The Rise and Fall of Opendoor: A Deep Dive into the iBuying Market

Introduction

In September of 2020, the infamous stock promoter Chamath Palihapitiya took the real estate technology company Opendoor public by merging it with a SPAC. Opendoor was, and still is, the largest iBuyer in the US.

iBuyers, short for instant buyers, offer homeowners instant cash offers on their houses with no hassle or negotiations by leveraging big data, artificial intelligence, and an easy-to-use mobile app.

Opendoor was supposed to disrupt the antiquated and inefficient real estate market. Seeing Opendoor’s skyrocketing valuation, the two online real estate giants, Zillow and Redfin, both hopped on the bandwagon and started their own iBuying businesses. In 2021 and 2022, both companies shut down their iBuying units after suffering hundreds of millions of dollars in losses.

While these were embarrassing blunders, Zillow and Redfin still had their core businesses to fall back on, so it wasn’t the end of the world. With Opendoor being a pure-play iBuyer, they had no choice but to continue with this business, no matter how many billions of dollars they were losing.

Since going public, their stock price has lost more than 80% of its value, putting the company just barely above penny stock status. In this article, we’ll take a deep dive into the rise and fall of Opendoor and whether the company has any chance of viability going forward.

Before we move on, I want to tell you about a recent study from the University of Manchester, which says having a job you don’t like can be worse for your mental health than not having a job at all. But if you want to change industries, how would you even go about doing that?

The iBuying Business Model

When you want to sell your house on Opendoor, the process is relatively simple. You just go on their website and answer a few questions about the house. Within minutes, they’ll give you a preliminary offer of how much they’re willing to pay for it. If you decide to move forward, an Opendoor representative will have a video call with you and ask you to walk around the house. This allows them to judge the wear and tear of the house and any repairs that may need to be done.

In some cases, Opendoor will send an inspector to inspect the home in person. Opendoor feeds the data from the inspections, as well as other market data, into its AI algorithms. Their algorithms can supposedly determine the value of a home far more accurately than traditional real estate agents who might calculate the value on the back of a napkin.

If you agree to Opendoor’s offer, they’ll wire the money to your bank account, minus a service fee of roughly 7%, as well as a deduction for expected repair costs. The entire process of selling your house to Opendoor can take as little as one to two weeks. The promise of technology disrupting an industry lies in increasing efficiencies and reducing costs.

For example, a Zoom call with a colleague is far cheaper than flying across the country for an in-person meeting. Similarly, you might expect that Opendoor, as an online platform utilizing algorithms and automation, might be more cost-effective than traditional real estate agents. Opendoor claims that their automated process allows each agent to conduct 12 times more transactions per month than a traditional realtor.

Given the efficiencies of an internet-based automated platform, you might expect that Opendoor could offer superior prices to home sellers while still making a healthy profit for itself. But, as we all see, neither of these are true. In its advertising materials, Opendoor used to claim that their offers represent fair market offers for the value of a home. They don’t make lowball offers and only profit from the service fee. They claim to provide superior net proceeds to home sellers.

For example, for a $200,000 home, Opendoor charges a 6.8% service fee, leaving the seller with $186,400 of net proceeds. A traditional home sale costs 7 to 10% in fees, including seller concessions and occupancy overlap costs. Seller concessions are effectively a reduction to the purchase price, so it’s questionable to call this a fee. If you’re willing to give concessions, the buyer will be willing to pay a higher list price, and vice versa.

If we use Opendoor’s math, the net proceeds under a traditional sales process are only $182,000, so the seller would be more than $4,000 better off with Opendoor. According to the FTC, Opendoor consistently gave offers thousands of dollars below the fair market value estimated by their own algorithms, despite publicly claiming that they don’t give lowball offers.

Opendoor privately bragged to its venture capital investors about how much money they are making from resale gains. Resale gains are the price they sell the homes for minus the price they paid. As early as 2016, internal communications amongst the company’s employees admitted that homeowners who rejected Opendoor’s offers typically sold their homes for higher prices using traditional real estate agents.

