Zillow Group, Inc. Class A (ZG) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the Zillow Group Third Quarter 2020 Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question and answer session. [Operator Instructions] Please note this event is being recorded. Thank you. I would now like to turn the conference over to Brad Berning, Vice President, Investor Relations. Please go ahead.

Thank you, David. Good afternoon, and welcome to Zillow Group's third quarter 2020 conference Call. Joining me today to discuss our Q3 results are Zillow Group's Co-Founder and CEO, Rich Barton; and CFO, Allen Parker. During the call, we will make forward-looking statements about our future performance and our operating plans based on current expectations and assumptions. These statements are subject to risks and uncertainties, and we encourage you to consider the risk factors described in our SEC filings for additional information. We undertake no obligation to update these statements as a result of new information or further events, except as required by law. This call is being broadcast on the Internet and is accessible on our Investor Relations website. A recording of the call will be available later today. During the call, we will discuss GAAP and non-GAAP measures, including adjusted EBITDA, which we refer to as EBITDA. We encourage you to read our shareholder letter and our earnings release, which can be found on our Investor Relations website, as they contain important information about our GAAP and non-GAAP results, including reconciliations of historical non-GAAP financial measures. In addition, please note, we will refer to our Internet, Media & Technology segment as our IMT segment. We will now open the call with brief remarks followed by live Q&A. And with that, I'll turn the call over to Rich.

