Opendoor (NASDAQ:OPEN) has jumped 150% since its June IPO. With a market cap of over $16 billion, Opendoor is now valued more than online real estate competitor Redfin (NASDAQ:RDFN) and nearly half of Zillow (NASDAQ:Z). But despite a red-hot housing market, I’m not chasing OPEN stock. In fact, I think it’s heading for a blow-up at these levels.
That’s because OPEN hides three key flaws behind its slick investor relations presentations. Not only are they hiding a toxic business model from customers. They’re also obscuring financials from regular investors. Add increasing competition from the likes of Zillow, Redfin and others, and you have a startup that’s living on borrowed time.
Opendoor wants to shake up the $1.6 trillion U.S. real estate market. The company, which originally pioneered an algorithm for flipping homes, is the latest “iBuyer,” or instant buyer. Instant buyers use proprietary online home value assessment tools to determine what your home is worth. They make fast cash offers and then resell homes.
OPEN claims that internet-based real estate transactions represented 1.3 million of the total 5.6 million home transactions closed in 2020.
OPEN Stock Red Flag No. 1: Faulty Value Proposition
Opendoor claims to offer “fair market prices.” But it’s not clear whether customers are getting the best price for their home.
In fact, according to many reviews, the firm preys on home sellers in need of quick cash. Many of Opendoor’s offers come in at $10,000 or more under asking price, but sellers agree to these conditions in expectation of a cash offer within 24 hours.
Even if sellers like OPEN’s initial offer, it’s subject to hidden costs. The company sends an inspector to assess the home for repairs, and deducts these costs from the purchase price. Many customers have reported seeing expensive adjustments in the minutes before deal closing.
On the buyer side, OPEN’s value proposition seems no better. The automated home-flipping firm has no dedicated renovation staff. Instead, it unloads the essential responsibility to third-party contractors, many of which offer substandard repairs.
Red Flag No. 2: Convenience Isn’t Free
Quick and easy sounds nice. But none of this convenience is free. And the cost isn’t easy to calculate.
OPEN charges customers a flat 5% service fee to account for carrying and resale costs, since it can’t immediately flip homes it buys for a profit. On the surface, OPEN’s fee is less than listing through traditional brokers, which typically charge 5.5% to 6% in commission. And with a cash offer, sellers no longer need to spend money on last minute fixes to spruce up the place for sale.
But the math only works if you get the best price for your home. And looking closely, you’ll see that OPEN’s algorithms are optimized to maximize its own margins as opposed to getting customers the best price. The company’s technology relates to how accurately the company thinks it can price its offers and the turnaround price and timeline in which it can sell the home afterward.
Opendoor’s cash offer is based on comparable home sales. In a slow market, more sellers are willing to accept less for the certainty of a quick sale. But in a seller’s market, where inventory is low, interest rates are near zero and buyer demand is high, bidding wars can drive up home prices well past comps, making OPEN’s offer less compelling than planting a “for sale” sign.
Red Flag No. 3: Transparency, Please
There’s another reason to be cautious. OPEN’s business model lacks transparency.
Opendoor makes money in two ways: from the service fees it charges, and from any difference between what it buys for houses and what it sells them for. Right now, the company isn’t profitable and doesn’t expect to break even until 2023. Adjusted EBITDA declined last year to 3.8% from 4.6% in 2019.
Much like the company’s service fees, understanding the company’s path to profitability requires reading the fine print. OPEN excludes interest expense from its adjusted EBITDA calculation, the company’s only reported profitability measure. Interest on the debt used to buy houses is OPEN’s largest operating expense. It’s also expected to increase as the company buys more properties.
By backing out this number from its calculations, OPEN’s losses look much smaller than they really are.
With its flat service fees, OPEN is clearly trying to lure in sellers and build inventory for future growth. And the more inventory the company can control, the more power it has to manipulate supply and demand dynamics in its favor.
For example, for a brief period in Q4 of last year, the company continued to purchase homes but stopped listing new homes for sale. Zillow continued to purchase and list new homes for sale during this period. The result: an artificial buildup of inventory. By withholding listings, OPEN pushed back the period when homes would sell, allowing the company to report better revenues in Q1 of 2021, its first quarter as a publicly listed company.
These financial shenanigans should make any investor think twice about buying Opendoor’s stock.
Too Much Too Soon
Opendoor is right about two things. Real estate transactions are a hassle. And there’s a lot of market share to grab.
But with convenience being the company’s only real selling point, and competition heating up, there’s no reason to bet on this horse just yet. Firms like Zillow are wasting no time in building out their own version of Opendoor’s business. Revenues at Zillow’s Homes business grew 23% in 2020, even as Opendoor shrank 45%.
OPEN stock trades at a pricey 4x sales, just under Redfin at 5x. Given an uncertain path to profitability, and aggressive growth expectations of over 50% per year, I think the shares are overvalued.
Expect a bumpy ride ahead.
On the date of publication, Joanna Makris did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Joanna Makris is a Market Analyst at InvestorPlace.com. A strategic thinker and fundamental public equity investor, Joanna leverages over 20 years of experience on Wall Street covering various segments of the Technology, Media, and Telecom sectors at several global investment banks, including Mizuho Securities and Canaccord Genuity.