Disrupting Housing Markets: iBuyers as Market Makers

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Introduction

Instant Buyers, or iBuyers, are companies that make instant offers to buy single family homes based on model driven valuations, such as Redfin, Zillow, and Opendoor.  These types of purchases are all cash offers, and the primary benefit is increased convenience and flexibility to the home seller. The primary drawback is that iBuyers typically charge higher fees than a real estate agent and require more maintenance work be done to the property before the deal is completed.  iBuyers are more common in places with homogenous housing, such as Phoenix Arizona where the housing bubble led to the construction of large master-planned neighborhoods, as price discovery is simpler and more consistent (Gomez).

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Market Structure

The ongoing shift away from the current broker-based market to a dealer-based market is certain to affect price evolution patterns and liquidity.  Residential real estate’s historically low price volatility and strong momentum—primarily due to sales driven purchase funding—will change as the source of funding shifts towards institutional capital. Additionally, due to leverage and homeowner risk aversion, liquidity in times of stress is likely to increase while momentum will decrease.  This is like other dealer-based, liquid financial security markets that are dominated by institutional capital and whose price evolution exhibits a random walk.

From a market making or dealer perspective, residential real estate is a large, non-homogenous market, when compared to U.S. Treasuries or other financial securities.  Dealers profit by having superior information regarding the value of a property, models being one source. Furthermore, since houses are not fungible, it is more convenient for a seller to transact with someone who is standing ready to buy rather than seeking out a natural buyer.  When prices fall, like in 2008, deals at previously higher prices fall through, but sellers often stay anchored to the original, higher price. When prices continue to decrease, homeowners without sufficient financial expertise panic and a “fire sale” ensues.  In other markets, there are natural buyers standing ready to buy cheap assets, but since real estate experiences strong momentum, traditional buyers are frequently overleveraged and in distress themselves (Hobart).

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Methodology

To best explore the growth of iBuying, and its effect on market dynamics, it is important to compare the market attributes of cities with relatively high iBuyer market share to cities with low iBuyer share.  We have identified the U.S. MSAs with the highest iBuyer market share as Raleigh, Phoenix, and Atlanta.  We then selected three similar cities with relatively low iBuyer market share to operate as a control group: Denver, Tampa, and Austin. The degree of similarity was determined by the following factors: similarity of occupation mix based on indeed.com data, city size, and economic growth rate (Kolko and Katz).

We will then use Housing Price Index (HPI) data from the St. Louis Federal Reserve, (Federal Reserve Bank of St. Louis) and iBuyer data from Redfin to compare the high market share set to the low market share set (Ptaszynski).  In addition, we will analyze any changes in market dynamics since the advent of iBuyers in 2016-2018, depending on the city.

There are a few places where this analysis is imperfect. For one, it is possible that the selected cities are not sufficiently similar in terms of local market structure, housing homogeneity, and demographics. Secondly, the share of iBuyers is still relatively small. The city with the highest market share is Raleigh at 7.9% with a global maximum of 8.5%. This market share may not yet be sufficient to statistically measure changes in volatility and momentum. Finally, the data may not be sufficiently granular.  Only quarterly data on HPI and iBuyer share exists. Additionally, since iBuyers only entered the market in 2016, there are very few data points to construct sequence/reversal ratios and conduct sufficiently robust statistical analysis.

Momentum

A common view before the 2008 financial crisis was that home prices could only go up. While this is clearly not true, and never was, it is a belief driven by the fact that real estate experiences tremendous momentum.  In fact, for each city we analyzed (except Denver which had an exceptionally low pre-crisis R2) previous quarter HPI was a strong predictor of following quarter HPI with R2 values ranging from .293 to .729. However, this trend has not been constant over time. If we look at the strength of momentum, proxied by R2 values of previous quarter returns on following quarter returns, we see that this trend has weakened from the pre-housing crisis period to the post-crisis period. In every case, except Denver and Atlanta, the R2 decreased from the pre to post-crisis periods. This supports the idea that increased institutional capital—including iBuyers— is shifting the market toward a dealer-based structure and decreasing market momentum. In fact, the average decrease in R2 of the high iBuyer cities was -.097 or nearly twice the decrease in the low iBuyer cities at -.049.

