The Opendoor Paradox: A Strategic Analysis

Last week I had the pleasure to visit Opendoor, the billion-dollar real estate disruptor, to give a presentation on emerging models in real estate around the globe. The presentation covered my two-year research into the winning models that are changing how houses are bought and sold.

There were some great questions from the audience, both on international models but also my thoughts on the Opendoor model itself. These thoughts, in addition to a number of recent conversations with investors interested in the space, led me to contemplate Opendoor’s future strategy and the complex competitive situation it faces.

The end result is what I call the Opendoor Paradox, and the premise is simple: the more successful the business becomes, the harder it will be to succeed.

Business model challenges

The business model of Opendoor and other iBuyers (those that buy houses directly from consumers and then sell them on) has a number of challenges:

• An undifferentiated product. At its core, all iBuyers offer the same basic product to consumers: certainty and simplicity. There may be price competition or various technologies to support the process, but those advantages lie in the margins. The typical consumer only cares about one thing: instantly selling their house.

• Resource intensive. The iBuyer model is expensive, and not just because it’s buying houses. To be successful, iBuyers need a lot of boots on the ground in each market they operate. These businesses are people intensive.

• No repeat customers. This is true for all of real estate, but it doesn’t change the fact that without repeat business the cost of attracting new customers is expensive. There are no economies of scale around attracting and retaining a loyal clientele. Most importantly, this levels the playing field and reduces the barriers to entry for competitors.

Competitive tension

The U.S. is big, but for whatever reason the growing pack of iBuyers have all decided to launch in the same bunch of cities. Phoenix, Las Vegas, Atlanta, Orlando -- that’s the battleground. It’s a mess of a competitive situation where they will end up spending valuable time and resources competing against each other instead of growing the market.

Markets in bold have three or more active iBuyers.

Traditional marketplace businesses have a first-mover advantage. The first to enter a market builds brand and audience, and with each day that advantage becomes harder to overcome (network effects).

But that’s not true with iBuyers. Being first to launch in a market doesn’t necessary bestow an unfair advantage.

Because of this, it’s most likely a winner-take-most market, similar to Purplebricks and the online agencies in the U.K. With a distinct lack of network effects, an undifferentiated consumer proposition, and no customer base, you end up with a healthy competitive field that, over time, is most likely dominated by one large player.

I would expect to see more competitors launch in 2018. The market is going to get very crowded very fast. And that forms part of the paradox: the more successful Opendoor and its model becomes, the more competitors will enter the space to get a piece of the action.

The real competitive threat: incumbents

While the various iBuyers might beat each other up through tough competition in each market, that’s not the biggest competitive threat they face. The top competitive threat is the massive real estate incumbents themselves.

This forms the next part of the paradox: the more successful Opendoor becomes, the more of a threat they become to industry incumbents, which forces them to respond. The most logical response from a major player such as Realogy or Keller Williams would be to launch their own iBuyer program.

This is what Redfin has done with Redfin Now. Redfin was able to spin this test up quickly and is now able to adopt a “me too” proposition when attracting new customers. For a small amount of effort, incumbents can blunt the iBuyer proposition.

It’s a simple extension: If a consumer decides to sell their home with an incumbent, they can choose the traditional agent services for a commission, or they can sell it instantly for a fixed offer and certainty.

Make no mistake, the offer and the experience from the incumbent is going to be bad. They’re simply not set up to provide the same quality of service as Opendoor, and most likely will lowball the seller to protect their margins. But the offer will be present and it will appeal to some sellers.

The proposition from the incumbents will be poor, but it will be enough to soak up a portion of the demand in the market and take momentum away from Opendoor and other iBuyers. And if Opendoor can’t scale or if it becomes too expensive to attract new customers, it’s game over.

The more successful Opendoor becomes, the more incumbents will be forced to react, and when they do it will harm Opendoor’s growth and profitability.

Scaling challenges

Opendoor faces a number of challenges over the next 12 months. The most pressing of which is how the business scales nationally.

The previous two years have been spent proving out the model. Opendoor has been refining its processes in its two core markets, Phoenix and Dallas, trying a partnership model in Las Vegas, and just recently launched in Atlanta, Orlando, and Raleigh.