Thank you, Brad. Greetings, everyone, once again from Zillow Group Cloud HQ. I hope you are all staying healthy and sane wherever you might be in this most challenging and interesting of years. I want to thank you for taking the time to dial in and join us today. I'm quite pleased that we are able to offer some counterprogramming to the election news drip torture. Zillow had another terrific quarter. The team is executing well, and we continue to drive great results. As we discussed in August, we believe Zillow is experiencing two powerful tailwinds, one in residential real estate and the second in technology. We believe these tailwinds will continue to blow for some time, and when paired with solid execution, should drive growth for years to come. I'd like to talk more about these macro trends, these tailwinds, especially in terms of their durability before I get into high-level results. First, let's talk about the residential real estate tailwind. Simply put, people want to move, and we see additional pent-up demand on the horizon, low mortgage rates are helping. And of course, there's been a major shift in the way we think about work, life and home. We have taken our usual calculus about where and how we live, and we've turned it on its head instead of stretching and wrapping our lives to fit around where we work, we've been forced to find a way to stretch and wrap our work to fit around our lives. Not for all, but for many, this has been a healthy and liberating inversion, one that prioritizes life above work. And now obvious byproduct of this inversion is that many are rethinking where they live. This is part of the great reshuffling I've been talking about. In September, we saw the pace of existing home sales climbed to the highest level since 2006, exceeding 6.5 million annualized units. Many are debating and doubting the longevity of this reshuffling trend. My intuition, everything I see in here externally and what is happening right here at Zillow with its 5,000-plus employees, is that a new distributed workforce culture has already been born. I sense this is happening across knowledge work at Corporate America broadly, though different companies are waking up at different paces. This doesn't feel temporal. It feels like it will take years to play out and could end up being the defining cultural trend of the decade. In addition, demographic realities lead us to believe that higher housing turnover is here to stay for some time, following the abnormally lower turnover since the global financial crisis. Going into the current decade, there were about 5 million more Americans in their prime homebuying years compared to 2010. As those millennials begin to move up, Gen Z, the even larger generation behind them, will be in a position to take the baton and begin buying homes. Additionally, the low rate environment feels like it's here to stay. These are additional factors supporting our expectation for continued home transaction growth, the residential real estate tailwind that I've been talking about. The second win, maybe even mightier than the first, the technology tailwind. Across every industry, there has been a COVID catalyzed and dramatic increase and reliance upon and adoption of technology. The concrete is setting on new digital habits for life and work, and it is highly unlikely that we go back to the old analog ways. We see the same technology acceleration in our residential real estate industry and Zillow as the digital leader is benefiting. There is increased shopping traffic at the top of the funnel and more adoption of the digital transaction at the bottom. Our customers are looking for more ways to reduce friction, and we have rallied quickly to bring to market products and services that have been in research and development. Virtual tour requests tripled when the stay-at-home orders began. Now nearly 2/3 of our Zillow Offers home purchases are closed digitally with a remote notary. We are investing our dollars in smarts into building these solutions on behalf of our customers. These new tools are immediately relevant today, and there is just no going back. They will change the expectations for new generations of buyers and sellers in the future. To be sure there is significant uncertainty in the economic environment in the near term and we do not have a crystal ball, this uncertainty and our long operating experience means that we maintain a posture that is balanced between offense and defense as we plan for the coming year. However, we believe these trends we're seeing in real estate and technology are strong in the near term and sustainable in the long term, underpinned by meaningful changes to consumer behavior and demographic trends. And whether it is today or tomorrow, no company is better positioned than Zillow to seize this opportunity. And now on to some results. In the third quarter, we continue to see momentum and great outcomes. We beat our outlook for revenue and EBITDA for each reporting segment. As a company, we are executing well to meet this moment. And we are pleased that our preparation and hard work are bearing fruit. Our Premier Agent business delivered its best sales and retention quarter on record in Q3, beating the high end of our outlook. We expect this momentum to continue in Q4. By focusing on the core inputs of this business, we've been able to reaccelerate our revenue growth. Our relationship with Premier Agent has grown far beyond advertising. Premier Agent continue to invest in Zillow because we are such an effective partner providing robust source of connections to new clients for them. As you've heard me say so many times before, regardless of how we monetize Premier Agent, we believe good news flows from partnering with high-performing agents and teams to deliver high satisfaction to our shared customers maximizing revenue and profit per customer for Zillow. In our Zillow Offers business, we are ramping back up across the country after pausing acquisitions back in March, and it will take time to rebuild our inventory levels. We added Jacksonville, Florida to our list of 25 markets where people can get a fair, hassle-free cash offer for their home. This option for home sellers to be able to move without showings, without open houses on their own time line is proving its appeal. As we build back, we are focused on improving our cost structure on every line item, while simultaneously delivering more ease and convenience for our customers. Last month, as part of that focus, we announced that we'll launch brokerage services for our Zillow Offers transactions early next year. Bringing those services in-house will allow us to deliver a more seamless experience for those buying homes from Zillow and reduce our selling costs over time. Additionally, Zillow Closing Services now -- is now operating in all of our Zillow Offers markets. For our Zillow Offers purchase transaction this quarter, we closed 98% with Zillow Closing Services. Our Mortgages segment revenue more than doubled year-over-year in Q3, buoyed by our originations revenue, which grew 4x compared to last year. We are taking advantage of the current refinance environment while we build our mortgage factory, and we are investing in technology solutions, building out our staff and integrating with our Premier Agent and Zillow Offers over time. I'm proud of the team's ability to drive all of this revenue growth in our segments, but I'm more proud that it has been coupled with operational rigor and cost discipline, which is translating into impressive profits. In Q3, we reported record EBITDA in our IMT segment and record consolidated EBITDA and net income in our overall business. We are benefiting from our leadership teams nearly 2 years focus on fiscal fitness and attention to the key inputs in our business. Allen will go into more detail about our outlook for the rest of the year, but we expect continued growth. Philosophically, we are focused on leveraged growth, but we remain ready to invest aggressively where we see opportunity to grow to amplify our competitive advantages coming out of COVID and to deliver better customer experiences. Speaking of longer term, I'd like to zoom out and say that we are just getting started on an immense opportunity to replatform and revolutionize our industry. The audience we built over the past 15 years is nearly double the size of our closest competitor and grew more than 30% in Q3. Our customers trust us with their shopping and dreaming, which positions us well to move down funnel with them and to be part of their homebuying and selling transactions. Even with this large and growing audience, our Premier Agents, who are responsible for our biggest business today, handle only a small fraction of all real estate transactions. There is potential for meaningfully more growth as we continue to improve our conversion rates and customer experience and make more connections between our high intent customers and our best-in-class high-performing agent partners. On the sell side, Zillow Offers makes up only a tiny fraction of all residential real estate transactions just 0.2%. Most sellers are also buyers. So as more people consider selling to us, we are able to build relationships that create additional opportunities when they go to buy their next home or are looking for other services. We're building adjacent services in both mortgages and title and escrow and will continue to drive market share and ecosystem economics as we spread our low customer acquisition cost across all of these services. This is our Zillow 2.0 vision for the future of real estate. Seamless customer experiences across our products and services, which will deliver additional economic benefits to Zillow, capitalizing on the customer trust we've spent so many years cultivating. Our mission is to help people unlock like this next chapter. In our shareholder letter, we included a link to a video testimonial from customers, Ken and Sharon Nichols. For 73 years, Ken, who has retired from a machine shop and where he would never leave his home state of Minnesota. Health issues for assumed to rethink that, and they decided to move closer to their family. They use Zillow Offers to get a fair cash offer and they moved on their time line. When the Nichols learned that they wouldn't have to deal with the stress of fixing up their house and putting it on the market in order to sell it, Ken captured it perfectly. He said, we're out of here. Across the country, more people are looking around their homes and saying those same three words. We're out of here. They are ready to turn the page and get to a better place, and we will be the partner and brand they trust to help get there. Okay. So let's now switch from PowerPoint mode to Excel mode and ask our CFO, Allen Parker, to take the cloud microphone. Allen?

