Why the real estate iBuying boom could 'end badly for a lot of folks,' according to an expert

Christopher Mayer, the Paul Milstein Professor of Real Estate at Columbia Business School, joins Yahoo Finance Live to explain the iBuying phenomenon, where institutions use technology to buy and flip houses, and what it means for homebuyers and the housing market.

Video transcript

JULIE HYMAN: Welcome back. We were just talking with Howard Lorber of Douglas Elliman about the market for residential real estate right now. I also want to talk about investing in that real estate. And, of course, there was one company that did that this year and had some big missteps. That was Zillow.

Let's talk about the outlook for these types of investments. Christopher Mayer is joining us now. He's the Paul Milstein Professor of Real Estate at Columbia Business School. Chris, thanks for being here.

I want to start with Zillow and some of these other companies that have been investing in real estate with an eye towards flipping and reselling. What do you think went wrong here? What was the big mistake that Zillow made, and are we going to see other companies fall into the same trap?

CHRISTOPHER MAYER: Well, it depends-- it depends who you talk to as to what the error was. If you listen to some of the commentary, maybe some of the things that Zillow talked about, they talked about challenges with their model and more technical issues.

I think about it much more broadly. I've been, you know, fairly negative about iBuying for years as an investment. The first thing to say is iBuying isn't new. What's new is having corporations do it. If you looked in Las Vegas and Phoenix and, you know, other places in the previous crisis, 30%, 40%, 50% of the houses that were transacted were flippers.

And iBuying, you know, in some ways is a fancy name for buying, you know, fixing up, and flipping houses. And that business has been around for decades, centuries, millennia wherever there's real-estate people willing to jump in and speculate.

The problem always is that this business is not predominantly driven by how great a model you have. It's driven really by two things. The first is where you are in the cycle. And the idea that people who are even the iBuyers still in the market can barely make money or still lose money when home prices are going up 20%, imagine what happens at some point in time when something happens to the market because prices don't always go up 20% plus and in some of the markets, as Howard said, 30%, 40%, 50%. And you have a lot of other people besides iBuyers who are buying hoping to sell to other people.

And as that share gets big, I just worry that, you know, the typical buyers are not people are going to sit in and use the homes and that this is going to kind of end badly for a lot of folks, which is what historically has happened for people who are, you know, buying, holding, flipping houses.

BRIAN SOZZI: Chris, is there another shakeout in this industry like we have seen with Zillow?

CHRISTOPHER MAYER: I mean, I don't know if there's shakeout. There's sort of two bigger players and a bunch of kind of smaller ones, but there's tons of local people who are doing this as well. Even the "New York Times," you know, wrote a favorable article talking about people who are in Austin, you know, buying houses hoping to resell them really quickly.

That's not that the home-- the returns for housing are not based on holding on to something and reselling it quickly. The returns for housing are really based on living in a home, you know, getting the value of a home, the appreciation. So is it going to end badly? I think for some of these folks, I think it eventually is.

And the problem is there's a real need for professional buyers providing liquidity, but it's not in markets like this where I can hold an open house, and get 20 buyers to show up at my open house, you know, and get five offers. This isn't the time we need people doing this.

Where we need liquidity is in a market like March or April or May of last year when people were really uncertain. Some people need to sell and faced financial distress. That's where we really need liquidity in the market, and that's when the iBuyers all dropped out.

And so like broker-dealers serving, you know, in larger markets, the need for liquidity is not when the iBuyers are providing it. The iBuyers are really kind of providing an accelerant to markets that are already rising more quickly, and that's not a particularly healthy sort of way to think about these markets. And it's definitely not healthy for individuals to buy and sell two, three, four homes. That's also not a great sign.

JULIE HYMAN: Chris, let's just take a step back. What is the difference between an iBuyer and a traditional real-estate investor?

CHRISTOPHER MAYER: Well, when you say a traditional real-estate investor, I think of traditional real-estate investors, you know, like my father or other relatives-- he owns several rental homes in Texas, and he bought them over the years. He fixes them up. He collects rents-- or people who are sort of in the market to buy really depreciated houses and resell them. They create economic value. They're in the market for the longer term. This isn't a business of just when prices are going up, buying more.

