Zillow's Move into House Flipping Prompts Stock Downgrade

April 20, 2018 — 12:34 PM EDT

Zillow Group, Inc. (Z) is getting into the market of buying and selling homes, something that at least one Wall Street watcher isn't happy about. Earlier this week, Zillow announced that it will start flipping homes in Phoenix and Las Vegas and that it is expanding its Instant Offers service. That news prompted Morgan Stanley to downgrade its investment rating on Zillow stock, raising concerns about the risks associated with this type of business venture.

"We appreciate the option value but see it as lower quality and riskier," wrote the investment firm in a research report covered by MarketWatch. The firm noted that the new business venture has "emboldened" short sellers, or those betting that the stock will decline, because of the lower margins associated with the new business.

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Morgan Stanley analyst Jonathan Lanterman downgraded Zillow shares to equal weight from overweight and lowered the firm's price target to $50 from $55, warning that 2018 will be volatile. With a price target of $50 per share, the Wall Street firm expects the stock to gain around 6% this year. With the prior target, the firm had expected a 17% rise in the share price. 

According to a report from Benzinga, Lanterman said in the note that there are many unanswered questions about Zillow's new interest in flipping homes that could affect the stock's valuation, including how quickly it will expand into new markets and the costs associated with that, what impact it will have on its agent partners and how this will benefit the company's agent revenue. He noted that the stock could jump if Zillow is able to show that the home-flipping business has the potential to make money, if there is margin expansion as a result of strong rentals revenue growth and if Zillow is able to launch in an international market and have successes.

Late last week, the digital real estate platform company announced that it will partner with West USA in Phoenix, Berkshire Hathaway HomeServices Arizona & Nevada Properties in Phoenix and Las Vegas, and Coldwell Banker Premier Realty in Las Vegas to compare real estate agents' market valuations of sellers' homes with offers from Zillow and other investors. If Zillow purchases the home, it will repair and/or update it and then list it as soon as possible. The local real estate agent earns a commission on the deal by representing Zillow in the transaction.

In addition to entering the real estate market as a flipper, the company announced that it is expanding its Instant Offers service in which sellers receive an offer from investors as well as an analysis of the market value of the home. The offer typically comes within two business days of providing information about the house's value. The service launched in May in Las Vegas and Orlando, and now Zillow is expanding it to Phoenix. Zillow said that, based on the results of the two markets it is already in, most sellers who request an Instant Offer sell their home through the service.