What happened at Zillow? How a prized real estate site lost at iBuying

Zillow, the popular online real estate marketplace and daydream fuel throughout the pandemic, is having a tough time. 

The company turned heads earlier this month when it announced it would be shutting down Zillow Offers, the algorithm-fueled home-flipping arm of its company. It also said it would try to offload more than 7,000 homes and exit the iBuying -- or "instant buying" -- business completely. That's $2.8 billion worth of homes. 

The announcement came as a major surprise, especially given the scale of Zillow's massive investments in its iBuying efforts in recent years. Its exit was precipitated by a series of missteps, including an overbuying fiasco that resulted in a glut of overpriced inventory. 

Now, according to an Insider analysis, more than half of the homes Zillow owns are listed for prices below what the company paid for them. In Phoenix, 93% percent of the homes Zillow purchased are listed for less than the original purchase price, and in Dallas, 81% are less. 

What is iBuying anyway?

To do iBuying, tech companies rely on algorithms to determine if it would be profitable to purchase a home to then resell. Using specific data -- the home's age, condition and ZIP code -- algorithms can predict which homes will rise in value, allowing the tech company to get into an emerging market early. Think of it like large-scale, automated home-flipping. 

If you're a homeowner, there may be a benefit to using an iBuyer to sell your home. For one, the process is streamlined over the traditional method: You don't have the stress of dealing with a real estate agent, showings or the uncertainty of the market. You'll get an immediate all-cash offer based simply on the algorithm's assessment of your home's data, though the tradeoff is a smaller profit margin. 

What went wrong at Zillow?

As an iBuyer, Zillow relied on these computer calculations to buy houses in decent condition on the cheap, spend minimal capital fixing them up and quickly resell them for a profit. Sound too good to be true? For Zillow, it was. The company ended up making thousands of above-market offers to homeowners. 

Zillow attributed the mishap to its technology, blaming its iBuying algorithms -- called "Zestimates" -- for inaccurately predicting the values of homes. Given surging prices and high real estate volatility in the last 18 months, it was a tricky undertaking in the first place. 

As homes appreciated at a rapid pace during the COVID-19 pandemic, Zillow's iBuying algorithms consistently and significantly underestimated market changes. That's what eventually led the company to shut down its instant-buying business for good. The real estate giant is set to lose an estimated $380 million on Zillow Offers, according to the LA Times.

"The challenge we faced in Zillow Offers was the ability to accurately forecast the future price of inventory three to six months out, in a market where there were larger and more rapid changes in home values than ever before," said Viet Shelton, a spokesperson for the company.

The company also said it will write off $569 million worth of homes and lay off 25% of its staff. Though the future is unclear for some of Zillow's languishing inventory across the country, there's reason to believe that institutional investors could win out in snatching it up. The company has agreed to sell 2,000 units to New York City-based investment firm Pretium Partners.

Zillow has said it intends to honor all existing deals for homes under contract. 

What do Zillow's problems mean for iBuying? 

Other competitors seem to have figured out the iBuying formula's secret sauce and are going strong. Two of Zillow's rivals, Opendoor and Offerpad, both posted new revenue highs for the third quarter, though neither company is profitable yet. Private equity firms like Blackrock have made headlines for their investments in instant buying. 

Though Zillow is no longer in the game, iBuying seems to be here to stay.