Thanks, Rich. As Rich discussed, Zillow Group delivered strong third quarter results. The inputs across our businesses accelerated more than expected. This, combined with our ongoing operational rigor, delivered results that exceeded our outlook for revenue and EBITDA on a consolidated basis and for each of our segments. We reported consolidated revenue of $657 million for Q3, exceeding the midpoint of our outlook by nearly $100 million. Consolidated Q3 EBITDA was $152 million, double our outlook of $70.5 million at the midpoint of our range. IMT segment revenue of $415 million, grew 24% year-over-year as we saw acceleration in all of our IMT marketplaces. Our strong position, brand and planful approach enabled us to participate in the great reshuffling that we're seeing, benefiting all of our marketplaces. IMT segment EBITDA was $195 million or 47% of segment revenue. IMT segment EBITDA grew 114% versus this time last year, which translates into more than $100 million of incremental EBITDA profit. We were able to increase revenue growth across our IMT marketplaces, while decreasing our operating costs by 6% year-over-year. Operational rigor and cost controls resulted in year-over-year decline in nearly all of our expense lines. Premier Agent revenue grew 24% year-over-year. Our partners found increased value in the Zillow platform from strong growth in customer connections. Our connection growth continues to benefit from innovations in how we service customers, looking to work with our partner agents and the varied calls to actions that our customers can select on our sites. Our Premier Agent revenue was also positively impacted in Q3 by our postpaid Flex monetization model. In accordance with accounting guidance, now that we have sufficient historical data available, we now recognize Flex revenue as leads are delivered to our Premier Agent partners based on the expected fee to be collected when a transaction is closed. This methodology more closely aligns the timing of revenue recognition between our market-based pricing and Flex models. Excluding the revenue related to Flex leads delivered prior to Q3, the revenue growth for Premier Agent would have been 20% compared to the 24% reported growth rate. In Q3, Zillow Offers continued its efforts to increase purchase activity following the pause in the first half of 2020. The strong industry demand, low housing inventory and our resell execution resulted in faster-than-expected sales velocity. Home segment revenue of $187 million, exceeded the high end of our outlook. Our Q3 Zillow Offers unit economics of 90 basis points loss before interest expense remained well within our plus or minus 200 basis point guardrails we previously set for ourselves while growing this business. This was despite the temporary pause in homebuying activities in the first half of 2020 that caused a higher-than-normal mix of older aged inventory sold during Q3. Aged inventory typically has lower unit economics than homes that are sold more quickly. With that said, it is important to note that at the end of Q3, we only had 23 homes remaining in inventory that were purchased prior to the temporary pause in homebuying. We expect to sell a higher-than-normal mix of newer inventory in Q4 as a result. In Q3, our Mortgages segment revenue increased 114% year-over-year to $54 million, and Mortgages segment EBITDA was $16 million versus our outlook for a loss of $1.5 million at the midpoint of our range. The revenue and EBITDA outperformance was primarily due to better-than-normal margins on selling mortgages to the secondary market, operational regular on cost lines and refinance volume reflective of strong market demand due to low interest rates. Turning to our outlook for the fourth quarter. Many of our businesses historically have seen seasonally slower activity levels in Q4, but 2020 has been anything but typical. While we are seeing some seasonality as we enter the quarter, we are seeing stronger inputs than would normally be expected in many of our businesses. Across the entire company, we are seeing strong inputs on our growth drivers, coupled with continued focus on profitability, which is resulting in guidance that reflects growth with leverage. We expect consolidated EBITDA at the midpoint of our outlook to be $119 million, up from a loss of $3 million last year. In our IMT segment, we are forecasting 27% revenue growth in Q4 at the midpoint of our outlook. Within the IMT segment, we expect Premier Agent revenue to be $300 million to $310 million, up 31% year-over-year and up sequentially from Q3 at the midpoint of our outlook. Our Q4 outlook for Premier agent revenue includes approximately 200 basis points of impact from Flex revenue expected to be recorded in Q4 related to leads delivered prior to Q3. We expect Q4 IMT EBITDA margins to be 44% at the midpoint of our outlook. As I said previously, the levers are within our control and we are planning to accelerate investments in Q4 from Q3, given the opportunities we see for the IMT segment right now. In Q4, we expect our Homes segment revenues to improve sequentially as we continue to ramp up the purchase activity levels in each of our 25 markets. We are focused on applying our learnings in the last 2.5 years as we move forward on scaling the business. We are continuing to develop our mortgages technology platform to provide our customers and partners a more streamlined experience. While we expect Mortgages revenue to be between $49 million and $53 million in Q4, we are not assuming the stronger-than-normal industry sales margins will be maintained. We also expect to continue to invest in growth, which we expect to result in Mortgages segment EBITDA between breakeven and $4 million. As you can see, my priorities remain focused on scaling our new businesses, executing within our IMT segment in order to fund investments in our new segments along with additional growth opportunities and implementing focused cost discipline and operational rigor across the company as we scale. We are pleased with our results and believe they demonstrate how Zillow has built a strong platform for growth. Our balance sheet is strong, our demand indicators continue to reach record highs and our platform and partners are well positioned and ready to help our customers unlock life's next chapter. And with that, operator, we'll open the line for questions.

