Interest rates are about to fall. Can Opendoor finally break the iBuying curse?

iBuying has been one of the most disruptive entry ideas into the real estate industry in decades. iBuying, which means instant buying, is home flipping taken to its logical end, done on a large scale by corporations rather than just a small entrepreneur.

The practice once held great promise as technology made it easier to buy and sell a home, see comparable sale prices and other useful information, and collect and analyze data to learn what’s working and what’s not. The concept has been embraced by almost all real estate technology players including Zillow and Redfin.

However, it didn’t work out as hoped for the two companies, and they threw in the towel in 2021 and 2022. Zillow shut down its iBuying business, Zillow Offers, in 2021 after finding that its algorithm for estimating home values it wasn’t nearly as good as he thought it was. At the time, CEO Rich Barton said, “We have determined that the unpredictability in the forecast of home prices far exceeds what we anticipated.”

Redfin followed suit the following year amid a sharp slowdown in the housing market. CEO Glenn Kelman pointed to the high cost of capital and risk in buying homes to flip, and the Redfin Now segment lost more than $20 million in 2022.

Image source: Getty Images.

Opendoor is still standing

Not all iBuyers folded, just like that Opendoor technologies (OPEN 2.38%) and Offerpad they seem to have been through the worst of the real estate market.

Interest rates are expected to start falling at the Fed’s next meeting in September, which will bring much-needed relief to mortgage rates and is likely to unlock pent-up demand in the housing market, which should favor Opendoor.

Investors seem to bet as much. Since Fed Chairman Jerome Powell said “the time has come” for rate cuts last Friday at the Jackson Hole Symposium, Opendoor shares have risen 24% in just two sessions. Offerpad, which is much smaller than Opendoor and trades at much lower volume, also rose by a similar amount, showing renewed enthusiasm for iBuying.

The case for such an increase in Opendoor stock seems clear. Home-flipping is a cyclical business. It’s easy to make money when housing prices are rising, but much harder to do when prices are falling.

Falling house prices have forced consequences for iBuying, with Opendoor shares plunging in 2022, but a rebound in home sales could save the company.

Can Opendoor take advantage?

As Zillow and Redfin shuttered their iBuying businesses, Opendoor also shrank. The company issued several rounds of layoffs, drastically reduced its housing inventory and made other cost cuts to ride out the sluggish housing market.

Opendoor made progress on the bottom line, shrinking its second-quarter adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) from $168 million in the year-ago quarter to $5 million. It also accelerated its home purchases, which rose 78 percent to 4,771 homes, showing confidence in the recovery of the housing market after the tightening of home purchases earlier.

Opendoor plans to get more aggressive with home buying by reducing its spreads, the discount to the home’s estimated value that it offers sellers. The company makes money with a 5% service fee it charges sellers, on top of the margin it makes on the sale.

Opendoor still expects a challenging housing market in the third quarter, calling for a contribution margin — which is gross profit after certain additional expenses — of $35 million, and also sees an adjusted EBITDA loss of $60 million USD – USD 70 million in the quarter. .

It’s on revenue of $1.2 billion – $1.3 billion, up 29% mid-year, though revenue isn’t the best way to judge this company because it’s easy for it to make unprofitable sales.

Opendoor expects tailwinds from falling interest rates, but did not factor that into its guidance.

Is Opendoor a buy?

As a stock, Opendoor appears well-positioned to capitalize on lower interest rates, and investors appear poised to bid the stock higher on favorable signs for the housing market.

However, the underlying business model is still unproven, and Opendoor was only briefly EBITDA positive in its publicly traded history, which came before home prices crashed in 2022.

Additionally, there is no guarantee that home prices will rise even if mortgage rates fall. After all, home prices are already at all-time highs, and lower rates could encourage more sellers to enter the market as they ease the “lock-in effect” from the pandemic’s low rates.

Under these circumstances, the best approach with Opendoor for those interested in the stock seems to be to open a small position for now and wait for clearer evidence that the business can capitalize on lower rates, as there is still a lot of uncertainty.

If the company can make iBuying work, though, there’s plenty of upside in store.