Zillow Talk

May 1, 2019

- By Stephen M. Perry

The Algorithm:

The lifeblood of Zillow’s business is its proprietary algorithm for valuing residential properties. Because they are based largely on public information such as assessments, prior sales, and square footage, these valuations may fail to reflect individual features of a home. When they are off, they can be upsetting not only to homeowners, but also to real estate professionals, who have to manage their clients’ expectations based on actual market conditions, rather than a value created by an algorithm.

In 2017, aggrieved property owners brought a class action lawsuit in Illinois, complaining that Zillow was publishing unfairly low valuations of their properties, which the company refused to remove or correct. But last year, the federal district court dismissed the class action, holding that Zillow’s published opinions of value were held as just that –opinions. And, in February of this year, the United States Court of Appeals for the Seventh Circuit affirmed the dismissal. Unless the law of some other state proves to be less hospitable, it appears that the Zestimates® are here to stay.

Consumer Financial Protection Bureau:

A more serious threat to Zillow’s business practices came from an investigation launched a few years ago by the Consumer Financial Protection Bureau (CFBP) concerning Zillow’s co-marketing program, which supplemented its “premium agent” program. Under the “premium agent” program, agents pay Zillow to be listed alongside real estate that is for sale and to receive leads from Zillow when consumers enter their information on the website. Under the co-marketing program, added in 2013, mortgage lenders could pay to appear on the same page as the real estate agents. The lenders’ payments to Zillow—the amount of which were negotiated between the real estate agents and the lenders—reduced the amount that the real estate agents had to pay to Zillow.

The CFPB was concerned that these practices might violate the Real Estate Settlement Procedures Act (“RESPA”). RESPA generally makes it illegal—a federal crime—for a real estate broker to receive any form of compensation from a lender in return for referring mortgage business. One potential concern was that Zillow’s program, as actually conducted, might be a backdoor way for brokers to endorse and refer customers to their co-marketing lenders in return for those lenders agreeing to subsidize the agents’ expenses of advertising on Zillow. Zillow’s stock dropped15 percent once the CFPB investigation was disclosed. In turn, shareholders brought a securities class action case against Zillow alleging that it had injured investors by fraudulently misrepresenting the lawfulness of its co-marketing program.

Last year, Zillow achieved victories on both of these fronts. First, in June 2018, the CFPB, under Director of the Office of Management and Budget’s Mick Mulvaney’s more business-friendly leadership, dropped its investigation into Zillow. And later in 2018, the federal district court dismissed the shareholders’ securities claim, finding that the complaint did not sufficiently allege that Zillow had violated RESPA– and even less that it knew it had violated RESPA, as would be required to establish a fraud claim. The plaintiffs recently amended their complaint in an attempt to meet the shortcomings identified by the court, but they are likely paddling upstream.

Future of Co-Marketing:

Does Zillow’s successful defense to date mean that brokers who sign up for Zillow’s co-marketing program are entirely in the clear? Not necessarily. No doubt the risks have lessened, especially because Zillow has already changed some of its co-marketing procedures in light of the CFPB claim. But participating brokers still need to make sure that any co-marketing arrangements that they enter into with lenders, whether carried out on Zillow or otherwise, comply with the anti-kickback provisions of RESPA.

Parties to a lawfully constructed co-marketing arrangement can share advertising costs, but it remains unlawful under RESPA for a broker to receive compensation from a lender that is explicitly or implicitly provided in return for the broker’s referral of business to a lender. The CFPB is likely to be unaggressive in pursuing these issues under the current administration, but there is still the possibility of private claims or a change in the CFPB’s leadership down the road.

“Zillow Offers”:

Meanwhile, get ready for the next phase of Zillow’s business expansion. Last year the company launched its a “Zillow offers” program in a number of test markets, including Raleighand Charlotte, NC., Denver, Phoenix, Atlanta, and Las Vegas. Under this program, the company will be using its valuation algorithm to make offers to buy residential properties, which it will then fix up and resell.

Zillow also recently purchased a mortgage company, which can assist in financing these or other sales. The company is also procuring a broker’s license in states, such as Arizona, where, in view of these new activities, the licensing law requires it to do so. But Zillow has reassured its Premier Agents that it intends to use them and to pay them or their firms a commission in connection with its purchase and sale of properties. Only time will tell how all of this affects the industry, and whether this expansion of the company’s business will lead to yet more legal and regulatory issues.