But 2018 is the big test: going national. I expect Opendoor to meaningfully be in ten markets this year. This will put a tremendous amount of pressure on the business, the management team, and the well-refined processes to see if they can all truly scale. It’s like NASA going to the moon after conducting tests in Earth’s orbit (which is exactly what they did). It’s a big step.

It will also be interesting to see how Opendoor approaches advertising. In the U.K., Purplebricks ran a national above-the-line advertising campaign (TV and radio) to build brand. That will be expensive in the U.S., but it’s a critical component to scaling the business, especially long-term customer acquisition costs. It’s also necessary to start building a moat between itself and its iBuyer competitors.

Opendoor will also face a significant challenge as it scales its people. As I mentioned above, scaling the business is resource intensive and is people dependent.

To win, Opendoor needs to provide exceptional customer service and needs to hire exceptional people. The more markets it expands to, the more people it will need. And the more people it hires, the more effort it will take to find exceptional people.

This contributes to the paradox. The larger Opendoor gets, the more difficult it will become to find quality people and maintain a high level of quality across a growing employee base -- all critical ingredients in delivering a superior customer experience.

The question of fees

Opendoor -- and its peers -- will also face ongoing challenges around its fees, both clearly explaining them to consumers and reducing them.

Opendoor needs to be price competitive with traditional real estate agents to succeed. The lower it can drop its fees, the more customers will flock its way. From the outside looking in, it appears to be doing this with the current fee structure, which happens to coincide with a noticeable uptick in activity in Q4 2017.

But more fundamentally, explaining fees is complicated. The pricing charts on Opendoor and OfferPad’s websites are long and complicated, as they attempt to explain holding costs, hidden costs, and somehow compare apples to oranges. If it takes more then five seconds to explain this to someone, you’ve already lost them.

Key strategic questions

Opendoor’s path forward is far from clear. As with all trailblazers, the future is uncertain, and in this case there are a number of threats. I believe the key strategic question -- and the area of utmost importance and absolute focus for Opendoor -- must be how to deliver the best experience possible to its customers.

Growth is key. Opendoor must reach scale for the business model to be sustainable and turn a meaningful profit. So it must venture forward aggressively, enter new markets, compete with fellow iBuyers, and be prepared to meet the incumbent’s threat head-on.

Opendoor must continue developing technology to automate the process (to improve efficiency) and deliver a superior customer experience (all-day open homes).

As it scales -- and because the business is so reliant on people -- it must attract and retain exceptional talent in each market it enters. This will be a key challenge, but not impossible. Maintaining a customer-focused culture with each new hire and each new contractor is easier said than done, but a critical task nonetheless.

And lastly, Opendoor must grow as efficiently as possible. It must continue reducing its fees and maintain its impressive operational efficiency. The holy grail would be combining the low-fee proposition of a Redfin or Purplebricks with the certainty of an iBuyer, but it may not be possible.

Growth comes with its own challenges and that is especially true of Opendoor. And as it grows, it will face the paradox of its greater and greater success bringing greater challenges to overcome. But only with great risk comes great reward.

The Opendoor Machine: 4 numbers you need to know

Opendoor, the real estate startup that purchases homes directly from sellers, leads the pack of a new breed of real estate tech companies. It continues to innovate and improve the experience of buying a selling a home, and as the analysis below shows, is making significant improvements to its business model as it continues to grow.

150 percent

I believe Opendoor’s ultimate metric of success is how many homes it sells. More than just buying homes (which anyone can do with enough money), the successful completion of Opendoor’s business model requires it to re-list and sell the homes it buys.

So it should come as no surprise that the first key number -- 150 percent -- is the growth in homes Opendoor has sold in 2017 compared to the same period last year. This is in its two biggest markets, Phoenix and Dallas.

The year-on-year growth is driven by Dallas, which came online in September of 2016. Entry into new markets will drive Opendoor’s overall growth. Over the same time period, Phoenix experienced a 55 percent increase in home sales.

The more recent growth in home sales has been driven by the Phoenix market, where Opendoor is selling a median average of 130 homes per month over the past three months, compared to 90 homes per month for the preceding three months.

After a big bump in Q1 of 2017, home sales in Phoenix are tracking in-line with last year.

However, there is a notable uptick in the number of homes purchased by Opendoor in recent months. Given that, we can expect a corresponding uptick in sales for the rest of the year and into early 2018.

