Zillow closes troubled home-flipping business amid a 'decelerating' housing market

We just witnessed the hottest stretch in the housing market’s tabulated history: In the 12 months ending Aug. 2021, U.S. home prices climbed a record 19.9%. But industry insiders say that historic run is beginning to lose some steam—something that’s already causing pain for Zillow.

The issue isn’t Zillow’s core online real estate listing business. Instead, it’s the home-flipping business Zillow started in 2018 that’s struggling. Last month, the company went as far as to pause the program, called iBuyer, because of struggles selling the homes for enough to recoup expenses. And, on Tuesday, it said it will scrap the service altogether and cut 2,000 workers.

“We’ve determined the unpredictability in forecasting home prices far exceeds what we anticipated,” Zillow CEO Rich Barton said in a statement on Tuesday. The real estate listing site also reported third-quarter earnings in which it said it had lost a massive $339.2 million during the quarter, largely due to the faltering iBuyer program. During the same quarter a year ago, it posted a $39.6 million profit.

Wall Street expects the troubles to continue this fall. Look no further than KeyBanc analyst Edward Yruma’s research note published this week in which he said two-thirds of the homes owned by Zillow (at least among the 600 he measured) are currently worth less than what the company paid for them.

Let’s be clear: This announcement doesn’t mean the housing market is heading backwards. Prices are still increasing. Instead, it stems from the fact that the strong housing market, industry insiders tell Fortune, has helped to cover-up some of the deeper issues in Zillow’s home-flipping business. After all, it’s easy to make money when home prices are climbing 19.9% (see the chart below). But future growth is expected to be slower as mortgage rates rise, as is expected. Fannie Mae predicts 7.9% home price growth in 2022, while CoreLogic expects a meager 1.9% gain. Now that the market is cooling, cracks are showing in Zillow’s iBuyer program.

“Home price appreciation is a major part of iBuyer profits … but as home prices start decelerating in some cities, Zillow’s model does not work so they’ve stopped iBuying to avoid massive losses,” says Nik Shah, CEO of Home.LLC, a startup that provides down payment assistance to homebuyers in return for a share of any profits, tells Fortune.

Zillow’s iBuyer program also got pinched by the combination of the ongoing labor shortage, soaring material prices, and product delays. Even lumber—which burst back in the spring when prices topped 300% above their pre-pandemic levels—are back up over 40% since August. Shah says the issues in Zillow’s flipping business only got “exacerbated” by these “staffing shortages and prohibitive repair costs.”

But don’t pin the failed iBuyer program simply on the housing market or the pandemic. This business unit was a major money loser from day one. The company struggled to both forecast home prices, as Zillow’s CEO admitted on Tuesday, and turn home-flipping into a scaled business.

“Zillow quitting its iBuyer business shouldn’t necessarily come as a surprise to those familiar with the flipping industry. Most successful flipping is done by local flippers using intimate knowledge of existing home conditions, renovation costs, and market idiosyncrasies, which is something that is very difficult to obtain purely through an automated home value estimate,” Ralph McLaughlin, chief economist at Kukun, a real estate analytics firm, tells Fortune. “In addition, flipping at scale is very difficult, if impossible, to do across many markets because of challenges associated with securing labor, materials, and expertise. But Zillow has surely learned a lot from this experiment, and I wouldn’t count them out for making a return to iBuyer in some form in the future.”

On the year, Zillow’s shares are down 37%. That doesn’t include the additional 11% drop after hours on Tuesday. Hardly, the return you’d expect for a company at the epicenter of a recording-breaking housing market.