For those kind of traditional buyers, that's a fine business, but iBuying isn't that kind of a business. It's a very different kind of business, and they sell themselves as, you know, the idea, well, you can just, you know, put your house on the market and get an offer tomorrow. What we discovered was Zillow is the people who are selling to iBuyers were people who couldn't get good offers on the house otherwise, and Zillow was way overpaying.

And the same thing is going to be true of anybody that uses a financial model to try and buy housing is you're going to be adversely selected is how economists would put it, meaning the houses you buy are the houses that they can't sell at an open house with 20 people walking through. And that adverse selection is all things that are not in a model, and, you know, it's a problem for the business model.

JULIE HYMAN: This is really interesting stuff, Chris. So we've been hearing from people who give recommendations on investing that real assets is something that can be attractive going into next year as we're seeing rates go up. So if people want to invest in some kind of real estate, whether it be residential or commercial or any other multifamily, whatever, what have you, what do people need to know, do you think, going into 2022? You know, what do they need to be aware of if they want to make those kinds of investments?

CHRISTOPHER MAYER: Sure. I think investing in real assets and where you were talking about when you looked at the market, right? People who are investing in real estate to buy and hold and collect dividends, I think there's-- you know, real estate is a little bit pricey relative to historical norms in some of these areas, and some of them like office, you know, and senior living, we just don't know what the future is going to be for some of those kinds of businesses.

So there are opportunities there. There are opportunities to kind of pick the markets that are going to be successful and earn a return and hold the property for a while. Those are traditional kind of real-asset investments, and I think they're fine opportunities to do that.

The parts I'm worried about are people who are sort of looking and saying I want to resell in 3, 6, 9, 12 months. Those kinds of things are not what I think of as traditional real-asset investing. So people who are buying, holding, fixing up, you know, providing economic value, renting to other people, there's still very good opportunities in some of those markets. A little bit pricey, but then in the stock market, things are a little bit pricey also. That's because people have a lot of saving coming out of COVID, and there are a lot more sort of individual investors in the market. So that's kind of pushed up prices for lots of investment assets, real estate included.

JULIE HYMAN: So, Chris, then finally I would ask, are we in a bubble in real estate, or are there-- I mean, you made some differentiation between different areas of the market. Are parts of the market in a bubble?

CHRISTOPHER MAYER: So I worry about some of the places. I worry about some of the second-home markets. I worry about some of these markets where, you know, you're getting 30% of the purchasers are not owner occupants. I worry that those prices are a little overheated.

Fundamentally around the country, we haven't built enough housing, but we're starting to see housing starts and construction grow, and I think over the next couple of years, we're going to continue to see that happen. Look, I'm not predicting prices are going to collapse, you know, in 2022 and we're going to see, you know, a repeat of 2008, but I do worry that we're starting to see signs of overheating that are sort of creeping out of the corners, you know, at the moment, and I think home prices are starting to rise faster than can be justified by interest rates and incomes and even the lack of other investment alternatives.

And so I think the long-run returns are going to start to suffer a little bit, but real estate doesn't sort of-- real estate doesn't kind of operate as we have this big boom and then everything slows down. And Howard said, you know, we have a couple of years of, you know, prices growing 5% a year. That's just kind of not how markets operate, and we tend to see things accelerate further beyond fundamentals followed by, you know, significant downturns.

And unfortunately, I'm not sure I-- you know, I worry that we will see that pattern into 2022 where things get well above fundamentals and then really, you know, start to fall out when we get hit with the next crisis, whatever that is. You know, I can't figure out-- I'm not smart enough to figure out what that crisis is going to be, but that's the history of how, you know, our economy and financial markets work.

JULIE HYMAN: Really interesting stuff. Thank you, Chris. Christopher, Mayer is the Paul Milstein Professor of Real Estate at Columbia Business School. Appreciate it.