13

This is the median average number of “prep days” between when Opendoor buys a home and subsequently lists it for sale. This is based on 50 recent transactions in Phoenix and Atlanta (where Opendoor recently launched).

Opendoor Prep Days

Impressively, this number is down from a median average of 20 days when I last did an analysis in December of 2016. That’s a 35 percent improvement! To quote that earlier analysis, “...given that Opendoor generally borrows 90 percent of the purchase price and is servicing that debt, time is money!”

That earlier analysis also predicted that a “battle-tested and efficient flip process” was one of three sources of competitive advantage for Opendoor. This improvement reflects strides made in Opendoor’s operational efficiency. It is clearly standardizing its operations and learning from past success and failures on big and small levels, to truly become a home flipping machine.

And it’s not just in Phoenix, Opendoor’s first market. It’s newest market, Atlanta, is on track just as impressively. Looking at 20 transactions shows a median average of 11 prep days. That’s a great start.

Most importantly, this shows that Opendoor’s growing operational efficiency is a transferable competitive advantage between markets. This is a critical ingredient for national expansion.

41

This is the median average number of prep days for Opendoor’s top competitor in the Phoenix market, OfferPad. This is based on a selection of transactions in July, August, and September.

It clearly shows that OfferPad is holding homes longer than its competitor -- over three times as long!

OfferPad Prep Days

In a world where time is money, this represents a significant business model and financial disadvantage for OfferPad. The longer it holds homes, the higher its holding costs.

It’s not clear what’s driving this number. Could OfferPad be spending more time and money fixing up houses before flipping them?

Regardless of the answer, the comparison of prep times between Opendoor and OfferPad illustrates stark differences in their respective business models. Opendoor aims to flip houses as quickly as possible with a super efficient process. OfferPad either has a different model, or is still working on optimizing its operations.

7.4 percent

All businesses need to make money, and Opendoor is no exception. Outside of charging homeowners a fee for its services, the second way Opendoor makes money is the difference between what it buys and sells a home for. This difference is the gross margin, and in Q3 of 2017, Opendoor’s gross margin in Phoenix was 7.4 percent.

Gross margin is a top line number (hence “gross” and not “net”), meaning it does not include the numerous costs associated with holding, repairing, and reselling a house.

What’s notable about this number is that it’s up considerably over the past year. My previous analysis in December 2016 showed a gross margin of 5.5 percent, and a comparison to Q3 2016 shows a gross margin of 5.6 percent.

This data is based on all publicly recorded transactions, so it’s not just a selection or a sample.

So Opendoor has managed to increase its gross profit on each home it sells by about 30 percent. We can speculate that this is in line with its recent strategy of lowering the fees it charges to homeowners. If it can make a bit more on each home and charge homeowners a bit less, it all evens out in the end.

Final thoughts

Working through this analysis highlighted a few key takeaways.

First off, Atlanta is off to a good start. The average number of prep days is strong and the gross margin is in-line with the more mature Phoenix market. It’s still early days, but this shows that Opendoor is able to transfer its honed operational efficiency to new markets, which is a requirement if it’s going national.

Secondly, Opendoor won’t achieve its goal of being in 10 markets by the end of 2017. Expansion is slower than originally thought. With over 100 employees in Phoenix alone, perhaps the Opendoor model is more time consuming and resource intensive than originally thought?

Lastly, and I believe most importantly, Opendoor continues to grow. The customer proposition is resonating with consumers in increasing numbers. The business model is being refined. And Opendoor is learning as it expands into new markets.

This new model of buying and selling homes is not going away. The entire industry can learn from the likes of Opendoor and the growing number of competitors that are popping up. Consumers are being increasingly drawn to new models that improve the customer experience of buying and selling a home.

A note on data: this analysis is based on MLS records, listings from Opendoor’s web site, the Maricopa City Assessor’s public property records, public records sourced from Redfin, and The Cromford Report, a specialist web-site monitoring the Greater Phoenix housing market. If you’re researching Opendoor and on the hunt for data, check out the iBuyer Analysis Pack.

iBuyer Market Update: Opendoor and OfferPad in Phoenix

iBuyer Market Update: Opendoor and OfferPad in Phoenix from Mike DelPrete

Are you researching iBuyers like Opendoor and on the hunt for data? Do you work at a consulting or venture capital firm? Check out the iBuyer Analysis Pack.

