Opendoor, the nation’s largest iBuyer, is going public. It is doing so via a merger with Social Capital Hedosophia Corp II (NYSE: IPOB), which is a special purpose acquisition company (SPAC) led by investor Chamath Palihapitiya. Opendoor published an investor presentation as part of its merger announcement in September, and last week the company filed its S-4 (similar to an S-1, but used for companies engaged in a merger process). The transaction values Opendoor at $4.8B (pre-merger value) and the company will receive north of $1B in proceeds ($600M PIPE and $414M via merger with IPOB). While the SPAC merger process is quite interesting on its own (good posts on the topic here and here), this post will focus in on the Opendoor business, its progress to date and its prospects for the future.

Opendoor, founded in 2014, transforms the process of selling a home into a seamless digital experience, eliminating uncertainty for sellers. Sellers can go to Opendoor.com, receive an offer for their home, sign and close on the date of their choice — a dramatic improvement over the traditional selling process which can take 100+ days. In return, Opendoor receives a 6–12% discount on the market value of the home. This model is remarkably consistent with the vision described in Opendoor’s Series A presentation (worth a read). In addition to the spread captured when buying and selling homes, Opendoor earns revenue via ancillary services related to the real estate transaction, including title insurance, escrow services and home financing solutions.

In 2019, the company sold 18,799 homes across 21 markets, generating $4.7 billion in revenue (up more than 160% from the prior year). While the growth of the business has been impressive, Opendoor remains several years from profitability, having posted net losses of $339 million in 2019 and $117 million through the first half of 2020. Opendoor has ambitious plans to reach nearly 38,000 annual home sales and $10 billion in revenue by 2023. The company expects to become EBITDA-positive (on a non-GAAP basis) by the second half of 2023.

While the core vision of the company is quite elegant (“building the digital one-stop shop to move” according to Opendoor founder Eric Wu), the path to realizing that vision is incredibly complex. It requires thousands of employees across dozens of markets, holding billions in home value at any given time. So what is Opendoor’s path to becoming a large and profitable company? Below I’ve outlined five key “things you need to believe” as the company marches down that path, as well as some thoughts around the Opendoor’s valuation relative to other public real estate companies.

1. Opendoor’s economies of scale drive down per-unit expenses & box-out competitors

Opendoor has built a massive home buying and selling operation that involves more than 1,000 employees across 21 markets. The company sold nearly 19,000 homes in 2019 (about 70 transactions per business day) and purchased thousands more. That scale is quite impressive given the fragmented, hyper-localized nature of real estate. This scale gives the company some important advantages:

• Opendoor has more borrowing capacity, a higher advance rate, and a lower cost of capital than many of its iBuyer peers; according to the company’s S-4, Opendoor has access to $2.8B in senior credit facilities with a total weighted average interest rate of 4%. It also has mezzanine facilities (loans that are subordinate to senior debt) in place to bring its effective advance rate to 100%. This allows the company to scale home purchase volume without tapping its own balance sheet.
• Opendoor has developed a third-party network of more than 10,000 subcontractors, managed by a centralized operations team. This model has led to a 50% reduction in spend per home over the last 2 years. Additionally, the company has been able to negotiate bulk discounts on home materials (more than 40% lower than retail prices). According to Mike DelPrete, Opendoor’s average repair costs are about 2–2.5% of home value, compared to an estimated 4% at Offerpad and 5% at Zillow.

Potential Challenges

While economies of scale have definitely kicked in at Opendoor, there are also quite large fixed costs associated with operating the business that require even greater scale to overcome. For instance, in 2019 the company sold 18,799 homes and generated $301M in gross profit; however, its total operating expenses as a percentage of gross profit exceeded 180%.

Additionally, as the company continues to scale home purchase volume, incremental returns to scale may be diminished. For example, there are limitations to the bulk discounts suppliers can offer, limitations to cost of capital improvements, and some areas in which costs will always scale in proportion to volume (i.e. property taxes, utilities and insurance). And with time, its fellow iBuyers may achieve similar economies of scale. Given this dynamic, we expect the company to pursue incremental revenue streams as a means of improving its margin profile (more on this later).

2. Accumulating advantages makes the Opendoor business better & more defensible over time

In addition to cost advantages that come with scale, Opendoor has developed a set of accumulating data advantages that are more proprietary and durable in nature. This informs the price it offers prospective home sellers, as well as the renovations made on purchased homes in order to maximize ROI. From the S-4:

We have conducted over 150,000 home assessments during which we collect over 100 data points on each home and its surroundings. These proprietary data points have led us to make over one billion annotations and corrections to Multiple Listing Services (“MLS”) and tax assessor data, as well as build out new, non-traditional geospatial data assets, such as power line ​proximity and road noise level. The additional home level data we collect from local vendors provides structured feedback on each home and further strengthens our data moat.