Perhaps Opendoor’s most egregious tactic was how they charge sellers for repairs. After the seller accepted the initial offer, Opendoor would frequently come back a couple of weeks later with a list of repairs that needed to be done. In many cases, the seller had already made a deposit on a new home and needed to sell their existing home immediately to fund their purchase.

Thus, the seller had little choice but to agree to Opendoor’s demands. The repair costs are deducted from the sale price. Internally, Opendoor employees referred to the strategy as a bait-and-switch operation. In many cases, the cost of repairs was inflated, meaning that Opendoor would pay far less for the repairs than what they charged to the seller. According to Opendoor’s own analysis, sellers received thousands of dollars less in net proceeds on Opendoor compared to traditional realtors.

In 2022, Opendoor was forced to pay $62 million in fines to the FTC related to these deceptive sales practices. Given that Opendoor was ripping off its customers, they must have been extremely profitable, right? Wrong. The company has never earned an annual net profit and has lost well over $2 billion since going public.

The worst kind of business is the kind that rips off its customers yet still manages to lose money. This begs a fundamental question: despite the seeming advantages of an internet-based instant home buyer, why is Opendoor losing so much money?

Opendoor Unit Economics

Despite the deceptive sales tactics alleged by the FTC, Opendoor doesn’t make that much money on each house sold. In 2019, they sold each home for an average of $252,000. Their total cost to acquire that home, including the price paid to the seller, inspections, repairs, title insurance, and other expenses, was $236,000. So, they made a gross profit of $16,000, or 6% of the home’s value.

In a traditional real estate transaction, the buyer is the end consumer, and the house title is only transferred once from the seller to the buyer. In the case of Opendoor, there are two transactions for each house: Opendoor has to buy the house and then sell it. Holding homes as inventory is risky because if real estate prices fall, Opendoor could suffer significant losses.

While Opendoor is holding the home, it is sitting empty and generating zero revenue, but Opendoor still has to pay property taxes, cut the grass, do maintenance, etc. Due to the risks and costs associated with holding inventory, it’s in Opendoor’s best interest to sell their inventory as quickly as possible.

They list their homes on their website, where people can buy them directly, but in the interest of offloading homes as quickly as possible, they often rely on external real estate brokers who charge fees. Also, because Opendoor both buys and sells the home, the title and escrow-related fees and taxes are incurred twice.

In 2019, Opendoor paid $8,000 of direct selling costs per house sold. They also incurred $3,000 of property taxes and maintenance costs while holding the house as inventory. Subtracting these costs brings their contribution profit down to $5,000 per house, a razor-thin 2% of revenue. But it gets even worse.

Opendoor pays for the homes upfront with cash, making it an extremely capital-intensive business. To fund its purchases, Opendoor borrows money under various revolving credit facilities. For Opendoor to be economically viable, they need to generate a contribution profit above their interest expense.

In 2019, Opendoor’s $5,000 of contribution profit was not even enough to cover their $6,000 of interest expense per house. After subtracting corporate overhead and stock-based compensation, they made an adjusted pre-tax loss of about $11,000 per house sold. I calculated the adjusted number by excluding non-cash inventory write-downs and other non-recurring expenses.

When the pandemic began in 2020, real estate transactions decreased substantially as buyers and sellers alike waited out the macroeconomic uncertainty. Opendoor’s number of homes sold decreased from 19,000 in 2019 to 10,000 in 2020. By the end of 2020, the housing market was starting to recover, thanks to the Fed’s interest rate cuts. Opendoor also received about $1 billion of cash from its SPAC merger.

Needing to show growth to investors, Opendoor expanded rapidly, buying up tens of thousands of new homes. The timing was perfect, as historically low mortgage rates caused the average US home price to surge by 19% in 2021. At any given time, Opendoor holds thousands of homes on its balance sheet as inventory. If the market is generally increasing, they’ll be able to sell their homes for higher prices.