[Operator Instructions] Your first question comes from the line of Ron Josey with JMP.

You're on mute, Ron.

Can you hear me now? Sorry, I was on mute.

Yes.

Great, thanks. Sorry about that. So I mean so much to talk about here, Rich, now, and thank you very much for everything. And congrats on the quarter. But maybe I wanted to talk just bigger picture, given the growth in the IMT business and PA specifically. And then the guidance from that's accelerating growth in Homes, et cetera. Maybe, Allen, can you talk about how -- if there's a change or how you're thinking about balancing growth with investments. And I ask that just given with IMT growth accelerating in 3Q and for 4Q and margins getting to 47%, I think this quarter and 44% next quarter. Just how do you think about consistent profitability, just given the growth that we're seeing and the investments that are likely coming on? And obviously, we'll have tons of other questions, but I'll leave it there for now.

Yes, thanks for the question, Ron, I'll take that. Hey, listen, we're very focused on inputs. And as I talked about in my prepared comments, the inputs are trending very positively right now, and the teams are executing. When I think about margins, I think our Q3 margins of 47% that we reported in Q3 are reflective of what this business model can generate at a steady-state business. But we still believe that there's a lot of opportunity for growth. We think we're in early days in some of these -- this transition, as Rich talked about, and the growth opportunities exist in this segment. And we plan to invest into that opportunity as necessary. The levers are within our control, and we are cautious. But we are planning to accelerate investments while continuing to focus on operational rigor to drive sustainable, profitable growth. If it helps out, what I guess I would say is perhaps looking at the implied annual margin rate may be more representative of going forward as we think about what investments are required. But again, we're going to reserve the right to invest as necessary to lean into this opportunity at Zillow.

