A few years ago I was moving out of state and looking to sell my 2012 Acura TL (RIP). Great car, but was getting a bit long in the tooth and having some mechanical problems. About 10% of the time, it would require a jump to start up (yes I tried replacing the battery). I had two options:
Sell to an individual
Sell to a company
I consider myself someone of above average integrity, so I didn’t feel right selling to a random individual (at least not with disclosing this unknown issue). But since I was also in the middle of moving my entire household I didn’t want to waste a ton of time haggling about this car. I went and looked at the KBB value and had a decent idea of what I could fetch for it. I tried 3 or 4 of the “instant car offer” type businesses and compared their offers. One company was a full $1,500 above the rest (and on the higher end of the KBB range). I brought it to them, rolled the dice on my 90% chance, and (thankfully) the car fired right up. The onsite rep drove it around the block and confirmed the offer, cut me a check and I was on my merry way. It felt immoral to sell the car in that condition to an individual, but totally fine to sell to a business. They are the professionals, if that’s all the due diligence they do - then that’s on them. Now take that story and insert ‘house’ instead of ‘car’ and you get to a huge problem for iBuyers.
For those unfamiliar with iBuyers, these are companies whose primary model is to buy a home directly from the Seller - and ultimately sell for a profit (TBD if that can be done at scale consistently). All cash, no showings, no repairs. Think Opendoor, Offerpad, and up until recently Zillow.
I imagine I’m not alone in my feelings about the sell-to-a-company vs sell-to-an-individual scenario. The big business should know better, they do this all day every day. And even if something does slip through the cracks they probably have contractors on payroll to fix the problem at cost. Screwing over another individual feels wrong (see: the golden rule), screwing over a big company feels “meh”. If enough of us feel this way, then these misses compound to cost iBuyers big bucks.
iBuyers know this, but are torn because they want to make the selling process as smooth as possible. Unfortunately for them that leaves open some serious risk from a due diligence perspective. iBuyer leadership finds themselves saying things like:
“Don’t bother the seller with too many pesky questions, we need minimal boundaries to get them under contract or they’ll go to a competitor.”
“Don’t bog down the process with multiple site inspections, it annoys the customer - or worse if we have to lower our offer accordingly they’ll get mad and won’t sell to us.”
And frankly they’re not wrong. iBuyers need to acquire homes - they’re an inventory company that needs inventory. iBuyers already have a stigma around them for ‘baiting and switching’ sellers. You’ve most likely heard this around your watercooler (are those still a thing?): “They offer you a high price just to get in the door, then scale the offer way down once they do their inspection.” The fact that this narrative is out there makes sellers hyper aware of it. Even though in some scenarios this is absolutely what should happen. iBuyers have to account for this and bend further than most traditional buyers. So iBuyers wind up purchasing homes that need some TLC (aka ‘bad homes’) - due to some combination of the seller not disclosing it, or the iBuyer not being thorough enough on their due diligence.
Let’s say 10% to 20% of iBuyer purchases are ‘bad homes’ (most traditional agents/buyers will argue a higher number, iBuyers will most likely argue a lower number - it's not super relevant for this exercise).
These homes end up on the market next to every other home listed. Buyers and their agents can spot these problems during showings and move along to the next home, or if the buyer does go into contract these issues creep up during the inspection - causing hefty seller concession or the buyer to terminate and move on to a different home. One of two things has happened here:
iBuyer took a loss.
The home goes back onto the market.
Not the absolute worst thing if one concedes that 80% to 90% are flipped within the industry average number of days. But what happens over time as these problem-homes sit on the market longer? They become a larger % of your active inventory. “Good homes” are here today, and gone tomorrow. “Bad homes” linger and get an ever increasing number of eyeballs on them (and subsequently scare all these eyeballs away to go tell other eyeballs). This is where the narrative of iBuyers having dilapidated inventory comes from. Truth is, iBuyers have some good homes and some bad homes, same as any other large aggregator of single-family homes, but the bad ones attract significantly more attention. These homes become a massive thorn in the side for iBuyers, they tend to sit on market for a much longer period of time - racking up the holding costs. Or they need to be sold at a deep “discount” (compared to what they purchased it for). Neither of these is good for business,
But wait - there’s more! As if this due diligence problem wasn’t difficult enough, there’s another equally important problem with the iBuyer model - and it’s centered around their pricing algorithms.
Let’s get the basics out of the way. No pricing algorithm is going to be 100% accurate - there are just too many variables (and a few of them unknowable). That of course won’t prevent iBuyers from investing significant resources to get their algorithm as close to 100% accurate as possible. The good news is that the model doesn’t have to be 100% accurate (that is if you believe in the iBuying model). They just need to be more accurate than the competition. With an “inaccurate” (anything less than 100%) pricing algorithm you’re going to miss on both the high side and low side of home valuations. You’re going to overvalue some homes, and you’re going to undervalue some homes. C'est la vie. The problem here is that the pricing algo is effectively negotiating against the homeowner - who in theory should know the home considerably better than the iBuyer does.
Back to my Acura TL example. As I said, I got a range from KBB so I had a ballpark idea of what I could expect in the market for my car. But I also knew that my car wasn’t 100%. So when the cash offers started rolling in from these companies I compared them to the range. A few of the offers were in the ‘below average’, and ‘average’ range. While the one I ultimately selected was ‘above average’. I jumped at that offer because realistically I should have been selling my car in the ‘below average’ range given its mechanical issue. So while the other companies that made the offer lost because they didn’t get to purchase my car, they won because they didn’t have to purchase my car. But here’s the kicker: if I knew my car was in pristine condition, I most likely wouldn’t have sold it to any of them. I would have sold the old-fashioned way. No amount of negotiating with these companies would have brought the offer above from ‘above average’ to ‘excellent’. They’re simply not in the business of buying at ‘excellent’ prices - there’s no margin left for them to make their money.
So again iBuyers have pricing algorithms that miss on both the high and low side. The sellers, who deep down know they have a ‘below average’ home, can’t sign the ‘average’ offer contract fast enough. The sellers who deep down know they have an ‘above average’ home see the offer as an insult and unsubscribe from all future correspondence.
While I’d expect the algorithm to have a bell curve distribution from an accuracy standpoint - iBuyers don’t get the benefit of both tales (at least not even close to any equivalent ratio). iBuyers have (and will continue to) undoubtedly overpay for some homes - that’s the cost of doing business. Unfortunately the accidental upside scenario is much less likely. The accidental upside scenario generally only happens in a pinch. When the seller has a very strong desire to sell the home with little-to-no hurdles (think divorce, estates, job relocation, etc.) Are there enough of these types of sellers to offset the downside? And if there are, can an iBuyer capture enough of this market to create a profitable business? The jury is out.
Circling back on my car story, I drove past that business the other day - it’s now a pool supply shop. Hopefully that’s not foreshadowing for all the iBuyers out there as I do believe they fill a real gap in this broken industry.
Redd