Growth in new markets: An analysis of Opendoor, Knock, and OfferPad

Last December we conducted a wide-ranging analysis of Opendoor, the real estate startup that purchases homes directly from sellers. A look at of thousands of MLS records formed the basis of that piece, showing trends and extrapolating insights from the data.

At the time there were a number of unanswered questions we wanted to dig into: how much money does Opendoor make per transaction, how big could the model really get in the U.S., and does Opendoor have a sustainable competitive advantage against competitors?

Four months later I’m once again looking at the data, with these questions on my mind:

• What does Opendoor’s traction look like in its (relatively) new markets, Dallas and Las Vegas?
• Are there any notable changes in Opendoor’s fundamental business operations and metrics?
• Opendoor has two well-funded competitors in the market, Knock and OfferPad. How are they doing?

After looking at the data, there are three main observations:

• Dallas, Opendoor’s second market, is doing remarkably well. The transaction volumes there reached parity with Phoenix after only six months.
• Las Vegas, Opendoor’s third market, is off to a slow start. Key metrics suggest Opendoor is still finding its sweet spot in that market.
• Knock, Opendoor’s Atlanta-based competitor, is very early stage and has yet to ramp up in any significant fashion.

A snapshot of current volumes

Last time we looked at the data (at the end of November 2016), transaction volumes in Phoenix were going strong, Dallas was on a promising upswing, and Las Vegas was still small.

Since then, overall transaction volumes have surged from around 200 home sales per month to over 300 sales per month in February. In other words, in February, Opendoor was selling ten houses each day (including weekends) across all three markets. Not bad!

This growth appears to be driven by sustained volumes in Phoenix and very strong growth in Dallas -- putting that market on par with Phoenix after only six months.

Opendoor does Dallas

Let me be clear: I’m impressed with the growth in Dallas. When I’m evaluating new businesses and new business models (see my article, The Two Principles of Startup Success), I always look for business model validation (does this work in one market?) and then the ability to scale (can this be replicated in another market?).

Opendoor’s success in Dallas is a resounding answer to that question. Yes, the business can scale beyond one market. This is a noteworthy achievement for the firm.

Like Phoenix, the average selling price in Dallas is well-clustered. During the past three months, Opendoor’s median sale price in Phoenix was $210,000, compared to $212,000 in Dallas.

This suggests that, like Phoenix, Opendoor has found its sweet spot in the Dallas market. It deals with houses in a narrow and specified value range and (generally) does not deviate from that.

Opendoor credits its success to the team in Dallas and their focus on providing customers an experience they love. “We're seeing that customer love translate to growing word of mouth, and a growing business there,” said JD Ross, one of Opendoor’s co-founders.

What about Las Vegas?

I’m so glad you asked. Opendoor started listing and selling homes in Las Vegas at about the same time as in Dallas, last September. But growth has been slow ever since.

The sale price is not as well-clustered as in Dallas and Phoenix. There’s quite a spread of prices that Opendoor sells its homes for.

The median sale price in Las Vegas is also materially higher than Opendoor’s other markets, sitting at $322,000 (compared to $210,000 and $212,000 in Phoenix and Dallas). It’s not a factor of higher house prices in Las Vegas, either. According to Zillow, the median home price in Las Vegas is $209,000 and the median listing price is $247,000 -- which is on par with Phoenix and Dallas.

In Phoenix and Dallas, Opendoor is selling homes for roughly the market’s median home price. But in Las Vegas, it’s considerably higher.

Opendoor has been selling homes for six months in Las Vegas; perhaps its median sale price started high but has been falling to normal levels over time? Nope.

There’s a noticeable oddity in the Las Vegas market, with slow growth, a less-clustered sale price, and a sale price that’s higher than normal. Why?

It’s because Opendoor’s approach to the Las Vegas market is different. “In Vegas we've been focused on partnerships, and haven't pushed to expand to the broader market there yet,” says JD.

This is a different approach than Opendoor has taken in its other markets, with correspondingly different results.

Opendoor has partnered with Lennar (a new home builder) to offer the Lennar Trade Up program for Las Vegas homeowners. It’s a way for homeowners to “trade in” their existing homes to Opendoor as part of a package to buy a new home from Lennar.

