated due to an event of default. Further, each SPE is required to repay any resulting shortfall if the value of the eligible properties owned by such SPE falls below a certain percentage of the principal amount outstanding under the applicable credit facility. Continued inclusion of properties in each credit facility is subject to various eligibility criteria. For example, aging criteria limit the inclusion in the borrowing base of properties owned longer than a specified number of days, and properties owned for longer than one year are ineligible.
This is not as clear as the Redfin language, but “limit the inclusion in the borrowing base of properties” sounds a whole lot like “if the property hasn’t sold after a while, you gotta pay it all back.”
I can’t imagine that Opendoor’s financing did not include such language. There is just no way that banks would tell Redfin and Zillow that if a home sits on the market too long, they have to essentially “buy it back” from the banks but tell Opendoor that they don’t have to.
So I have to assume that Opendoor was facing a situation where they had homes in inventory that were sitting on the market simply because activity had shut down. Sure, real estate was declared essential in many states, but not in other states. It took some time for things like digital signatures and roving notaries and so on to get going. And quite a few buyers ended up falling out of deals because they got laid off or furloughed or what-have-you.
The Cash Crunch
The scenario then is that Opendoor is sitting there with $200 million in cash: more than enough for operating expenses until the IPO. But suddenly, they’re facing the prospect of having to “buy back” a whole bunch of loans from the banks that gave them the $3 billion in financing.
The critical question is, how many? How many homes were in danger of falling into that “sat on the market too long” bucket?
A reader in the finance industry sent me some data under conditions of anonymity. I gather this data comes from one of the webscraping data vendors, and is deemed reliable but not guaranteed. Here’s what that data says about Opendoor’s inventory at the time it suspended buying, according to my source:
- Total homes in inventory: 2,315
- Total Value: $566.4 million
- DOM 30 or Less: 708 homes, valued at $171.8 million
- DOM 30-60: 547 homes, valued at $138.3 million
- DOM 60-90: 372 homes, valued at $87.1 million
- DOM 90-120: 235 homes, valued at $57.1 million
- DOM 120-150: 180 homes, valued at $45.0 million
- DOM 150-180: 116 homes, valued at $27.7 million
- DOM 180 or More: 164 homes, valued at $39.5 million
We don’t know what the trigger is for Opendoor’s financing. Is it 180 days? Is it 90 days? But whatever it is, this is hardly good news.
Let’s say that the trigger is 180 days: if a home sits on the market for 180 days, the bank has the right to force Opendoor to buy it back. That means $40 million went out the door. In another 30 days (say the end of April), Opendoor is writing another check for maybe $25 million. 30 days after that, at the end of May, Opendoor is writing a check for $45 million. (Obviously, if they sell these homes before the deadline, then we think about different things, like “Did you break even on the house?”)
Suddenly, that $200 million or so in the bank doesn’t seem so large. At the end of May, Opendoor might be looking at only $75 million in the bank (remember, we assumed that Opendoor’s monthly burn is $7.5 million or so)… with another $57 million due to the bank by the end of June.
It doesn’t much matter that all of those homes would have sold once the market lockdowns were lifted, and sold for a profit. What’s necessary is cash, and Opendoor simply didn’t have enough.
Under this cash crunch scenario, Opendoor really has no good choices. It can try to go raise more money, but obviously that didn’t work out, especially with the investors themselves feeling nervous about the global financial markets. It can try to negotiate with its bankers, but again, that obviously didn’t work out… and Wall Street banks are not known to be kindhearted men when it comes to business.
iBuyer Model is Unaffected… and Likely Booms After COVID
The thing to keep in mind is that the iBuyer model has nothing to do with this cash crunch. If anything, having to buy back the loans from the financiers means higher profits when they sell: no interest payments, and all of the proceeds go right to the topline. You’re booking the entire $250K sale price, instead of just 10% of it, with the rest going to pay off the bank.
Furthermore, let me copy and paste a part of the COVID and Real Estate Report I wrote recently, based on interviews with 16 of the top brokers and agents in the industry:
Nonetheless, in speaking with some of the top producers in the industry, it became evident that the better agents and brokers see the truth: the iBuyers will have an enormous advantage in the aftermath of this crisis.
