Mankind has a long and storied history of letting ego get the best of us. There’s always someone who thinks they’ve got it all figured out and they’re smarter than everyone else. But unless you’re Elon Musk that rarely turns out to be true. The latest inductee into the Hall of Hubris in this sense is Zillow. Zillow thought they had created an algorithm that could predict the housing market and were using it to automatically purchase houses that it believed could be resold later for a profit. This didn’t quite work out as planned and led to a massive selloff of Zillow Group’s stock.
Marketwatch.com recently reported the debacle and here is an excerpt from their article:
Zillow thought it had revolutionized the homebuying experience with advanced algorithms. But it was no match for the pandemic-era market. Zillow Offers was meant to be the company's secret weapon for flipping homes. Launched in 2018, the business used algorithms to value homes, purchase certain properties, and sell them soon afterward for a healthy profit. The company aimed for this instant-buying arm to become a new cash cow. It was targeting annual revenue of $20 billion. Now, Zillow Group Inc. is calling it quits on the home-flipping business, while disclosing expected losses of more than $550 million on homes purchased in the second half of this year for which the company admits it paid too much.
"Fundamentally, we have been unable to predict future pricing of homes to a level of accuracy that makes this a safe business to be in," Zillow CEO Rich Barton said. In a sign of what an existential risk this unit was becoming, Zillow also announced plans to lay off 25% of its staff. Barton said this algorithm had a "high likelihood, at some point, of putting the whole company at risk, not just the instant-buying arm business."
The factor that Zillow was unable to bake into its algorithm was that of human behavior. Markets are constantly impacted by the people who participate in them, and those people are impacted by a never-ending flood of daily information that can change their behavior on a dime.
Just the fact that there could be a perceived bubble in a market can massively change behavior and this is what Zillow couldn’t capture.
For example: Joe Bob has a house valued at 200k but knows in this market is hot and thinks he could get more, so Joe lists his house for 250k. Zillow notice a house for sale at 250k, so its algorithm offered 275k to purchase the property, in hopes to list it for 300k, but in reality, the house would sell for 260k, costing Zillow a loss of 15k.
Any of us investors know that predicting the markets in the short term is pretty much impossible and that getting the results you want isn’t just about your investment, but your goals and expectations around it as well. Who knows, maybe Zillow’s algorithm would have worked in the long term, but that wasn’t what they were trying to accomplish and weren’t willing to hang on to those properties to find out. We may not be able to predict markets, but we can have plans and contingencies to deal with their unpredictable nature. That ability is the true mark of a good investor.