This is a different approach than Opendoor has taken in its other markets, with correspondingly different results. My guess is that it’s a lower-cost option for the firm that effectively outsources lead generation to a partner while allowing Opendoor to focus efforts elsewhere. In other words, it’s a test, which is exactly what a you’d expect from a young, growing company.

Knock, Knock

Since the last analysis, two well-funded competitors have entered the U.S. market: Atlanta-based Knock and Phoenix-based OfferPad. Both announced that they raised over $30 million each in January of this year.

Knock is live in Atlanta and currently trading with tiny volumes; we’re talking about one home sold each of the past two months. It also has a very small number of new listings each month, anywhere between one and six over the past four months.

Knock either does not have the price discipline we’ve seen work so successfully for Opendoor, or is not yet enforcing it.

The median sale price for Knock’s ten listings that sold is $290,000. But underneath that, if we look across all listing prices, you can see they’re not clustered at all. The home values are all over the show, meaning Knock either does not have the price discipline we’ve seen work so successfully for Opendoor, or is not yet enforcing it.

There are several key takeaways in looking at Knock:

• This is a difficult business to be in. Raising money doesn’t give you market share. It takes time, skill, and good operations to build scale.
• Knock is super early stage. Its transaction volumes suggest it is still tinkering with its core operations and proving it can make the model work before attempting to scale up.
• Price discipline is important. It may be tempting to deal with higher-value homes where the fees are correspondingly higher, but Opendoor has shown us where the sweet spot for this model really is.

OfferPad, on the other hand, is a more mature business with better traction -- at least in the Phoenix market. With the help of friends at ATTOM Data Solutions, a real estate data company that aggregates data directly from property records (as opposed to my usual MLS sources), I was able to gather a snapshot of relative traction for both businesses in Phoenix.

It's worth a deeper dive into OfferPad, its model, and relative merits. But that will have to wait until another time.

A look at Opendoor’s operations: anything interesting?

To wrap everything up I took a quick look at Opendoor’s core business metrics to see how things are tracking.

To begin with, the much-talked-about home value appreciation has stayed the same with a median average of 5.4% (looking at 43 recent sales). That’s the difference between what Opendoor buys a home for and eventually sells it for -- about $11,000.

And listen: That’s the difference between the buy and sell price. Opendoor takes on a number of costs associated with sprucing up, holding, and selling a house. So don’t confuse that number with profit; it’s not.

If you prefer small dots to blue bars, below is another way to visualise the same data.

The average days on market in Phoenix has seen a slight improvement, moving down to a median average of 41 days from 47 days in the last analysis. That’s a 12% improvement, which if I were running the business I would have as a key metric. It’s a small improvement -- but when time is money -- a welcome one!

Opendoor also has a new logo.

It will be interesting to watch Opendoor’s progress from here. With Phoenix and Dallas firing well, will it expand to a handful of new markets, or is Las Vegas the next area of focus? When it enters new markets, will it follow the partnership model? And will Opendoor launch in Atlanta before Knock puts the foot down on the accelerator?

Are you researching iBuyers like Opendoor and on the hunt for data? Do you work at a consulting or venture capital firm? Check out the iBuyer Analysis Pack.

Inside Opendoor: what two years of transactions say about their prospects

Read every analysis I've posted on Opendoor, Zillow Offers, and the iBuyer business model.

This article was co-written with Sib Mahapatra, former manager of strategy at Redfin, and now an entrepreneur and real estate tech enthusiast based in San Francisco. 

Raising $210 million is enough to get any business into the news. That’s especially true when the business in question is Opendoor, the 2-year-old real estate startup that aims to bring simplicity to the housing market by purchasing homes directly from sellers and flipping them over to buyers after a quick spruce-up.

This latest infusion of capital, announced in late November, brings Opendoor’s total war chest to $320 million. Based in San Francisco and led by CEO Eric Wu, Opendoor plans to use the capital to expand its active market presence from Phoenix and Dallas to 10 cities by the end of 2017.

Investors and stakeholders in residential real estate have eyed Opendoor with wary interest since the company was launched as “Project Homerun” in July 2014 by former PayPal exec Keith Rabois. With tons of dry powder and two years of operations in Phoenix behind it, Opendoor is building momentum: the company is already the largest brokerage in Phoenix by transaction volume.

