January 2022 – Housing, Humans, and Algorithms…

Echoing the past, it seems Zillow has re-experienced some of the business dynamics that brought down the hedge fund LTCM, as was famously described in the book When Genius Failed.  Zillow announced in November of last year that it would close its house flipping business, Zillow Offers, and write off over $500 million in losses.

As with LTCM, Zillow Offers was an algorithm-driven predictive business model that, unfortunately, didn’t live up to expectations.  And while it had grown to account for most of Zillow’s total revenue – it contributed nothing to Zillow’s profits.  This is the leading real estate company, with the best teams, the best information, and the most cutting-edge digital strategies and algorithms – and they still couldn’t get it right.

Yet at face value, Zillow’s flipping business seemed to make sense.  Tech-driven models are now common in securities analysis, so why not use similar models to value real estate trades?  But beware, business leaders and managers – all that glitters quantitatively is not necessarily gold, and there is much to be learned from both LTCM and Zillow Offers including:

  1. Markets, whether securities or real estate, can and probably will vary to the extreme from the best of predictions. (see PriSim’s previous post on VUCA – Volatility, Uncertainty, Complexity, and Ambiguity)
  2. Even the best technology can’t forecast the intangibles of human emotion and behavior and the resulting effects on markets because human beings are not, “machines guided by silicon chips…but run in flocks and retreat in hordes.”
  3. Algorithms and models can only attempt to predict outcomes based on the past and on what has already happened – and can’t forecast the uncertainty of the future.
  4. Expertise in one business area (Zillow’s core real estate listing service) doesn’t necessarily extrapolate to expertise in everything surrounding it (direct home purchasing, renovation, and sales).

The good news is that the closure and write off of the Zillow Offers subsidiary hasn’t sunk Zillow Group – and you can still check to see if your home’s Zestimate has gone up this week…