Home / Tech / Insiders explain how iBuyers like SoftBank-backed Opendoor mix algorithms and human decision-making to flip houses and find new markets

Insiders explain how iBuyers like SoftBank-backed Opendoor mix algorithms and human decision-making to flip houses and find new markets

buying home

  • iBuyers, companies that purchase homes with almost instant all-cash offers, renovate and quickly resell them, were born in 2014 in the heat and sun of Phoenix, Arizona. 
  • With Phoenix as the model for iBuyers, companies have expanded to markets that share many characteristics with the desert city, testing their pricing models and operational acumen against different potential variables.
  • The model, composed of both algorithms and human-decision makers, tries to find the lowest price that a homeowner would accept, the lowest-cost renovations with the highest returns, and, with some operators, the highest price that will sell the home quickly on the market. 
  • Business Insider spoke to six experts in the iBuyer world to see which characteristics make for easy price modeling, how companies are testing the limits as they expand, and whether iBuyers will eventually be an option for homesellers throughout the country, and worldwide. 
  • Read more BI Prime stories here.

iBuyers, companies that purchase homes with almost instant all-cash offers, renovate and quickly resell them, were born in 2014 in the heat and sun of Phoenix, Arizona. 

SoftBank-backed Opendoor, now valued at $3.8 billion, first started purchasing homes in Phoenix that December.

By 2015, competitor Offerpad was also buying and flipping homes in Phoenix. The iBuyer model has continued to grow, with established real-estate listing players like Redfin and Zillow entering the fray. There are now active iBuyer markets in almost every region of the US, and even some international regions.

While iBuyers have tested new markets, Phoenix’s lack of seasonality, an active local economy and housing market, and largely new housing stock has made it the iBuyer capital. 

A report from Mike del Prete, a consultant who studies iBuyers, found that they make up almost 6% of all home purchases in Phoenix, while a Redfin report that iBuyers made up almost 7% of home purchases in Phoenix by December 2018, the most recent figures.

With Phoenix as the model for iBuyers, companies have expanded to markets that share many characteristics with the desert city, testing their pricing models and operational acumen against different potential variables.

While this process of trial-and-error expansion will likely continue in the near future, iBuying advocates aren’t in agreement as to the limits of the model. 

Will we ever see iBuyer’s purchasing and renovating 19th century brownstones in Boston’s Back Bay, or ranches in Montana?

Business Insider spoke to six experts in the iBuyer world to see which characteristics make for easy price modeling, how companies are testing the limits as they expand, and whether iBuyers will eventually be an option for homesellers throughout the country — and worldwide. 

If you work in real estate and would like to share your experiences or comments about tech tools in the space, please send me an email at anicoll@businessinsider.com.

Read more: We asked 7 real estate experts how far tech can go in replacing human agents

How iBuyers work

The iBuyer model is, at its most basic level, trying to maximize the profit a company can make in quickly buying, renovating, and selling a property. 

The model, composed of both an algorithm and actual human decision-makers, tries to find the lowest price that a homeowner would accept for their property, the lowest cost renovations with the highest returns, and, with some operators, the highest price that will sell the home quickly on the market. 

The algorithm, and the decision-makers, use a range of variables to create an accurate pricing market. The main variables in the algorithm are the characteristics of the homes in the market, the operational challenges of the market, and the economic characteristics of the city. These variables are given different weights. But these variables, and their weighted importance, can change drastically between different markets. 

Margins in the business are small, so the algorithm needs to be tightly dialed in. 

A report by Mike del Prete found that the average margin for an iBuyer is only 1.3%. Of course, iBuyers are also making money on their fees, which are 7.5% on average, 1.5% higher than the typical 6% that real estate agents charge, but it would be hard to continue operating if they were losing money on each sale. 

But like any algorithm, high-fidelity data is extremely important to getting consistent results. 

Phoenix, and markets like it, offer a mix of favorable market conditions that make it easier to make confident bets on home prices. As these companies expand to new markets, in theory the algorithm trains itself on new data sets, with the hope of being able to predict pricing under less favorable conditions. 

The next section will run through the most important variables, why they are important, and how companies are testing the model in markets where those variables are less favorable than in Phoenix.