Key questions

Now that Opendoor has a track record and a mandate to grow, it’s a good time to assess its progress to date and provide an informed perspective on the following question: is Opendoor the way forward for residential real estate? Does the Opendoor model represent a sustainable, profitable and scalable platform for reinventing how homes are bought and sold? 

Several thought-pieces have explored the pros and cons of Opendoor’s business model and its impact on the real estate industry at a high level. Our goal is to dig deeper by using public records and MLS data to shed light on Opendoor’s transaction history and inform a bottoms-up analysis of the unit economics and viability of the business. By the end of this analysis, we’ll provide answers to three questions that underlie the proposition above:

• How much money does Opendoor make per transaction? Is Opendoor offering its customers a fair value for houses?

• How big could this model really get in the U.S.?

• Does Opendoor have a sustainable competitive advantage against competitors that might enter the space?

Business model

Before jumping into the overall revenue opportunity in the U.S. market, it’s worth understanding Opendoor’s business model and how it makes money. Here are the key takeaways:

• Opendoor buys houses and owns them, acting as a middleman (as opposed to a matchmaker) in residential real estate transactions.

• Opendoor won’t buy every house -- qualifying properties include single-family homes built after 1960 with a value between $125,000 and $500,000.

• Opendoor makes money in two ways: from the service fees it charges, and from any difference between what it buys houses for and what it sells them for.

• Opendoor works with real estate agents, offering to pay full buyer commissions, as well as seller commissions if a sale comes from an agent.

Opendoor charges a variable fee for its services, starting at 6 percent and rising to 12 percent for more risky properties. The average fee falls between 8 percent and 9 percent for sellers, which is higher than the standard 6 percent fee charged by traditional real estate agents. But with the higher fees come certainty around a transaction.

The customer proposition for using Opendoor is strong. For home sellers, Opendoor offers to eliminate all of the hassle and uncertainty of selling a house with a simple, transparent offer. In other words: don’t worry about fixing the fence, mowing the lawn, picking the right agent, and wondering if and when your home will finally sell. 

Opendoor takes care of it all, completing the whole process in a matter of days. In our opinion, it’s a seller experience that’s truly 10x better than the status quo.

Opendoor’s unique model lets it offer industry-leading benefits to buyers, too: 

• All day open homes, seven days a week

• 30-day satisfaction guarantee (if you don’t like the home, they’ll buy it back)

• 2-year home warranty

Upside and revenue opportunity

It’s hard to argue against Opendoor’s compelling seller value proposition. But can the business make money and become profitable enough to justify its massive valuation?

First we need to understand how much money Opendoor makes on each transaction. We’re going to stay focused on revenue for the moment and not worry about costs (yet). As discussed above, Opendoor makes money from the service fees it charges, plus any difference between what it buys houses for and what it sells them for.

The analysis of average purchase value and appreciation below is based on over 350 recent listings in the Phoenix market where Opendoor bought a home, relisted it on the market, and in the case of 235 listings, eventually sold it. We also looked at over 1,500 Opendoor MLS listings throughout 2016 to get a sense of the firm's traction in Phoenix.

The chart below shows the number of sales per month in the Phoenix market over the past 20 months. As you can see, traction has increased to over 120 sales per month.

The average price paid by Opendoor for a home in Phoenix is $217,370, and is tightly clustered. Opendoor knows its sweet spot and generally sticks to it.

Our analysis shows an average appreciation of 5.5 percent from the price Opendoor buys houses for and what it ends up selling them for. Again, this figure is generally well-clustered, with the few loss-making outliers offset by a few big-profit outliers.

When we plug these figures into our model, we can build up a revenue estimate for the Phoenix market in 2016:

It’s possible that Opendoor books additional revenue from service fees when it buys a house, but the cash only hits its bank when a house is sold. Assuming another 400 houses in the Phoenix market that are active and will eventually sell, that’s another $7.8 million in booked revenue.

Cost and profitability

Opendoor’s seamless experience comes at a high price. By serving as an active middleman in the transaction, Opendoor effectively doubles transaction costs and incurs a wide variety of rehab and holding costs.