This data asset leads to better pricing models that can assign specific values to home features (i.e. granite vs. tile countertops) as well as identify the areas in which home renovations may drive the highest return. Better pricing accuracy creates an important flywheel for the business: pricing accuracy improvements allow Opendoor to lower the fee it charges, which increases purchase volume, which in turn further contributes to its data asset and pricing accuracy. There are also accumulating advantages around brand which may improve Opendoor’s customer acquisition costs over time. It’s no surprise that despite the proliferation of iBuyers over the last several years, Opendoor remains the largest with 64% market share (as of 2019).

Potential Challenges

As the chart above indicates, iBuyers in total capture about 0.7% of U.S. home sale volume (pre-COVID). In Phoenix, Opendoor has bought and sold homes for the last six years, completing thousands of transactions and refining its pricing and operational models along the way. In Q1 2020, Opendoor reached 4.1% market share in Phoenix before pausing home buying due to COVID-19.

While that’s certainty impressive scale in a single market, it’s also indicative of the potential limits to capturing even more share — a large subset of sellers may simply prefer to market their homes as opposed to selling to an iBuyer at a discount. The next chapter of Opendoor’s growth story may not come solely from better pricing models, but instead by building new products and services that cater to multiple customer segments.

3. Opendoor will be able to increase gross profit per transaction via ancillary products and services

Critical to the Opendoor strategy is its ability to attach additional products and services to its transactions. The company expects its gross profit per home to increase by about $8,000 in 2023, driven primarily by these ancillary revenue streams. In its investor presentation, Opendoor highlighted several service areas, including:

• Integrated title insurance and escrow services (via its acquisition of OS National in 2019). 80% of Opendoor home transactions that closed during 2019 included the in-house title & escrow service (in the markets in which the service was available). This represents $1,750 in incremental margin per home.
• The company recently launched Opendoor Home Loans, a tech-enabled mortgage platform for customers looking to buy or refinance a home, which is licensed in eight states. This represents $5,000 in incremental margin per home.
• Opendoor plans to add additional services over time, such as home insurance, home warranty, moving and storage, and home repair and maintenance. It believes these services represent up to $7,500 in incremental margin per home.

The roll out of multiple services allows the company to create incentives for bundling. For example, Opendoor may be willing to lower its home purchase fee (currently 6%-12%) if a customer agrees to finance their next home with Opendoor Home Loans, or purchases an Opendoor home insurance policy. Bundling may then improve seller conversion rates — according to Opendoor’s investor presentation, sellers are about twice as likely to sell their home at a 6% fee vs. a 12% fee.

This strategy has been executed successfully by home builders for many years. For example, Lennar has an in-house financing arm called Eagle Point, which is used by buyers to finance about 70% of Lennar’s home sales.

Potential Challenges

As the Lennar expample indicates, this strategy around attaching multiple revenue streams to a real estate transaction is not new — it’s common amongst real estate brokerages, home builders, and technology-enabled real estate companies like Zillow. While Opendoor has demonstrated that it can generate a high attach rate with title & escrow, the company did not provide data around its mortgage business or buy-side services. Title & escrow are typically viewed as commodity offerings and consumers are more likely to optimize for convenience vs. “shop” for better pricing (thus contributing to the high attach rate). We’ll have to wait for data on how its other ancillary services are performing in future quarters, although data from Mike DelPrete suggests that the Opendoor Home Loans attach rate is currently only about 2%.

4. Over time, Opendoor will become a marketplace for both sellers and buyers

Implicit in the company’s vision (“transforming how people move”) is the recognition that Opendoor will help enable both sides of the real estate transaction — serving both sellers and buyers. To that end, the company launched several buyer-side products over the last year, including:

• Buy with Opendoor: Allows home buyers to tour homes on-demand, make an offer and shop for financing in a single platform. Opendoor acquired Open Listings in 2018 to augment its buyer experience.
• Home Reserve: Launched in 2019, Home Reserve is designed for dual-track buyers; Opendoor purchases homes on behalf of a buyer, after which it will list the buyer’s existing home for sale.
• Trade-In: Opendoor will coordinate the sale of an existing home and purchase of a new home such that homeowners can avoid carry two mortgages simultaneously.

Why is serving the home buyer so important to Opendoor? It directly impacts the company’s ability to expand margins and grow market share.

• Margin expansion by disintermediating agents: today, nearly half of Opendoor’s per-home gross margin is lost to direct selling costs, which largely consist of commissions paid to a buyer’s agent when a home is sold. At a 3% commission on a $250,000 transaction, Opendoor is surrendering $7,500 in potential gross profit to the agent. Over time, Opendoor may be able to circumvent agents in the transaction process, which would directly impact its margin profile.
• Market share expansion by building “multiple front doors”: more products and services targeting at both the buyer and seller allows Opendoor to leverage its existing team, infrastructure and brand to grow market share outside of iBuying.
• Overall reduction in inventory holding period: by better matching buyers and sellers, Opendoor can increase its transaction velocity and reduce the time and cost associated with holding homes in its inventory. This is enabled by scaling the number of buyer relationships on its marketplace, and learning over time how to match individual buyer preferences to Opendoor’s inventory of homes. And in cases where Opendoor is assisting a buyer in their home search, there would be no holding costs associated with completing the transaction, leading to margin improvement.