Your next question comes from the line of Tom White with D.A. Davidson.

Yes, thanks for the counterprogramming here to my -- it's been on my cable TV all day. Two, if I may. Rich, I just wanted to -- I wanted to follow up on your comments around the sustainability of this really nice growth that you guys have been seeing. It sounds like you think the kind of broader underlying market strength can persist here. I was just hoping you could give us a little more color on what kind of gives you the confidence there? And then with regards to the technology transformation you referred to, you talked about a couple of things like digital closings and virtual tours. Curious if you think the pandemic will have a lasting structural change on how brokerages and agents operate. And I guess what I'm really trying to get to is, will this sort of long predicted, but never really materializing compression on agent commissions maybe become more of an issue as technology kind of disrupts that business? And maybe how does that impact you guys?

Okay. Tom, thanks. So it's -- how sustainable is this stuff is the question of the day and we spend a lot of time thinking about it. And as you heard me use in my prepared remarks, like to me, it feels sustainable. We do not have a crystal ball. We do not know there's so much uncertainty that we're all trying to plan through right now and keep a steady hand on the tiller, that it makes us -- the uncertainty could give us a pessimistic outlook. But these trends that are driving our growth, they feel much -- they feel deep to me, not shallow, okay? Just take the technology one. The off-line to online trend preexisted, was well underway, has been accelerated, and it's pretty hard to believe that we're going to go back and backtrack much. I don't think that one is very debatable that trend. I think the great reshuffling, which I use pretty broadly, it's not just moving, it's kind of we're all reshuffling our lives and reshuffling -- the society is reshuffling right now and how we think about home is a part of that. And this one is more complicated. But I will tell you, and I don't have to tell you, but we all have a good intuition for this, that moving decisions are not made quickly, okay? These moving decisions take time. And despite record transaction levels that we're observing right now, 6.5 million-plus units September annualized, despite that, we're seeing all of this top-of-funnel traffic, I think we're up 40 million new user year-over-year. Brad nod if I have that one incorrect. Yes, Brad's nodding in my Zoom window here. 40 million new user growth year-over-year, I would have guessed might be not possible, if you'd ask me that a year ago. And that is a leading indicator of transactions, okay? That is what people do when they are thinking about moving as they start shopping. And I think companies are slowly awakening to what a cloud-based company is going to look like, what a distributed workforce is going to look like and are slowly beginning to let go of this antiquated or this kind of legacy office culture thing that we have, that kind of face time office culture-based thing. And as companies let go, people are going to make moving decisions. And so it's interesting and scary, but also quite exciting. So I see this one as playing out over likely a very long period of time. So that's why I'm confident that we see some subsidence, some sustainability in this. Of course, our position, I think the technology one is undeniable and that this is just a better way to shop and transact, and it can get better is undeniable as well. So regardless of what happens with these macro trends, I think Zillow is in a really good position to replatform this industry. We're so lightly penetrated on the transactions right now. We have plenty of upside. So we don't rely on these to grow, but we expect them to sustain. All right. That was long-winded. I'm sorry, Tom. And you asked the second one, which is, is the pandemic going to change the way brokerages operate? And you asked the question as operate, I think you meant commissions. But certainly, it's changing the way we all operate, okay? And the -- I guess the usage of software in this industry and technology in this industry is taking a great leap forward. And that, of course, is changing the way we operate with our agent partners and the way brokerages themselves and the whole industry operates. So absolutely, what we see as the effect on the business model, it's -- I would say this has been speculated -- compression here has been speculated about for a long time. We see agents adding real value as consultants to consumers. That is why we partner with them. That is what they tell us they want. And so we continue to see that. So we don't foresee a -- we don't predict a big change there.

Your next question comes from the line of Tom Champion with Piper Sandler.

