As interest rates rise, mortgage rates have climbed close to 7% over the past few months. This means that demand for housing has come down significantly. A number of factors, including the prevalence of working from home, has led many people to move away from metropolitan areas. Now that interest rates have risen, demand has cratered and home prices have also stymied. Prices may correct 10% through the year and could be down as much as 30% to 40% in the next downturn, if not more.
Real estate tech companies have had to reassess their business model and the entire sector has experienced issues. On the bright side, the supply shortage (primarily due to individual investors who bought second and third homes in order to supplement their income) means that builders will bring new inventory to the market.
As the tech real estate market restructures, many companies like Zillow Group Inc. (NASDAQ: Z) will want to keep their head above water after witnessing their stocks deteriorate. However, due to a number of poor decisions from management, including taking on a lot of speculative real estate assets and hoping they could resell them (a model that reflected the pre-2008 real estate frenzy), the company has fared poorly.
Zillow has managed to scale back the home-flipping aspect of its business and focus on providing logistics and realtor services to homeowners. Zillow’s losses have slowly turned into profits as losses from the sale of its portfolio finalize and the house-buying program more or less ends.
In 2021, a record number of real estate agents appeared in the United States, according to the National Association of Realtors. More than 156,000 people joined in 2021 and 2020 — more than 60% higher in the two years prior. An increasing number of realtors may be forced to quit their jobs, mainly as years of real estate exuberance extinguishes. Ironically, this may allow Zillow and other tech companies to fill the gap as more and more people opt to purchase their houses through alternative sources in order to gain easier access to properties, access standardized sale procedures and experience cheaper transaction fees.
Any significant correction in the realtor market could lead to a readjustment in the overall scenario in market share and leave some room for Zillow to grow. Currently, the company has a 12% market share, which could increase if market dynamics change.
The coming quarters will likely see weaker-than-expected revenue, with U.S. home sales at 4.8 million in August after topping out at around 6.65 million in January.
Market headwinds will weigh on revenue in the short term, but the long-term prospects for Zillow remain steady. Revenue is likely to come in again around $1 billion for the next quarter and may stay tepid for a few more quarters after that. However, valuations remain within reasonable levels and Zillow could see profit margins head back to around 3% in the short term and around 5% for the long term. Zillow has cut costs and reduced staff related to its home-flipping business. Gross margins have probably bottomed out and will likely come in much higher. More constrained operational costs should help the company get back on track to profitability.
Zillow has a business model that is relatively sustainable now that the company has slowly returned to its roots and ditched add-on services.