The characteristics of homes in the market

When considering the characteristics of a home in a market the homogeneity of the housing stock, the age and condition of the average home, and the home price are the most important factors. 

Homogeneity is important because the models work similar to agent’s pricing models: they determine value by finding “comps”, or the selling price of comparable homes in similar areas. 

Age and condition determine the amount that would need to be spent on renovation, with the hope of removing any costly surprises once the home is purchased. Low home prices reduce the amount of capital that needs to be invested in a home, allowing iBuyers to buy and sell more homes more quickly, with less risk. 

A majority of homes in Phoenix were built after 1980 according to Census data, and the average home value is just below $260,000. 

This price is well within the typical band for iBuyers: Mike del Prete found that two-thirds of iBuyer purchases were for homes between $150,000 and $300,000. Much of the city is tract housing, or homes with similar floor plans that are clustered together on one, subdivided, piece of land. Tract housing makes “comps” significantly easier, while Phoenix’s newer, and relatively cheaper housing prices lower the risks for iBuyers. 

Los Angeles

But Los Angeles, where Zillow, Redfin and Opendoor all launched in 2019, is the antithesis of Phoenix.

Its median home price is north of $600,000, double the high end of the majority of iBuyer sales, and a majority of homes were built before 1970, according to Census data. 

Los Angeles, with older homes that weren’t built in subdivisions or with repeatable floor plans, doesn’t have Phoenix’s easy comps. The problem is compounded by the hills, whose famous views make pricing more challenging. 

“In Los Angeles, you have issues with mountain views,” Rob Reilling, Phoenix general manager at Opendoor told Business Insider. “Different houses on the same street, depending on how high up they are on a hill, can have vastly different values.”

This problem is repeated in Miami, where Zillow operates its iBuyer and high-rise condos complicate the picture. 

“There’s a significant price difference if the condos are facing ocean or inland, to the tune of $50,000 to $100,000,” Josh Swift, SVP of acquisitions and operations at Zillow Offers, told Business Insider. 

Swift also highlighted the difference in homeowner association fees and amenities between different condos as another factor to consider. 

Read more: These 12 real-estate tech startups are transforming the financials of homeownership

The operational characteristics of the market 

Operational concerns in the market range from the ease of commuting, the impact of seasonality on the market and on home conditions, and the legal hurdles to quickly renovating property. 

The ease of commuting is important when thinking about the challenges of inspecting, renovating, and selling homes at a large scale. The lower-case i in iBuying seems to imply that the process is wholly digital, but iBuying requires people to be physically present at the home at multiple points in the process. 

Winters suck for flipping homes.

In a city like Los Angeles, where bumper-to-bumper traffic is a fact of daily life, one iBuyer executive said that they began their operations in a tight geographical area to make sure that their renovation crews weren’t collecting money, and wasting time, by sitting in traffic all day. 

Seasonality has two impacts, both on the material condition of the home, and the delays that winter-time drops in activity can bring to iBuyer’s breakneck speed. Other than Phoenix, many of the other areas that iBuyers have proliferated have mild, or nonexistent winters: Las Vegas, Los Angeles, Raleigh/Durham and Charlotte, North Carolina, cities in Texas, and Atlanta. 

Denver skyline

Minneapolis and Denver are the two areas with harsh winters where iBuyers operate. If an iBuyer purchases a house in December, and it is largely unoccupied for the next month or two while it is renovated and sold, there’s a high risk that pipes could freeze, causing a costly leak. If they’re purchasing the home while there’s snow frozen on the roof, it’s unlikely that they would notice any potential leaks in the roof.  

“Winters suck for flipping homes,” del Prete said, highlighting the potential for frozen pipes and general discomfort as main factors.

Homes in areas with more severe winters are also less likely to sell during the winter, leaving them on an iBuyers’ balance sheet for a longer — and riskier — amount of time. 

Chicago, which doesn’t yet have any iBuyers, shares the winter issues of some of the markets outside of the Sunbelt, but brings its own local operational challenges. Construction permits that take a few days in Arizona can take a few months in Chicago, according to Cortney Read, director of communications for Offerpad. This delay adds a significant cost and risk for any iBuyer. 