Potential Challenges

Moving to the buyer-side of the transaction puts Opendoor in more direct competition with the large real estate portals, such as Zillow and Realtor.com, as well as the tech-enabled brokerages like Compass and Redfin. Both Zillow and Redfin have launched iBuying services as a competitive response to Opendoor, albeit at a smaller scale for now (Zillow purchases about 6,000 homes in 2019 compared to more than 19,000 at Opendoor).

But Zillow and Redfin do have some inherent advantages on the buy side that Opendoor will need to overcome — namely, large audiences of prospective home buyers using their web and mobile applications to browse listings. More than 90% of home searches begin online, and every month nearly 200 million users visit Zillow’s portal. Part of the challenge for Opendoor will be in capturing more “top of funnel” traffic on the buy side, i.e. buyers who are just initiating their home search. Perhaps that can do so by offering exclusive listings or cost-saving incentives to buyers.

5. Recent macro-tailwinds accelerate Opendoor’s path to reaching this end-state

The Opendoor investor presentation highlights several shifts in consumer behavior prompted by COVID-19, which create tailwinds for the Opendoor business. These include: a rise in demand for digital home buying and selling experiences, de-urbanization and relocation to the lower cost, suburban markets in which Opendoor operates.

Monetary policy has also created an attractive home buying environment for Opendoor and its customers. Interest rates are near record lows (and will continue to stay low), and government stimulus efforts in response to COVID-19 have led to a rise in average household wealth in 2020. This directly impacts Opendoor’s cost of capital and the demand for homes in its inventory — two critical elements of building a profitable business. [Related: In May, I published some data on the health of the U.S. housing market]

Potential Challenges

While there are certainly some interesting macro-tailwinds benefiting Opendoor, the pandemic also sheds light on how future housing market shocks may impact the company’s financial performance. Opendoor projects a 47% year-over-year decline in revenue in 2020, driven by its decision to pause home buying efforts in Q2. While a once-in-a-century pandemic is certainly a valid reason to suspend home buying, the company and its peers have been slow to resume its buying efforts, even as the broader housing market has continued to perform well. For example, in Phoenix, iBuyer volume dropped by nearly two-thirds in April. By June, the Phoenix housing market had returned in full force (home sales were up 2% year-over-year), but iBuyers have yet to scale their buying efforts to pre-pandemic levels.

This creates some questions around the company’s ability to grow during other challenging periods. For instance, during a recessionary environment in which demand for homes falls, Opendoor’s average holding period for existing inventory may lengthen (takes longer to sell a home) and its expected revenue per sale may decrease (home prices decline). This would have the effect of eroding margins, at least temporarily. During the pandemic, home prices were remarkably resilient, which helped the company maintain gross margins through Q1 and Q2 2020.

How to value the Opendoor business?

Given Opendoor’s novel business model, there aren’t any perfect public companies by which to compare valuations. There are three sets categories which are potentially relevant: real estate brokerages & portals, mortgage originators, and single-family rental REITs.

While the Opendoor SPAC agreement was announced at a $4.8B enterprise value, the price of IPOB shares have since increased, which imply an enterprise value of about $12B. This indicates that investors are willing to price Opendoor at a premium relative to other public real estate comps such as Zillow. See the graph above, which plots each comp: EV / 2021 Gross Profit multiples on the Y-Axis and 2021 project growth on the X-Axis.

Real Estate Brokerages & Portals: Both Zillow and Redfin have launched competing iBuyer offerings, but revenue attributed to those efforts is quite small relative to their core businesses. Zillow, for instance, generates about 60% of its revenue from its advertising and media business, 10% of its revenue from its mortgage business, and the remaining 30% from its home buying business. Over time, these companies will be the compete more directly with Opendoor, both as iBuyers and via traditional brokerage offerings (i.e. Buy with Opendoor).

Mortgage Originators: Rocket Mortgage recently became a publicly traded company, valued at more than $40 billion. The company has benefited from many of the same tailwinds mentioned above, particularly around the low interest rate environment which is driving demand for refinancings. Like Opendoor, Rocket Mortgage has built several ancillary revenue streams, including loan servicing, title & escrow, auto and personal loans, and an agent referral network. Rocket Mortgage and its peers typically trade on a multiple of EBITDA or net income.

Single-Family REITs: these companies have developed similar expertise around acquiring, renovating and managing a large portfolio of single family homes. For example, Invitation Homes owns 80,000 homes in 16 markets across the country. Whereas Opendoor intends to quickly sell the homes in purchases, SFRs tend to rent properties to tenants for several years, capturing both cash flows associated with rental income, as well as home price appreciation during its hold period. These companies are typically valued on a multiple of net operating income (NOI) or funds from operations (FFO).