Indeed, 2021 was Opendoor’s best year ever. They generated a gross profit of $35,000 per home sold and a contribution profit of $24,000, or 7% of revenue. Yet even with a 7% contribution margin, they still managed to lose money.

The Fed-induced real estate bubble of 2021 wouldn’t last forever. As the Fed started increasing interest rates, the average home price declined by about 5% in the second half of 2022. One of the biggest problems with iBuyers is that they are effectively forced to buy high and sell low. This chart compares the net change in Opendoor’s inventory per quarter versus the Case-Shiller real estate price index.

In 2021, Opendoor used its SPAC proceeds as collateral to borrow billions of dollars to acquire thousands of new homes. When real estate prices declined in late 2022, their unit economics deteriorated, their stock price tanked, and lenders were less willing to extend credit. They were forced to sell off their inventory at the bottom of the market. They only started rebuilding their inventory after home prices had recovered back to all-time highs.

In hindsight, it would obviously have been better to buy houses during the second half of 2022 when prices were low, but due to liquidity constraints, this was not possible for Opendoor. By 2023, Opendoor’s unit economics had deteriorated, with its gross profit margin falling to 1% and its contribution margin falling to -4%.

Over the past few years, the US real estate market has been relatively benign. The peak-to-trough decline in 2022 was only 5%. For comparison, home prices fell by 27% in the 2008 financial crisis. Given that Opendoor loses money even when home prices are rising, had they existed back in 2008, their losses would likely have been catastrophic.

When Opendoor went public, its SPAC promoter Chamath Palihapitiya talked up the company’s strong revenue growth and unit economics. Neither of these has panned out. Since 2019, the company has incurred almost $3 billion in cumulative net losses. In 2023, they sold 18,878 homes, slightly fewer than the number of homes they sold in 2019. Investors have completely lost faith in Opendoor, with its share price having fallen by more than 80% since the SPAC transaction.

To be fair to Opendoor, it’s not just them. Every company that has entered the iBuying market has suffered similar losses. There’s another pure-play iBuyer called Offerpad, which also went public by merging with a SPAC. Its share price has fallen by 97% and appears to be on the brink of bankruptcy.

And as we discussed earlier, both Zillow and Redfin shut down their ill-fated iBuying units after suffering hundreds of millions of dollars in losses.

An Unviable Business

The entire iBuying business model relies on homeowners accepting a lower price in exchange for speed and convenience. For most people, their home is their most valuable asset by far. If you have a mortgage, the value of your home may even be greater than your entire net worth.

Thus, most people are willing to put in the time and effort of working with a realtor to get the best possible price. It’s important not to overstate the difficulties of the traditional home selling process. The median home in the US is sold after being listed for about 50 days. Only a very small percentage of homeowners are willing to cede thousands of dollars of value to Opendoor just to sell their home two months faster.

The reason that investors love tech companies so much is because they’re inherently scalable and capital-light. Take the example of Airbnb: they operate as a platform and don’t put any of their own capital at risk. They don’t need to do any physical inspections or repairs. The marginal cost for Airbnb to expand into a new market is extremely small. Opendoor is the opposite.

When they expand into a new market, they need to hire local property inspectors. They also need to build relationships with local contractors to do repairs and maintenance on the houses after they’re purchased. This is an enormous administrative burden.

In the markets Opendoor currently operates in, they only have a 2% market share of all home sales. Given the razor-thin margins they make on each home, this isn’t nearly enough to cover their corporate overhead. Expanding into new markets won’t solve the problem because this will further increase their overhead costs. At the end of the day, Opendoor’s business model faces significant challenges in terms of scalability and profitability.

Conclusion

The service that iBuyers provide is too expensive to be attractive for most homeowners, and without sufficient economies of scale, it’s hard to see any path to profitability.

What do you think about Opendoor? Let us know in the comments section below.