More than US$1bn of bonds that funded Zillow Group's home-flipping operation are under increased scrutiny after the real estate services firm suddenly quit this once-touted business because of its inability to accurately predict future home prices.
The Seattle-based company on Tuesday stunned investors when it announced it was pulling the plug on "Zillow Offers", a part of its instant buying (or iBuying) operation. It expects to lose more than US$550m on the homes it bought in the second half of this year after overpaying due to its faulty pricing model. It also said it planned to lay off a quarter of its 8,000 staff during the unwinding of the home-flipping business over the next several quarters.
The speed of the turnaround is remarkable given the company had raised over US$1bn in the securitisation market in the last three months to help finance its home-flipping plans.
One investor who participated in the debut issue, ZH Trust 2021-1, said he was waiting for more information from the banks on when investors would be repaid or how the deals may be unwound.
"Everyone is trying to figure out what's going on. I want to know if the repayment might be accelerated. Will I be protected? I’m not taking a loss in just three months," the investor said.
Its first ever "i-Buyer" deal in August raised US$450m and was followed by another offering that took in US$700m in September. Credit Suisse, Goldman Sachs and Citigroup were the joint bookrunners on both issues, which were upsized due to strong investor demand. Credit Suisse is also the warehouse lender for the two deals. Goldman and Citigroup have credit lines with Zillow.
Citigroup and Credit Suisse declined to comment. Goldman and Zillow could not immediately be reached for comment.
Market players speculate that private equity firms with single-family rental operations like Blackstone and residential rental REITs such as Invitational Homes could easily take homes off Zillow's hands.
Home-flipping flopped
Before last week's move to pull out of home-flipping, Zillow had hoped to take advantage of its "Zestimate" home pricing algorithm to create an arbitrage between the costs of the homes it buys and related expenses to fix them up and the projected resale price. A small but growing number of homeowners has been drawn to "i-Buying" platforms from Zillow, OpenDoor and Redfin to sell their homes because they offer instant offers to purchase the homes in cash and do not require renovations before sale.
The business sank back into the red in the third quarter following three straight profitable quarters from the fourth quarter of 2020 to the second quarter of this year, according to JP Morgan. The step to pull out of the sector came less than three weeks after Zillow said it would pause home purchases into year-end, blaming an operational backlog of renovations and closings.
Market participants flagged when Zillow came to the bond market that a major risk in the company's securitisation deals was the revolving nature of the trust, whose value could fluctuate depending on the timing and prices on the homes Zillow flips. None of the deals carried credit ratings.
A buyside source familiar with the Zillow RMBS said it had been too early for Zillow to tap the RMBS market – especially considering the complex structure and unstable cashflows. But many fund managers had been eager to own paper backed by a higher-yielding asset, even if was unproven. "The reach for yield and a kind of leap of faith from debt investors rarely make a good combination," the source said.
Price action
Given the lack of information for noteholders so far, secondary market action for the unrated Zillow notes has been scant. There was a senior Zillow note on a bid list on Tuesday, which offered in the mid-to-high 90s range, but did not transact. There was another senior Zillow note – from the second deal, ZH Trust 202 1-2 – on offer on Wednesday, but it was quickly pulled. A couple of dealers had bids on Thursday to buy Zillow paper at a discount.
While its RMBS were in pause mode, Zillow shares had a tumultuous time, losing nearly a third of their value in two days.
The investor who bought the senior note in the first Zillow deal is optimistic that he will recover his investment because Zillow pledged to absorb up to 30% of the losses from the homes they pledged as collateral for the two deals.
Another positive factor is that underlying housing fundamentals remain strong, although home appreciation has cooled from its blistering pace seen earlier this year, the investor said. This would allow Zillow to steadily unload its homes rather than force a fire sale, he added.
The investor acknowledged the risk of Zillow's "Zestimate" before buying the bonds, which he still believes are protected by their credit enhancement. "I always knew the risk was their algo," he said.
Separately, several law firms said they were looking into Zillow's moves to see whether they violate any securities laws. When asked whether the US Securities and Exchange Commission has launched a probe into Zillow, a spokesperson said: “The SEC does not comment on individual filers."