Rich, you've been an observer of the housing market for a lot of years now and you've already offered some comments on this. But I'm wondering if you could just say or offer some perspective on the current market conditions? And what are the 1 or 2 or 3 defining characteristics of this period, whether it'd be low inventory or higher transactions rate or high price? What is the 1 or 2 or 3 really defining characteristics of this time? And then separately, very impressive visitor growth at scale. I'm curious if you could talk a little bit about the visitor growth specific to the 25 Zillow Offers markets. And what growth looks like there and how that funnels down into the Premier Agent business?

Okay. Tom, I'm not sure I quite got the second question, but let me answer the first and then we can get you to restate it. Yes, on all 3 of those variables that you mentioned, I think the headline variables for the market that are garnering the most attention seem to be shockingly low inventory, okay? That seems like a terrific headline. And then the next most shocking one, I think, is probably home price appreciation at record levels not seen since a while, okay? Those are the big ones. To me, the most important and interesting and actually significant one is days on market. It's a little bit harder to work for most people from a headline perspective, but this is the most important one. It's down to 12 days. In fact, I think new data just came out today that put 11-point something. Maybe Brad can chime in. But average of 12 days on the market is down from 29 or 30 days a year ago, okay? So that's just a huge factor, and of course, it's the multiplication of that times the inventory and some not so complicated way that leads to transactions, which are way up. So I think that demand is -- what this says to me is demand is extremely high, okay? Things are moving off the market quickly. Prices are moving up, therefore, and that, of course, will lure more supply into the market. That's just the way these things work. I guess that's my take on it. Now your second part was something about what we're seeing in Zillow Offers markets?

Yes. Maybe I'll take a second crack at that. So broadly speaking, you're seeing incredibly strong visitor growth at scale. But I'm curious if you could zoom down into your Zillow Offers markets and look at the unique visitor trends in those markets and whether or not the Zillow Offers business is having a halo effect upon the core Internet segment, whether visitor trends are roughly the same? Or do growth rates look the same in those markets? Or are they better? Are they worse? I'm just curious if there's any mention there.

Yes, I have not personally done that. Maybe we'll take in a look at it. I have not personally done that, so I don't know. But you know what, my guess is like awareness in most of the Zillow Offers markets, awareness of Zillow Offers is very low, okay? So the likelihood that it's having an impact on the top of the funnel is extremely low, I would guess. So we have a lot of work to do. And that's just because we're so lightly penetrated. We're just educating people on what it is right now.

Your next question comes from the line of Lloyd Walmsley with Deutsche Bank.

I was wondering if you can talk about how you're scaling up the partner leads [Technical difficulty] what you're seeing in terms of mix of buy-side and sell-side leads in that? Two years ago, you gave us some color around the Phoenix market. Any update on those tests on how many people are coming through that funnel as it looks at the market.

Lloyd, we know it's you. We know it's you. But you're coming through like sile-on. Yes, we can't -- we really can't understand it. Maybe work on your connection, we'll come back to you. Let's take another question maybe, and then we'll come back to you, if you don't mind. Operator, David, can we go to the next one?

Your next question comes from the line of Ryan McKeveny with Zelman & Associates.

Congratulations on the results really across the board. I wanted to dig in with 2 questions on the Mortgage business. So firstly, of course, great to see the big growth in originations, revenue, EBITDA. One of the industry dynamics going on this year is really strong volume across the board, but capacity constraints in terms of loan officers, processing staff, you name it. A lot of lenders saying I kind of can't hire as fast as I can or I can't find the talent that I want to hire. So my question is, as you embark on expanding Zillow Home Loans, how do you feel you are at this point in just the inroads you're making on kind of ramping up that headcount, ramping up your own internal capacity? And how that's kind of trending relative to the customer demand that you're seeing for mortgages? That's kind of the first piece. And then secondly, on the Mortgage segment. So I think that some investors tend to focus on this idea of kind of attachment to iBuying. But I tend to think that with your online audience, theoretically, the mortgage opportunity could be much more significant and more of a kind of direct-to-consumer fashion, which I'm sure you're kind of embarking on to some degree. You mentioned the refi side of things in your note. So just curious if you can talk about this year, what you're seeing in terms of, kind of, iBuying attachment on the mortgage side versus more of a direct-to-consumer type opportunity? And ultimately, how you think about those and kind of strategize on that for the years ahead?

