Description

Offerpad offers the opportunity to invest in a top 3 iBuyer at an undemanding valuation relative to its future potential. While the short-term valuation metrics may not appear low, given the iBuyer industry’s infancy and future potential growth, the potential asymmetric upside with up to a 15x return in a bull case makes this a compelling investment.

Business Description

Offerpad is the third largest iBuyer (a company that buys from home sellers desiring a fast and certain close and after some minor renovations sells to a home buyer) with a sales run-rate of $2.1 billion per year based on the annualized high-end of Q3-guidance. It was founded in 2015 by Brian Bair, a single-family real estate investor and before its de-SPAC, had raised only $200 million in invested equity capital. It went public through a September 2021 merger with Supernova Partners (SPNV), a SPAC sponsored by Alex Klabin (Senator Investment Group co-founder) and Spencer Rascoff (Zillow’s CEO from 2008 to 2018). As of June 30th, Offerpad operated across 16 metropolitan markets: Atlanta, Austin, Birmingham, Charlotte, Dallas, Denver, Houston, Jacksonville, Las Vegas, Nashville, Orlando, Phoenix, Raleigh, San Antonio, Tampa, and Tucson. The company is fairly capital efficient with EBITDA losses of only $25 million in 2019 and $8 million in 2020. It has approximately 644 employees with a corporate headquarters in Chandler, Arizona.

Estimated Returns

We see the potential for Offerpad to increase 5.1x to 14.9x in an optimistic base and bull case. Even if it is difficult to have a high degree of precision in these numbers, the high potential and asymmetric returns if things go well warrant an investment.

Fannie Mae estimates that existing home sales will be ~5.7 million units by the end of this year, and the latest average home price is $434,200. That results in approximately a $2.5 trillion market in 2021, or $2.7 trillion in 2030 assuming a 1% CAGR (intentionally conservative to reflect possibility of rising interest rates or slowing transactions).

iBuyer’s buybox is typically described as 50% of homes, but it seems reasonable to project that buy-box will expand to 60% by 2030. This results in a $1.6 trillion TAM in 2030. Assuming a 15% iBuyer penetration by then, implies an iBuyer market size of $244 billion. Currently Offerpad has a 13% market share, which can be projected to remain stable (further discussed below) and would result in $32 billion in revenues. At a 2% after-tax margin, and a 20x multiple, the market capitalization would be $12.7 billion, a 5.1x increase from today’s price over 8.2 years (through end of 2029) or a 22% IRR. In a more aggressive case, using a 20% iBuyer penetration, 18% market share, 2.5% after-tax margin, and a 25x multiple, results in a $36.5 billion market cap, or a 15x multiple. For the sake of simplicity and given the high dependence on terminal value, we assumed cash accumulation is a relative wash vs. potential incremental equity sales over an 8-year time frame.

Key Industry Points

iBuyers are likely to take significant share of the home purchase market as a result of agent disintermediation, scale efficiencies, and ability to cross-sell services.

At a high level, it does not make sense for individuals selling their most significant asset to pay 5-6% of the proceeds to intermediaries (agents) who do relatively little. However, this system survived for a while given the real estate market’s historical opacity (pre-Zillow), sellers funding buyer’s agents (incentivizing buyers to use them), and inability to market homes without agents (before widespread internet shopping). The entry of a risk-taking principal in the middle of this process (the iBuyer) is finally reorienting the ecosystem. iBuyers are leveraging this high fee-rate from agents, along with economies of scale in renovations, the opportunity to sell final buyers title and mortgage, and the ability to have lower payout to buyer agents to make compelling offers to home sellers that still allow iBuyers to have good margins. Beyond price, customers value the ability to quickly sell their homes, without having to do renovations and tours, and have the proceeds available to purchase their next home (rather than having to carry two homes simultaneously or not having cash for their next home).

The proof that customers are finding this valuable is that even in the current environment, with homes selling very quickly and a strong economy, iBuyers are seeing good growth with strong profitability.  That said, the iBuying industry is still at a very nascent stage - at the high end of Offerpad, Zillow’s, and Opendoor’s Q3-guidance, their run-rate of revenues is less than $16 billion, or approximately 65 basis points of national existing home sales.

Target Profitability

Offerpad has a relatively simple path to achieving 250 bps of pre-tax margin (the above base case). In 2019, Offerpad’s contribution profit per home was 4.2%. Assuming 90 bps of normalized interest costs (4% debt turned over 4x per year at 90% LTV), 150 bps of overhead, and 225 bps of profitability improvements offset by 155 bps of fee compression to grow the TAM results in 250 bps of profitability. By comparison, Opendoor is guiding to roughly 400 bps of earnings before tax and D&A (~ 500 bps of EBITDA less about 90 bps of interest), but the D&A is very low in this business.

Key ways to improve profitability from here include:

1.       Lowering buyer agent commissions – 100 basis points.

a.       Because buying from an iBuyer is easier than from a traditional home seller, and the iBuyers have enough resources to go around agents, iBuyers’ payouts to buyer agents (a significant portion of the cost structure) are likely to shrink. This is driven by either offering lower payouts to agents themselves (already being trialed by Zillow and Opendoor), or offering incentives to use partner agents who charge less.    