Below, we have done our best to estimate Opendoor’s gross profit per transaction in the Phoenix market. Again, we assume that on average Opendoor pays $217,370 for a home and charges a 9 percent fee, holds the home for 88 days, and sells it for 5.5 percent more than it paid:

Many costs are out of Opendoor’s control. For the foreseeable future, Opendoor will rely on the MLS to help it market and sell homes fast, making it tough to avoid paying the buyer agent commission. Phoenix is probably as good as it’s going to get in terms of closing costs, since it charges no transfer tax on real estate transactions.

Opendoor has more control over holding time and rehab expense. For every month Opendoor holds a home, it spends roughly $500 per $100,000 of home value. Flipping homes faster will lower the variable cost per transaction while freeing up dollars to deploy on the next purchase, reducing its effective cost of capital. By hiring in-house staff, buying supplies in bulk, and using data to identify high ROI improvements, Opendoor could shave precious basis points off the process of maximizing curb appeal. 

There are two big takeaways here. First, given the costs associated with the middle-man model, it’s tough to imagine Opendoor being price competitive with agents. The best disruptors are both better and cheaper than incumbents, and we think cost has implications for Opendoor’s addressable market. Second, our analysis shows that on average, Opendoor’s fees barely cover its costs; appreciation on the sale is critical to profitability.

Fair value for homes?

Many people question whether Opendoor is really doing what it claims: offering a fair value for the houses it buys. 

To recap: an analysis of 235 houses that Opendoor bought and eventually sold in the Phoenix market shows an average appreciation of 5.5 percent.

The analysis also shows an average of 20 days between the time Opendoor buys a house and then subsequently lists it back for sale. That gives its team three weeks to fix up and prepare a house for sale on the market. That’s a quick turnaround, and given that Opendoor generally borrows 90 percent of the purchase price and is servicing that debt, time is money!

Once a home is prepped and listed for sale again, what sort of premium does Opendoor list it at? The short answer is around $20,000.

There is a tight clustering right around the $20,000 mark, with an actual average of $21,570. But keep in the mind the final sales price is half of that, an average of $10,245 for our sample of 215 homes that sold.

At the end of the day, we believe it’s a fair assessment to say Opendoor offers generally fair offers for the houses they buy. It does not lowball sellers. But it does not seek the high returns that a typical home flipper would look for, only looking to recoup its investment in the property plus a small margin. (This conclusion was later validated in this extensive research study: Do iBuyers Like Opendoor and Zillow Make Fair Market Offers?)

Market opportunity

How big could Opendoor really get in the U.S. market? In order for Opendoor to reach $1 billion in annual revenues, we’d need to believe the following:

The key assumption is that each new market Opendoor enters can reach the same maturity level of Phoenix. There will be overs and unders in terms of market size, average house price, and closing costs. But for a quick, back-of-the-envelope estimate, we’re keeping things simple.

While we have no certainty of what future market traction will look like, we can look at the Dallas expansion (Opendoor’s second market) for early indications. It started listing properties in August and selling in September, giving us three month's worth of data to review.

The comparison above shows good traction -- just under half the volume of Phoenix in three months.

In other words, it’s not farfetched to imagine Opendoor reaching $1 billion in annual revenues. It sees its total addressable market as between 50 and 70 markets in the U.S., with plans to expand to 30 markets by 2018. Given the data we’ve seen, this is achievable. The major brakes on Opendoor’s ability to reach this scale are the availability of financing -- purchasing 30,000 houses a year would require a revolving credit line of approximately $1.5 billion, assuming its average hold period and purchase value stay the same -- and whether its automated valuation model will work well in markets that have less liquid and homogenous housing stock than Phoenix.

Risk

For investors and industry observers, the scariest part of the Opendoor model is market exposure of directly holding homes. To its credit, Opendoor clearly takes risk management seriously (it is hiring several capital markets and risk associates), and defends its robustness against market risk by making the following claims:

• It can monitor price and market liquidity to detect a market correction early and adjust fees and home pricing, minimizing any loss.

• As Opendoor gets bigger, it will have a more diverse portfolio of homes; all markets and asset types won’t collapse at the same time.

• In a downturn, Opendoor doesn’t have to sell; for example, it can rent homes.

We’re most compelled by the first strategy. If Opendoor can predict a downturn before it’s widely known and shed old inventory fast with a preemptive discount, it can effectively employ a “stop-loss” mechanism that constrains the total downside. 