It has to sell, and sell fast

The most important variable for iBuyers, and the one where compromise and experimentation is least likely, is the health of the housing market in the city. Speed is of utmost importance for iBuyers, so they need to operate in markets where homes move quickly. 

The main hubs for iBuying across the Sunbelt, and outliers like Denver and Minneapolis all have booming housing markets, with positive immigration and job creation numbers. These strong markets make the probability of a quick sale much more likely

Will we see iBuyers explode across the nation — and even abroad?

iBuyers have expanded rapidly since 2014, but, outside of Minneapolis and Portland, have largely been clustered in the most booming markets in the south.

While the companies all have slightly different plans for expansion, their general strategy will be the same: collect as much data as possible, try markets that are one variable away from the markets they’ve historically worked in, and then test and adjust the model as it continue to buy more homes. 

“The basic iBuyer business model needs to be tested for resiliency in different market positions,” del Prete said. 

Just like any algorithm, iBuyers are learning by consuming as much data as possible. This requirement may give Zillow, with its long history of collecting data and creating its Zestimate, and Redfin, which has bundled iBuying in with its brokerage, an advantage.

“We have the luxury of operating within an existing platform and an existing company,” ZIllow’s Josh Swift said.  

While this means that they’re able to use more internal data in their calculations, it also means that they have the ability to promote their iBuyer services through their more established, and more popular products.

“This option can change real estate in the agents flavor,” Quinn Hawkins, head of Redfin Now said. 

This also has the added bonus of bringing in more business to their traditional sectors. In Zillow’s case, a seller may reject their iBuyer offer, but could then be referred to one of Zillow’s agent partners.   

wealth management and tech 1 4x3

“They saw an opportunity to try and move closer to the customer, which they believed and still believe probably means they can increase their influence with Realtors, which are their main customers,” said Brad Erickson, an analyst at Needham. 

Other companies in the space are beginning to offer iBuyer like services to homebuyers and sellers, offering full cash offers for homebuyers or the ability to sell their home to a company and then stay as a renter.

Offerpad has partnered with Keller Williams so that buy-side agents can offer the service to their potential clients.

Opendoor, with $1.5 billion raised from a list of investors that includes deep-pocketed fund SoftBank and private equity firm General Atlantic, has cash and an early head start in the iBuying business. 

Offerpad’s expansion plan, highlighting depth instead of breadth, is the opposite of Zillow’s rapid expansion, with 23 markets opened in 20 months of operations. The company has focused on expanding to small submarkets near the areas it has already been operating, and it believes that the model will work in more rural markets, a belief that not all operators share. 

“iBuying is unique in that it can operate in both small markets and large metro areas,” Brian Bair, Offerpad co-founder and CEO wrote to Business Insider over email. 

Another trend that could expand the areas where iBuying is profitable, one that all of the iBuyers are incorporating into their business plan, is the bundling of title and mortgage services to the transaction. 

If customers were to use these services, this would significantly increase the margin for iBuyers, which could lead them to expand to riskier markets. 

There’s always a segment of homes in each city to tap into and then expand from there.

 

Our intention is definitely to go all the way across the country,” Josh Swift of Zillow Offers said. 

International onlookers have become involved too. Fairhomes, a Dutch startup, has launched an iBuying business in Copenhagen, and plans to expand to Berlin shortly.

Kamran Ahmed, CMO and cofounder of Fairhomes, believes that the model could work in any city. 

“There’s always a segment of homes in each city to tap into and then expand from there,” Ahmed said. 

Kodit, a Finnish iBuying company, has recruited Mike del Prete to advise it. Loft, a Brazilian brokerage that offers iBuying services as well as creating its own local MLS, raised $175 million earlier this year in a round led by Andreessen Horowitz that included funding from proptech fund Fifth Wall. 

Others are less optimistic about the model’s ability to expand worldwide, stressing the importance of quick sales and the right kinds of housing stock, conditions that don’t exist in rural areas or in old, large cities like Boston and New York. 

“I think that folks in every market has that problem,” Quinn Hawkins of Redfin said. “I do think it will come to every market, but it will be a long time before it comes to Boston.”

Join the conversation about this story »

NOW WATCH: WeWork went from a $47 billion valuation to a failed IPO. Here’s how the company makes money.