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Zillow - could it be a 10 bagger?

Lachlan Hughes

Swell Asset Management

Valued at US$36.2 trillion, the US housing market is nearly five times larger than the Australian market. Yet despite its size, the industry in the US remains plagued by inefficiencies and has been slow to move towards a digital model. NASDAQ-listed Zillow Group is changing this and as a result, we believe it represents an exceptional long-term investment opportunity.

What is Zillow?

Zillow is a data-driven real estate company with a mission “to give people the power to unlock life’s next chapter”.  Its listings platform boasts:

  • 221 million monthly active users
  • More than 135 million homes
  • 2.5 billion visits in the most recent quarter  

How does Zillow make money?

Zillow’s revenue is derived from three primary sources:

  1. Agents pay for leads and advertise listings (Advertising)
  2. Buying and selling homes (iBuying)
  3. Lending money to buyers (Lending)

Advertising

Zillow is the market leader in US real estate advertising, through its Zillow and Trulia websites, which command more than 67% market share. The monthly visits to the websites of Zillow and its peers are highlighted in the chart below.  

Average monthly visits in March 2021 (millions)

Competitive advantage

Zillow’s leading market position is fortified by several factors:

  1. Significant brand and data advantage
  2. Large engaged audience
  3. Best in class technology
  4. Experienced management team

Addressable market

The addressable market for advertising is expected to increase by more than 50% between 2020 and 2024. By 2024, 75% of real estate marketing will be digital equating to US$32 billion. We forecast Zillow’s market share to increase by 3% to 11% or US$3.5 billion, more than doubling.  

Improved monetisation of its c.10 billion annual visits is driving this growth. The chart below compares revenue received by Australia's REA Group (ASX: REA) with Zillow's revenue relative to total visits, with REA Group receiving $0.74 per visit while Zillow currently generates only $0.11.

  

"Ad load” is the concentration of advertising on websites, and Zillow falls far behind REA in capturing this opportunity. We believe Zillow has the capacity to meaningfully increase its ad load without impacting the user experience. 

  

In addition to revenue growth, Zillow’s digital advertising margins are materially lower than global peers as demonstrated below. Being a digital business Zillow will benefit from significant operating leverage as the business scales.

EBITDA margin peers

While digital advertising is maturing, iBuying is in a nascent stage as it moves to disrupt an inefficient industry structure.

Key facts about US real estate market
  • Realtors used by both sellers and buyers
  • Typical realtor fee 6%, split between buyer’s and seller’s agents
  • 2 million realtors, 28% have another occupation
  • Median realtor income with < 2 years experience is $8,500

The traditional home buying/selling process is lengthy, complex and uncertain, involving many intermediaries. Intermediaries have benefitted from an informational advantage and personal network which is increasingly being displaced by the internet. 


iBuying?

iBuying or instant buying is the streamlined process consumers are seeking to remove the typical impediments associated with a real estate transaction. It has several benefits, but the main ones are:

  • Reduced complexity
  • Increased transparency 
  • Reduced time

Zillow's position to grow the iBuying market

Zillow is focused on simplifying the real estate value chain, acquiring homes at fair value and eliminating the need for sellers to style homes beforehand. They provide flexibility and dedicated support, guaranteeing payment within 7 days after closing.

Zillow is able to facilitate this transition as it focuses deeply on data and the customer experience. Its pricing algorithm continuously refines price estimates reducing errors. While operating in only 25 cities now, this will expand to 100 in coming months.

Zillow’s large database of 135m+ homes provides an informational edge. More data allows Zillow to perfect its proprietary pricing models to offer more accurate prices for sellers and buyers while ensuring a profitable business model for Zillow. The business benefits from scale as it relies on the law of large numbers to provide a stable win rate over time, which the company calls its contribution margin. Zillow believes the long-term contribution margin will be around 4 to 5% once the business is at scale.

By leveraging Zillow’s brand and scale advantage, management was able to significantly grow its iBuying market share from single digits in 2018 to 30% in 2020. Since 2018 Zillow has acquired thousands of homes, including 5,337 in 2020 alone with the average home listed at around US$320,000.

Three long-term trends will drive the next decade of iBuying growth:

  1. Demographics as millennials enter the housing market

  2. The ‘Great Reshuffling’ as people move toward flexible work and living

  3. Offline to online as agents and brokers streamline business operations


How big is the iBuying opportunity?

We estimate the iBuying market will account for 3% of total transactions by 2025, up from 0.6% in 2018. While 3% seems minor, the market is large, with annual home sales expected to reach US$2.4 trillion by 2025. Millennials are now the largest buying group in the US and the younger buyers share has been steadily rising. We expect this trend to continue, supported by early adopters looking for more efficient housing transactions and services. 

The iBuying segment also positions Zillow to offer additional services like closing and escrow, insurance, warranties, renovation, and moving services. These adjacent services provide further upside when iBuying becomes more widely adopted. 


Home loans

Also burdened by deeply rooted intermediaries and inefficiencies, the traditional US loan underwriting process can take as long as 45 days. Zillow can leverage first-party data from its large customer base to streamline the process to reach the total addressable market of US$156 billion, of which Zillow currently manages 0.1%. We estimate Zillow could increase its market position to 0.85% over the next 5 years, an 8x increase in revenue. Zillow also partners with mortgage brokers, providing referrals.

Management

The executive team is led by Rich Barton (CEO) and Lloyd Frink (Executive Chairman). Rich co-founded Expedia and Glassdoor and worked for both Microsoft and Netflix. Lloyd shares Microsoft as a former employer with Rich and is presently affiliated with the food delivery service Grubhub. Both Rich and Lloyd have fifteen years’ experience at Zillow.

At Swell, our investment process is focused on the long term, and we believe Zillow’s value will increase as the advertising business matures, consumers experience the benefits of iBuying and adjacent services like mortgage lending flourish. With successful execution, we believe Zillow can increase its market capitalisation many times over.

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This document has been prepared without consideration of any specific client's investment objectives, financial situation, or needs. While this document is based on information from sources that are considered reliable, Swell Asset Management, its directors, and employees do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Any views expressed are taken to be those of the individual sender, except where the sender specifically attributes those views to Swell Asset Management and is authorised to do so. Swell Asset Management is an authorised representative of Hughes Funds Management Pty Limited ACN 167 950 236 AFSL 460572

1 stock mentioned

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Lachlan Hughes
Lachlan Hughes
CIO
Swell Asset Management

Lachlan is the founder and CIO of Swell Asset Management, a boutique investment manager specialising in global equities.

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