Zillow Proves a Hypergrowth Model Won't Work in Housing

(Bloomberg Opinion) -- Zillow Group Inc.'s decision to exit its home-buying business reflects a tension between investors who are expecting tech-like growth and scale from a disruptive business model, and the basic nature of a volatile real estate market. Home-valuation models respond to market conditions, sometimes recommending to buy more homes, while pulling back at other times. When that guidance conflicts with its mission, what's the right decision for a company to make?

Zillow has blamed its blunder on bad algorithms, but it's more likely that the algorithms just didn't agree with its growth plan, so the company chose to override its pricing model and go for the scale that its investors craved and expected — a decision that turned out to be a mistake. And they paid the price.

When the company announced its ambitious "Zillow 2.0" plans in February 2019 to buy and sell homes in a major way, it targeted $20 billion in revenue in three to five years, with profitability only coming once the company had hit a certain scale. That's the lens to use when viewing their errors over the past several months. Zillow's stock soared almost 500% over the ensuing two years as the business line began to grow.

The problems cropped up this year. In the first quarter of 2021 the company didn't purchase as many homes as it had planned as rapid home-price appreciation and inventory shortages limited the universe of available houses. By the time they reported earnings in early May, the stock had already fallen significantly from its February highs.

This was the key moment for the company — should it pull back on buying homes given the rapid home price appreciation and limited inventory levels, as a market model would surely have suggested, or should they override the algorithms and keep buying homes to meet investors' expectations of growth? They chose the latter, and here we are.

There's another angle to the supply chain crisis here as well. Just as automakers need semiconductors to produce vehicles, and homebuilders need lumber, and Peloton needs container ships to get its bicycles from Asia, Zillow needed a reliable and reasonably-priced supply of homes to grow its Offers business. Due to the extraordinary housing conditions we've experienced over the past year, that supply chain broke down. It's possible the issue would have sorted itself out over time as pricing normalizes and more homes come onto the market. But that didn't happen soon enough for Zillow.

My own personal view is that Zillow's decision to exit the iBuying home market doesn't mean the business can't work for a competitor. It does provide a few lessons, though. To the extent scale is needed for the business to work, companies are going to be limited in the number of homes they can buy and sell at a sustainable pace — which suggests that Zillow or one of its peers were inevitably going to have to exit the overcrowded market.

It also means that if a company has to decide between the growth trajectory it promised investors or signals from its pricing model, it needs to follow the pricing model. And above all, patience matters — scaling up a home-buying business isn't the same thing as scaling up data centers or web traffic. Hypergrowth models work for some things, just not, it appears, for housing.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.

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