We are less convinced by the second and third tactics. Diversification across U.S. geographies smooths risk in placid markets, but the most recent financial crisis suggests that American real estate markets are heavily correlated during the kind of market correction that would threaten Opendoor.

Finally, Opendoor’s ability to wait out a downturn by renting homes depends on the terms of its agreement with its debt issuer. We don’t know what that agreement looks like, but it isn’t likely to be as flexible as that of a hedge fund, for example, which often benefit from flexible investment mandates and “lock-up” periods where investors can’t get their capital back. In the last crisis, banks weren’t exactly known for their patience with capital calls.

The indisputable fact is that Opendoor’s extraordinary opportunity also exposes it to deep and intrinsic risk. For the purpose of a venture investor with a five-year horizon, perhaps this doesn’t matter, but it raises questions about Opendoor’s ability to endure across economic cycles and exist as a durable franchise that permanently changes real estate. With such a thin margin, even a slight market shift could mean the difference between profit and loss.

Competitive advantage

Let’s assume that Opendoor’s model works well enough to attract the attention of potential copycats. What is the moat that will keep new entrants at bay? We’ve identified three sources of competitive advantage for Opendoor: 

• Proprietary automated valuation model (AVM)

• Access to capital

• Battle-tested and efficient flip process

Ultimately, we believe a major long-term risk to Opendoor is that the key elements of its seller customer experience -- a fast and well-priced offer -- are replicable. Lack of access to capital and an accurate AVM may keep smaller aspirants out, but won’t dissuade big asset managers from entering the fray; Blackstone has directly invested in residential real estate for years. If Opendoor continues to profitably flip homes, we don’t see a compelling reason why an institutional investor with deep pockets won’t enter the market by hiring data scientists (or licensing an AVM from Redfin or CoreLogic) and undercut Opendoor by offering to beat any offer by an extra grand.

If it comes down to the highest offer, Opendoor is still well positioned to win. Its trusted brand will provide a barrier against new entrants, a better automated valuation model will let it charge less for market risk, and its experience flipping homes will pay off in lower holding costs. But victory won’t be free: we predict that competitive pressure will drive Opendoor’s unit margin below where it sits today.

Concluding thoughts

The real value of Opendoor is that it’s forcing the industry forward. The current home selling process is filled with friction, and Opendoor should be applauded for taking a gutsy approach to solving many of these pain points in a single stroke.

The data and analysis above suggests that Opendoor has a sustainable business model. It is buying and selling hundreds of homes each month with upward traction. At scale, it is reasonable to see Opendoor generating over $1 billion in annual revenues and operating profitably. Traction and market potential like that cannot be ignored.

As the first mover and brand leader in this space, Opendoor is in a strong position, but we see two roadblocks that could prevent it from succeeding at scale. The first is proving out its risk management approach to the satisfaction of lenders who will need to issue a massive amount of debt to fund tens of thousands of home purchases. The second is figuring out how to differentiate from new entrants and avoid getting dragged into a race-to-the-bottom price war that would decimate its slim margins.

Whether or not Opendoor emerges as the eventual victor in this space -- is this model definitely the next step for residential real estate? The main barrier we see is cost. Opendoor could become a very successful business by serving even a small percentage of U.S. home sellers, but its addressable market will fall short of its true potential unless it can make its service both better and more affordable than the status quo. 

A note on data: our analysis is based on MLS records, listings from Opendoor’s web site, the Maricopa City Assessor’s public property records, and public records sourced from Redfin. We used industry benchmarks to estimate the costs and fees associated with flipping homes in Phoenix. The data out is only as good as the data in, and the MLS system can be inaccurate. The analysis should be taken as such -- a review of available public records -- and not a verifiably complete picture. While absolute numbers may be off, we believe that directionally our analysis provides a very good look at the business.

Read every analysis I've posted on Opendoor, Zillow Offers, and the iBuyer business model.

At the Inman Connect Las Vegas 2019 conference, Mike DelPrete, an entrepreneur, analyst and real estate industry strategic adviser, took to the stage to explain the seismic shifts shaking up the residential real estate market.

---

The 2020 iBuyer Report

The iBuyer Report is a 150+ slide, evidence-based look at the world of instant home buyers. Unmatched in its breadth and depth, it explores behind-the-scenes, national data and presents an unbiased strategic analysis of the sector, the players, and the implications for the industry.

---