2.       Attaching mortgages – 50 basis points.

a.       Using a 40% attach rate (between the broker industry average of 20% and homebuilder of 75%), 80% LTV, 3% gain on sale, and 50% margin, results in an incremental 50 basis points of profitability.

3.       Further automating systems, improving home valuation systems, reducing CAC – 75 basis points.

Potential Incremental Options

Longer-term there is significant option value in the tangential businesses iBuyers could build to serve individuals not selling homes to them:

1.       Power Buyers:

a.       This service purchases a home for a customer and allows them to move in while listing the old home. Once the old home is sold the customer uses the funds to purchase back the new home from the Power Buyer. The Power Buyer makes this an attractive economic model by earning the commissions traditional agents get.

b.       Opendoor has demonstrated that an iBuyer can do this well with its product having crossed $1 billion run-rate. Offerpad offers this as an option within its Flex program, but flex remains less than 1% of its revenues.

2.       List with the iBuyer: this service would result in a lower commission for the home seller.

3.       Mortgages:

a.       iBuyers should offer mortgages to sellers to buy their next home given their close relationship with the customer.

b.       Additionally, given the iBuyers will all build out modern significant mortgage origination operations, they will likely be able to market refinancings (both to new customers and past customers), and purchase mortgages for potential home buyers who end up purchasing a non-iBuyer home.

4.       Other services including moving, renovation, warranty, insurance, and energy efficiency solutions.

Historical Execution

The company has had strong historical execution. Offerpad grew its homes acquired from 583 in 2016 to 4,998 in 2019, or 8.6x in just 3 years. Simultaneously its revenues scaled from $100 million to $1.1 billion. It did so while burning little cash: the company’s adjusted EBITDA loss in 2019 was only $25 million. By contrast, Zillow, with its significant resources, traffic, and brand recognition, had only slightly higher homes revenues ($1.37 billion), but adjusted EBITDA losses of $241 million in its Homes segment. Offerpad’s lower overhead does not result in weaker unit economics; in fact it maintained better pre-interest contribution profit than Zillow in 2019 (4.2% vs. -0.1%), and Opendoor (1.9% in 2019). Offerpad’s strong cost discipline is a key advantage in a low-margin business, and also enables it to more efficiently spend its growth capital now that it is less capital constrained.

Investing in the #3 Company

Frequently investing in the third largest company in an intensely competitive sector (especially “tech”) is not a great idea. There are several reasons we believe that should not stop an investment in Offerpad, especially given the meaningful discount it trades at vs. Opendoor (OPAD trades at 1x Q3 annualized sales, vs. Opendoor at 1.6x).

The reasons small companies underperform larger companies include lack of scale to invest or lever overhead costs, network effects, lacking customer brand recognition + trust, and not being supported by a larger ecosystem. The first of these is usually a reasonable hinderance to success, however it is possible to overcome it through superior execution and nimbleness which Offerpad has demonstrated. Having a smaller “network”, or not having an ecosystem is not a problem in the iBuying business because those are not important success drivers in this specific business. Similarly, not having as much brand recognition + trust is not as critical because OPAD will have enough scale to demonstrate it closes transactions and home sellers will want to accept the highest financial offer and as a result search out for more potential iBuyers, given how significant this asset sale is for them.  There is even the potential for Offerpad to increase its market share given it will be less capital constrained post-merger, and customers will be evaluating home purchase offers primarily on price. Currently Offerpad is 27% of Opendoor’s size and 35% of Zillow’s size.

Risks

Increasing competition from new entrants/home builders/power buyers. This is risk, but this business is fairly difficult to build and run and requires significant scale for meaningful profitability. As a result of these two factors, even if there is additional competition, it will turn this into a slightly lower margin business rather than a bad business.  

Agents reduce their commissions in order to compete with iBuyers. We believe this is unlikely to be a significant risk over the next 5+ years because agents will feel little pressure to reduce commissions while iBuyers are less than 5% of the total market. Subsequently the iBuyers will be too big to disappear and may face some pressure from agents reducing commissions, but not fundamental business disruption. Additionally, agents make relatively little money and would face significant financial pressure if they even reduced their own commissions 20% (imagine a middle class person losing 20% of his or her salary).

Debt maturities: currently the industry finances itself with relatively short maturities. For example Opendoor has significant debt outstanding that matures as early as July 2023. We believe that ultimately once the industry is more proven out, the debt terms will get longer and be de-risked. In the interim, there is risk of funding drying up (in theory, though the fed seems to prevent this in practice), but the assets’ liquidity (individual homes are relatively easy to sell and slow to fall in value) should protect the companies from excessive balance sheet impairments.

Falling home prices are another risk, but as wjt commented before, the exposure at any one time is not overly bad.  

Catalyst

Continued business growth and improving profitability, incremental sellside coverage, potential acquisition by an entity with significant capital to invest.