Pre Crisis Post Crisis
  R2 Beta R2 Beta
Raleigh 0.482 0.885 0.320 0.541
Phoenix 0.729 0.881 0.557 0.721
Atlanta 0.293 0.655 0.336 0.618
Denver 0.041 0.215 0.336 0.545
Tampa 0.715 0.891 0.372 0.559
Austin 0.339 0.607 0.239 0.474

 

While there has been an obvious change in market momentum this millennium, it is not entirely clear that this is exclusively due to iBuyer activity.  Other sources of institutional capital, such as Invitation Homes, American Homes 4 Rent, and others have entered the single-family residential market and it is extremely difficult to correctly attribute the change in momentum to the correct source.  Furthermore, because real estate is a local game, there is a tremendous confluence of factors that are involved in determining price evolution. Without sufficient knowledge of each local market’s cultural, social and various other qualitative factors, we cannot determine, for example, why Atlanta and Denver saw an increase in momentum while the other cities, and the nation as a whole, saw a decrease.

Volatility

We regressed the standard deviation of returns, over a trailing two-year period, versus the iBuyer market share for the end of that period. In each case, the regression results were non-significant.  Unfortunately, the available eight data points simply is not enough to satisfy the law of large numbers breaking the assumptions for the regression. While the data set is insufficient to make conclusive claims on the hypothesis, the effect of iBuyers on return volatility warrants further consideration. With access to a more robust data set—either more frequent data points or a longer time span—the regression results would be far more compelling.  Therefore, no conclusions can be drawn on the effect of iBuyers on return volatility.

If we look at standard deviation of returns before and after the housing bubble burst, the results are mixed. Raleigh, Atlanta, Denver and Austin saw an increase in volatility while Phoenix and Tampa saw a decrease.  However, this can be partially explained by the fact that Atlanta and Denver saw less than 10% price appreciation in the bubble period while Phoenix and Tampa appreciated by more than 90%. All in all, no conclusions can be drawn on the effect of iBuyers on return volatility.

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Conclusion

It is clear that the structure of the single-family home market has changed since the housing crisis with the introduction of institutional capital in general and iBuyers in particular. Momentum and American’s exposure to housing assets have decreased, which should decrease the whiplash effect that occurs in periods of market stress. There is substantial literature on the benefits and detriments of the financialization of housing and iBuyers, but this is not the focus of this analysis. In either case, the trend is here to stay. Invitation Homes’ market cap has increased by $9.6bn since its IPO in early 2017 while American Homes 4 Rent’s market cap has increase by $3.3bn in the same time period. Meanwhile, Zillow has invested hundreds of millions into its iBuyer platform despite currently losing $2,868 per home and Opendoor is set to go public at a valuation of $5bn.  Therefore, it is key that investors understand how the structure of the market is changing.

 

 

Works Cited

Gomez, Joe. “What Is an IBuyer – All You Need to Know: Opendoor Guides.” Opendoor, 13 Oct. 2020, www.opendoor.com/w/guides/what-is-an-ibuyer.

Hobart, Byrne. “The IBuyers: High(Er)-Frequency Trading Comes to Home Buying.” Medium, The Startup, 18 Oct. 2019, medium.com/swlh/the-ibuyers-high-er-frequency-trading-comes-to-home-buying-f34c80718976.

Kolko, Jed, and Josh Katz. “What Is Your City’s Twin?” The New York Times, The New York Times, 3 Apr. 2018, www.nytimes.com/interactive/2018/04/03/upshot/what-is-your-citys-twin.html.

Ptaszynski, Alina. “IBuyer Real Estate: Cities with the Highest IBuyer Market Share and Sales.” Redfin Real Estate News, 7 Oct. 2020, www.redfin.com/news/ibuyer-real-estate-q4-2019/.

“S&P/Case-Shiller U.S. National Home Price Index.” FRED, Federal Reserve Bank of St. Louis, 29 Dec. 2020, fred.stlouisfed.org/series/CSUSHPINSA.

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