Zillow has officially withdrawn from the iBuyer race – leaving Opendoor as the clear winner in this category. If you're not familiar with iBuyers, don't worry... I'll explain very shortly. But, the consequence of this decision by Zillow caused its stock price to drop 20% in a day, including the afterhours – where it officially reported with Q3 earnings.
The iBuyer pioneer, Opendoor, also dropped 17% during the session; and competitor Offerpad also dropped nearly 3%.
I've been watching these names for a while, since de-SPAC, but haven't yet made a move. But, I put some in after this drop as a long-term play. I'll explain my thought process, and hopefully it makes sense for you.
iBuyer Business Model
The business model for Opendoor, and iBuyers, is actually quite straightforward. But, first, to understand why it the model holds value over a traditional real estate transaction, let's quickly review the flow of a traditional sale.
There model basically simplifies the entire process by buying directly off the seller, and acting as middleman – as opposed to an agent. This model is actually nothing new, it's just digitizing the already existing "cash buyer" or wholesaler model. A cash buyer offers a price on the home, below market value for "as is" condition. Thereafter, they can either assign the property or sell it to someone else or flip it themselves after renovations.
Opendoor, and other iBuyers, are just more efficient because they can make offers based on their AI and algorithms very quickly. They also manage the entire close process digitally, making it super smooth. That's the real disruptive part.
Opendoor makes money in two ways: from the service fees it charges, and from any difference between what it buys houses for and what it sells them for.
Opendoor works with real estate agents, offering to pay full buyer commissions, as well as seller commissions if a sale comes from an agent.
It's pretty clear to see the reason why this model, and Opendoor, is gaining market share in a huge $1.6T/year market. It's just much easier, and it makes sense for more people as long as the offers are fair and reasonable for the convenience.
Alright, let's talk numbers and get straight to the chase...
The first thing you're probably wondering is, "how much do they make on each house?" Well, this varies by geography and how long they've been in the market, but on average you can see they started the year making about $7k per house... whereas that number is now $37k. I don't expect that number to sustain, because the housing market has been on fire in the past year, so I don't think they are making offers based on those expected margins.
Opendoor and Offerpad have pretty much identical models, but Opendoor is being far more aggressive with growth and Offerpad (along with growth) is not losing sight of profitability. I think it's very important in this space to maintain profitable growth, because the real estate industry changes so fast and has strong headwinds with higher interest rates on the horizon. That's the more conservative approach, but I understand that doesn't necessarily correlate with stock returns.
You can actually see the volume of listings, selling prices, and gross margin by iBuyer on this very useful site: https://ibuyerstats.com/#volumetrends This confirms both the points I've made above.
As usual, my analysis if available for premium subscribers for on the email list, should you want to play with the assumptions to build your own model.
I'm expecting Opendoor to grow its revenues to $13bn by 2025, by selling approximately 40K homes. You can see that's an average selling price of $400K. The selling price is fairly conservative, and doesn't factor in much appreciation considering their current average sold home is $373K. The revenue growth rate, comes mostly from their guidance which (so far) they are blowing past.
If we assume the lower-end of their long-term target EBITDA margin of 4%, they'll be at $520M of EBITDA. I honestly think EV/EBITDA or P/EBITDA multiple is most appropriate to value Opendoor and other iBuyers, because they're very capital intensive. There are no benchmarks to this model, and valuing based off sales or earnings will be impossible to ration. At the end of the day, even a price/book holds some value here, because of their housing inventory. As of now, Opendoor is trading at an almost 200x 2021E EBITDA multiple. This is obviously very high, and expecting a compression to about 100X in 2025 (when they're expecting profitability) they'd be valued at $86/share – a 3x or 300% upside from here.
Is this possible? Quite frankly, I don't know. I can't bullshit you and say I feel confident about that, because there are lot of risks (which I'll get into).
But, before we discuss those, let's take a look at competitor Offerpad to see how they compare. Obviously there's no point discussing Zillow here.
As I mentioned before, Offerpad's numbers are very similar, BUT already had a profitable quarter in Q2 2021. They're however, growing and expected to grow at a much slower pace – about half of Opendoor's growth rate. So, where are relatively valued?
Offerpad's valuation is actually about half of that of Opendoor's. I know I said P/S is probably not the best method to value these companies, but for comparative purposes it's fine. Opendoor is currently at 2.4 x sales; whereas Offerpad is 1.0x. Opendoor is also significantly more reasonable for an EBITDA margin of below 60x.
I honestly don't think there should be compression in the valuation of Offerpad, instead it should expand as the market takes notice or analysts cover Offerpad. However, if we assume a 40x EBITDA multiple in 2025 (assumed $7.5bn of revenues at 4% EBITDA margin) we get a price of nearly $54 – which is nearly 600% or 6x from here. There's obviously a much higher margin of safety with Offerpad, than there is with Opendoor. It's a clear winner in terms of valuation... but does that mean you should buy Offerpad?
- Housing market – the market has been heated for quite some time, now and is bound to cool... these stocks will be hit hard in that case.
- Interest rates – no doubt, these are going up... which doesn't favor these stocks or the industry
- Competition – competition among these iBuyers can squeeze margins (i.e. Uber and ride-sharing market)
Offerpad is a clear winner in terms of valuation, but the growth story is overwhelmingly in favor of Opendoor. As much as I can sit here and convince you that Offerpad has the better business model that's primed for success and long-term profitability and a more attractive valuation... none of that matters, unfortunately. The markets will, and have been, favoring growth. So, I'm afraid to jump all in with Offerpad because it may be a "value trap".
Because Zillow is now out of the picture, it leaves a more bullish picture for Opendoor, as the market leader. As much as I have a tough time swallowing the valuation for Opendoor, I would probably allocate to both iBuyers to hedge my margin of safety and maximize returns.
Another key reason to do this, is the risks I mentioned. There are significant headwinds for the real estate market, consider the rising rate environment we're going into. That's why I've stayed away from stocks like Lowe's – because this is a cyclical industry. As much as we are in tech here, we're still susceptible to the real estate trends. That makes me uncomfortable to go in with any significant amount.
My stance is mostly getting real estate exposure with real assets, and having a separate portfolio for that – which I do have. But, this is an intriguing play, so I will take part in it because the model is truly disruptive.
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