Wells: The downside of algorithmic intelligence, the rise of the institutional investors

There has recently been some big news in the world of real estate. In short, Zillow — the world’s largest real estate portal — made a large gamble on the way people will buy and sell homes, which it called the Zillow Offers program. The gamble failed.

Zillow Offers represents a trend that’s become known in the industry as iBuyer, a sector that includes the likes of Opendoor and Offerpad. The business is built on a model in which the iBuyer provides cash offers to prospective home sellers, saving them the “hassle” of listing the home on the open market. What many fail to realize is that trade off for convenience usually comes at a cost of equity in the form of higher fees. 

In theory, the iBuyer process removes some of the steps in the traditional transaction process, offering convenience and certainty to sellers who desire a shortened timeline. The iBuyer applies algorithms, or complex automated data processing equations (that sometimes includes hundreds of variables), to assess real estate values. Armed with that information, the iBuyer will then make competitive offers on properties while simultaneously weighing their risk and potential profit rewards.

After purchase, these companies subsequently make small cosmetic changes to the property, then either sell it back on the open market or seek institutional investors to purchase multiple properties as part of a larger portfolio.

Zillow learned first-hand that algorithmic intelligence works well when there are constants; but that’s not the reality of real estate. With all the hyperlocal variables of real estate markets, specifically pricing, the role of a true trusted adviser in a professional Realtor still holds immense value and mitigates risks of tossing away equity earned. 

In early November, Zillow announced it was shuttering its Offers program. In the words of Zillow CEO Rich Barton, “Fundamentally, we have been unable to predict future pricing of homes to a level of accuracy that makes this a safe business to be in.”

In turn, Zillow is laying off 25% of its 8,000 employees and will mark up total losses in excess of $1 billion from its Offers program. Here in Northern Colorado, we have already seen the fallout of Zillow’s exit plan. Many of the Zillow-owned homes that were algorithmically purchased at inflated prices are being sold at losses ranging from $50,000 to $60,000 — to be more in line with market prices today.

Real estate has always been a high-risk, low-frequency transaction. The attempt to commoditize the transaction fails to account for the fact that algorithms never set foot in the house. Real estate has been, and always will be, hyperlocal. There is no one market; different price points, different products, and different neighborhoods all reflect their own unique individual markets. 

Meanwhile, in the shadow of the Zillow news, other larger transformations are occurring that are impacting the future of home ownership. Large institutional investors are chomping at the bit to gobble up swaths of housing inventory in the United States. Namely, these investors are chasing returns created by the continued escalation of rental rates across the country, as well as the explosive appreciation fueled by the dwindling supply of homes for sale.

If you’re a prospective home purchaser, this trend means you are no longer competing with other families for the home you desire. You are competing with deep-pocketed institutional investors. In fact, developers across the country are constructing and delivering new, large-scale BFR (Build For Rent) communities; these developments avoid any sales-and-marketing costs, turning much sought-after housing supply into investor-owned inventory.

These dynamics are changing the face of real estate today. Everyone wants a slice of the U.S. housing market pie.

Brandon Wells is president of The Group Inc. Real Estate, founded in Fort Collins in 1976 with six locations in Northern Colorado. He can be reached at bwells@thegroupinc.com or 970-430-6463.