Things aren’t going well for property technology company Opendoor Technologies (OPEN -0.95%). Bloomberg reported that Opendoor lost money on 42% of the homes it sold in August, though that doesn’t include the 5% fee the company collects from sellers. Many might remember how former competitor Zillow previously tried its hand at iBuying homes but gave up last fall due to poor unit economics.
But there are some enormous forces at work here, and given the recent Bloomberg coverage, investors should ask whether Opendoor will suffer a fate similar to (or worse than) Zillow’s iBuying business or if there is hope for long-term success. Here’s why Opendoor’s darkest hours could be upon us — and why there could soon be light.
A different company with different problems
It feels natural to compare Opendoor and Zillow. After all, they’re both real estate technology companies that have pursued the same goal of making a profitable business out of iBuying, the practice of pricing and buying homes with the help of algorithms and then reselling them on the market. But Zillow ultimately failed as it couldn’t accurately price homes, leading to huge losses and the company shutting that segment down last October.
But the circumstances between Zillow’s failure and Opendoor’s current challenges are very different. Zillow Offers, the home-buying business, technically launched in 2017, but the company leaned into it in Feb. 2021 when it paired Zillow Offers with Zestimates, its home-valuation algorithm, in 23 major cities. The median price of an existing single-family home in the U.S. appreciated 14% over the next eight months before the company ended its iBuying efforts. In other words, Zillow failed in an up-market!
Opendoor did just fine during this time, though it wasn’t profitable in 2021. A high number of transactions helped spread out the company’s total costs, and non-GAAP (adjusted) earnings before interest, taxes, depreciation, and amortization (EBITDA) were positive for the first year in the company’s history at $58 million.
You can also see below how Opendoor, a dedicated iBuyer, was able to improve its net losses despite far more iBuying transactions versus Zillow, whose losses exploded as soon as they got started:
Data by YCharts.
But the housing market today isn’t doing very well. According to the S&P CoreLogic Case-Shiller Index, home prices decelerated at their fastest pace on record in July. Real estate data needs time for transactions to close and that data to trickle through to reports, but you can see the beginning of the turn below:
Data by YCharts.
Rapidly decreasing home prices mean Opendoor is likely struggling to sell homes fast enough to offset the decline in value between the time they buy a house and resell it. Investors will find out more when the company reports third-quarter earnings. Still, management guiding for an adjusted EBITDA loss between $175 million and $125 million after posting positive EBITDA of $218 million the previous quarter is troubling. Remember, management provided that guidance in early August, so at that point, the company had already seen how part of its third quarter was unfolding.
What’s the problem, and is there a solution?
So why are home prices plunging? These questions never have simple answers, but the surging federal funds rate is a big clue as to what’s happening. The Federal Open Market Committee, in charge of monetary policy in the United States, is jacking up rates to combat inflation. This rate dictates how much it costs banks to borrow money, meaning a lender providing a mortgage must raise their own rates to make money.
You can see the clear correlation between the federal funds rate and mortgage rates below:
Data by YCharts.
A $300,000 mortgage at a 3% interest rate over 30 years will cost $1,265 per month. But if you increase that to the current rate of 6.7%, that monthly payment for the same amount of principal jumps to $1,936. It’s becoming much harder to afford homes at the same prices, especially with high inflation and increasing living costs. So what happens? Real estate demand falls, and prices follow suit.
Opendoor charges a 5% fee when you sell your home to them. On top of that fee, the company collects a spread — the difference between what it pays for a home and what it resells the home for. Opendoor can manipulate this spread, which management noted in its second-quarter earnings call, to compensate for expected home depreciation. In other words, it can offer lower prices on the houses it acquires. Opendoor’s problem is that it didn’t expect home prices to slide and mortgage rates to rise as quickly as they have, catching the company off guard. That doesn’t excuse the misstep, but it seems like a manageable issue once Opendoor takes its lumps and begins pricing homes with higher spreads.
Home prices and mortgage rates ideally need to stabilize — it’s not the direction things move but how fast they move that affects Opendoor the most. Economic forces are pushing rates and home value changes at their fastest pace in decades, and in some cases, in history. So while Opendoor’s hurting as a result, surviving this tough climate might be as much evidence of the company’s staying power as you can ask for. Risky, yes, but Opendoor is still a stock with lots of potential.
Justin Pope has positions in Opendoor Technologies Inc. The Motley Fool has positions in and recommends Opendoor Technologies Inc., Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool has a disclosure policy.