Thanks, Ryan. I was on mute. Allen, maybe you want to start out on that?

Sure, sure. So thanks, Ryan, for your question. This is Allen Parker. So on the capacity side, first, we feel good about the team's execution in growing the factory. We're still building out the platform, but we have been able to grow our capacity, both with the loan officers as well as the fulfillment team to close on the loans, and that's consistent with the ForEx growth that Rich called out on our originations business in Q3, and is reflected in our guidance in Q4, again, with us possibly not counting on some of the kind of extremely wide margins that were experienced in Q3 given some of the capacity constraints as well as a few other factors. So we feel good about the team's ability to continue to build the factory. With respect to your second question, we view this as an opportunity to serve our customers regardless where they come in. So Zillow Offers is one, working with our Premier Agents and their customers is another as well as direct-to-consumer. We also have a marketplace business. So we think that there's a lot of opportunity if we build a great product and an integrated transaction to make it seamless and less friction to continue to grow this business. We're just in the very early stages. We're really happy with the leadership team we brought in to build the originations business, and we're in very early innings, but we see a lot of opportunity there.

Your next question comes from the line of Brad Erickson with Needham & Company.

Allen, I think you mentioned 200 basis points of help Flex may be getting in the Q4 PA guide, I guess, for leads delivered before Q4. So I guess just to clarify, can you quantify just how much help the Q4 PA guide is getting from Flex in total? And then more broadly, I guess, for Rich or Allen. Just talk about what you learned with Flex to date and wonder if you're able to talk about any updates to expanding the rollout of that program into more markets as we look out to next year?

Great. Thanks, Brad. I'll take the first part of that. So yes, just to be clear, we called out in my prepared comments the change impacting Q3 and it will have an impact on Q4 growth. And what that change is, just following accounting guidance now that we have more data and historical data to estimate what we believe the value of the leads we deliver to our Flex partner agents will be at the time of the transaction close. And the way that rolled out was that any leads we provided to our agents in Q3, we recorded the estimated value of those leads in Q3, and any leads we provide in Q4 will record the estimated value in Q4. But what you have is kind of this lag effect of leads we provided since we launched Flex that have not closed yet that are still going to be recorded on a cash basis as the transactions close. And we estimate that, that has an impact of about 400 basis points on revenue growth in Q3. And again, in Q4, it will be about 200 basis points, but it has to do with leads delivered prior to Q3. So from Q3 on, we're clean, and that number will become immaterial going forward. So going forward, our MBP-based revenue recognition and our postpaid Flex revenue recognition are going to be more closely aligned and consistent. And so I think we won't be having any puts and takes anymore, which is great. Does that -- hopefully, that helps answer your question. And to respond to your second part of the question, what are we learning in Flex. It's still early innings. We have over a year under our belt. We believe that we have a variety of monetization models that work well to deliver a great experience for our customer, working with our partner agents, either under MBP or under Flex. Both MBP and Flex reflected in the guide for Q4 show continued growth and accelerated growth. So we're happy with both. And we're continuing to test and iterate and figure out how to maximize customer satisfaction for our customers, improved conversion, and increased revenue per lead. That's what we're focused on, and we have a variety of monetization models to do that.

Your next question comes from the line of Brian Nowak with Morgan Stanley.

I have two. First one on Flex. Maybe just sort of a big picture one. Talk to us about what are the gating factors or the characteristics that you all are monitoring to sort of determine the pace at which you push Flex out to more markets? Then the second one on Homes and the iBuying. I think you started to sort of talk about some steps to remove external agents from the business in January '21. How do we think about the impact of the overall long-term profitability of Homes with those changes?