Our broker in the Denver area, who has a great deal of experience with iBuyers and keeps track of their activity, reported that prior to COVID and the disruption it caused, iBuyer inquiries in his market in January and February were up threefold year over year. The recently announced suspension of iBuying activity made the future harder to gauge, but he thought they would come back and come back strong.
As he put it:
My prediction is, the iBuyers are really going to help the market recover because they provide — and not on an individual consumer basis, but on a market wide basis — they’re going to provide liquidity, certainty and speed. And that’s what markets need to recover.
I agree with this broker, especially in light of the likely change in consumer mindset after COVID.
Sellers are not going to be all that excited about having dozens of strangers walk through their homes, where they live and their children sleep. Buyers are unlikely to be all that thrilled about walking through a stranger’s home, even if they touch nothing, just for a quick “Do we like this house?” tour. In both cases, a vacant home becomes a far more valuable thing.
When other people are bad for your health, the perceived downside of selling your home to an iBuyer, or buying a home from one, decreases fairly dramatically.
Liquidity, certainty and speed — all three will be more valuable to consumers when we come out of the lockdowns. Anybody needing to sell will have lost months during the lockdowns, and we already know that REALTORS are advising some of their sellers to pull the listings off the market given the chaos and unknowns. If you pulled your house off the market in April, then put it back on the market in July, are you really eager to be waiting for the normal market process to play out?
Any buyer needing to move for a new job, for a new baby, etc. will have spent a lot of time online but far less time actually seeing houses. Investors might buy a home based on a virtual tour; I find it difficult to imagine that family buyers will. Some might of course, but then again… some people do mail order brides too. That doesn’t make it the new normal.
A 60-day close might not work for people in a hurry to get it done, especially if nobody knows if The Bug is coming back with the colder weather.
There are only two limiting factors to how big iBuyers can get when we come out of this crisis. One is capital: would the big money investors and big money banks make capital available to iBuyers who are left standing? Zillow had $1.5 billion in lending facilities at the end of 2019 to finance its iBuyer activities (that is separate from the $2.5 billion in cash). Could Zillow get $15 billion in credit instead to 10x their iBuying activity? Who knows? Maybe.
The other limiting factor is boots on the ground: we know from the past couple of years that iBuying is not “click a button, sell a house.” We know that people have to go see the house, price it, adjust whatever number the computer spits out, then after buying the house, people have to clean it, freshen it up, maintain it, and ultimately sell it. There’s a lot of actual labor that goes into the process. No one other than a few Zillow executives know exactly what their capabilities are. Could they 10x the number of transactions? Probably not. Double? Who knows?
But now we can assume that Opendoor’s capabilities are 35% less than they were a month ago.
It does seem likely to me that the big money guys would see Zillow as more of a sure bet when we emerge from the lockdowns and consumer demand for iBuyer services (vacant homes with liquidity, certainty, and speed) goes through the roof… and its top competitor, the former #1 with a bullet, will be trying hard to come back instead of forging ahead.
For the Industry
I do think it is dangerous to conclude that the iBuyer phenomenon was just a fad based on Opendoor’s layoffs. Those layoffs had little to do with the underlying model and everything to do with a cash crunch brought on by the government shutting the country down. Opendoor could not take all of the inventory onto its balance sheet, and was staring bankruptcy in the face unless it could get more liquidity. It could not (yet), so it was forced to cut to the bone to survive.
Zillow can. Take all of its inventory onto its balance sheet, that is. Zillow can write checks to its lenders, bring all the houses onto its books, take a big hit (say it’s the same as Opendoor’s $566 million or so), and still have almost $2 billion in cash left.
If Opendoor finds a white knight — say someone like Amazon, Quicken Loans, or one of the title companies — then it too can write checks to all of its lenders, take the hit, and come back with a vengeance when the market is freed up.
Brokers and agents had to evolve to deal with the liquidity, certainty, and speed that iBuyers offered before COVID. They’re going to have to deal with those again after COVID, and much more so as changes in consumer psychology will impact things.
“You’re leaving money on the table!” thing was marginally effective Before COVID and based on deliberate confusion of actual iBuyers and flipper-investors. It will be even less effective After COVID when people are worried about catching an infection more than they are about making a few thousand dollars more.
Get antifragile. Adapt. Become better. It is not enough to defend the status quo and hope for a return to it, as the status quo is likely destroyed for good.
-rsh
