This Beaten Real Estate Tech Stock Could Rise Again

Things aren’t looking good for the real estate tech company Open door technologies (OPEN -0.95%). Bloomberg reported that Opendoor lost money on 42% of homes sold in August, although that did not include the 5% fee the company collects from sellers. Many may remember the former contestant Zillow tried its hand at iBuying Homes before, but dropped out last fall due to poor unit economics.

But there are huge forces at work here, and given recent Bloomberg coverage, investors should be wondering if Opendoor will suffer a similar (or worse) fate to Zillow’s iBuying business or if it there is hope for long-term success. Here’s why Opendoor’s darkest hours may be upon us – and why there may soon be light.

A different company with different problems

It seems natural to compare Opendoor and Zillow. After all, they’re both real estate tech companies that have pursued the same goal of making iBuying a profitable business, the practice of pricing and buying homes using algorithms, and then selling them. resell on the market. But Zillow ultimately failed because it couldn’t accurately value homes, leading to huge losses, and the company closed that segment last October.

But the circumstances between Zillow’s failure and Opendoor’s current challenges are very different. Zillow Offers, the home-buying business, was technically launched in 2017, but the company leaned into it in February 2021 when it paired Zillow Offers with Zestimates, its home valuation algorithm, in 23 big cities. The median price of an existing single-family home in the United States appreciated 14% over the next eight months before the company ended its buying efforts. In other words, Zillow failed in a high-end market!

Opendoor has performed very well during this period, although it was not profitable in 2021. A high number of transactions spread the company’s total costs and non-GAAP (adjusted) earnings before interest , taxes, depreciation and amortization (EBITDA) were positive for the first year in the company’s history at $58 million.

You can also see below how Opendoor, a dedicated iBuyer, was able to improve its net losses despite significantly more iBuying transactions compared to Zillow, whose losses exploded as soon as they started:

Data by YCharts.

But the housing market today is not doing very well. According to S&P CoreLogic Case-Shiller Index, house prices slowed to their fastest pace on record in July. Real estate data needs time for deals to close and for that data to flow to reports, but you can see the start of the turn below:

Table of median selling prices of existing homes in the United States.

Data by YCharts.

The rapid decline in home prices means Opendoor is likely struggling to sell homes fast enough to compensate for the drop in value between when they buy a home and resell it. Investors will know more when the company releases its third quarter results. Still, Management Expects Adjusted EBITDA Loss Between $175 Million and $125 Million Post-Publication positive The EBITDA of $218 million in the prior quarter is troubling. Remember that management provided this guidance in early August, so by then the company had already seen how part of its third quarter was going.

What is the problem and is there a solution?

So why are house prices falling? These questions never have simple answers, but the spike in the fed funds rate is an important clue to what’s going on. The Federal Open Market Committee, in charge of monetary policy in the United States, raises rates to fight inflation. This rate dictates how much it costs banks to borrow money, which means a lender providing a mortgage must raise their own rates to make money.

You can see the clear correlation between the fed funds rate and mortgage rates below:

Table of the upper limit of the federal funds target rate.

Data by YCharts.

A $300,000 mortgage at 3% interest over 30 years will cost $1,265 per month. But if you increase that to the current rate of 6.7%, that monthly payment for the same amount of principal increases to $1,936. It is becoming more and more difficult to afford houses at the same price, especially with high inflation and an increase in the cost of living. So what’s going on? Real estate demand falls and prices follow.

Opendoor charges a 5% fee when you sell your house to them. On top of these fees, the business receives a margin – the difference between what it pays for a house and what it sells for the house. Opendoor can manipulate that spread, which management noted in its second-quarter earnings call, to offset expected home depreciation. In other words, he can offer lower prices on the houses he acquires. Opendoor’s problem is that it didn’t expect house prices to fall and mortgage rates to rise as quickly as they did, which caught the company off guard. That doesn’t excuse the misstep, but it seems like a manageable issue once Opendoor picks up its pieces and starts evaluating homes with higher spreads.

Ideally, house prices and mortgage rates should stabilize – it’s not the direction things are moving, but the speed at which things are moving that affects Opendoor the most. Economic forces are pushing rates and home value changes to their fastest pace in decades, and in some cases, in history. So while Opendoor is suffering as a result, surviving this harsh climate might be as much proof of the company’s resilience as you could ask for. Risky, yes, but Opendoor remains a value with great potential.

Justin Pope holds positions at Opendoor Technologies Inc. The Motley Fool holds positions and recommends Opendoor Technologies Inc., Zillow Group (A shares) and Zillow Group (C shares). The Motley Fool has a disclosure policy.

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