Brian, maybe I'll take a crack at least at the first part, Allen, maybe I can do both. But Brian, we're not thinking about it in the way you're asking the question anymore because this accounting change kind of liberates us from what Allen just described as the puts and takes of Flex. We're really trying to optimize for a great customer experience, a great partner experience, getting the customer what they really want, which is the transaction. And then at the end of the day, getting more revenue and profit per customer. And that comes as a result of the prime business model. And then ultimately, because of these ecosystem economics that we get when we are able to integrate multiple aspects of the transaction in one customer. And so we really like having a menu of business models, and we will continue to innovate on business models, a menu of business models to use, to test and to basically optimize. We're now seeing this as an optimization problem. And so it will go where it goes, and it's going very well. On the -- and you can see that in the results, obviously. On the Homes side, we view our recent announcement to begin to bring some of the ZO-owned Homes transactions in-house simply as a customer streamline experience move. We are high volume, low uncertainty, so high certainty of close. It's a very cut and dry transaction that doesn't involve a lot of stuff. So we are a scale player here, and we're basically just trying to optimize for customer experience and cost. And that's what -- that is what that is about on this very relatively very small number of transactions. Am I missing anything there on that one, Allen?

No, no. I think that's right. I'd say improve the experience, reduce the friction and a byproduct will be improved cost productivity, but that's not the priority. It's an outcome of the transaction.

Your next question comes from the line of Lloyd Walmsley with Deutsche Bank.

All right. Can you hear me now?

Yes.

All right. Two questions. The first one was just, can you talk about the partner leads product a bit more in terms of how you're thinking about expanding the tests kind of from a timing perspective? What you're seeing maybe in terms of mix of buy-side and sell-side leads? And I don't know, 2 years ago, you gave us some color around the Phoenix market. Any update on those tests in terms of the scale you're seeing of the markets you're in? And then the second one was just on the Rental business. Big acceleration there. Is that product-driven? Is that market strength? And is that level of growth sustainable for the next few quarters until you kind of comp through it or more just a function of market activity that is going to be subject to the market?

Rich, do you want to hit Rentals and then I'll cover the other one.

Yes. Why don't you start with the other one and then I will zip in, yes.

Okay. Lloyd, thanks for the question. This is Allen. So listen, on partner leads, as we've talked about, we believe that as we build this platform, we have opportunities for a variety of adjacent revenue incrementality. That includes our closing services, the HL and partner leads. We are still in very early days, but we're excited about the long-term opportunities. As Rich called out, DCS achieved 98% attach on purchase transactions on ZO-acquired Homes this quarter. Our Mortgages business is going really, really well as we build the factory. So we think there's opportunities to offer a streamlined service there. And on partner leads, we are continuing to make progress on understanding how to work with our customers throughout the funnel. So I don't have any specific update on stats. We're coming off pause and opening up into 25 markets and there's a lot of noise with the low end right now. But as we have more and more adjacent services, they positively -- they reinforce each other positively. And as we're getting the pieces together, we're getting better and better at linking the services. And that's why we feel like we're so well positioned with the current environment as well as our platform and our product offerings to do really well here. So we feel really good about where we are and the opportunity ahead of us.

Okay. That was great, Allen. I mean, yes, I'll just hammer that point these kind of -- we're pretty focused on these ecosystem economics. As we think about all of these adjacent opportunities, and we really see our kind of P&L and business advantage as translating this low customer acquisition cost that we have with this huge traffic base in this big brand that we've built over all these years, and being able to, A, do more transactions, convert to more transactions; and then B, add more other transactions to that transaction and maximize the number of spin-off transactions from all those. So it is a really -- it's just a -- it's a really interesting long-term opportunity that we see lots of blue ocean. On the Rentals question, we're really excited by the results that the Rentals team has posted. We have a very big top of funnel. We have a lot of rental shopping demand and activity, and I'm really pleased with the way the team is translating that into results right now. There is some noise about migration out of cities, de-urbanization et cetera. And I think there is a little -- there is some relatively speaking more interest in non-city locations. However, the tide is so high that there is just more shopping demand everywhere and that includes Rentals. So the whole of the housing industry is atypical, but very healthy, and that includes the Rentals business.

The next question comes from the line of Naved Khan with Truist Securities.

This is Robert Zeller on for Naved. So just on the average fee for Zillow Offers, so how sustainable do you think the 7% average fee is? And has it come down at all recently? How should we think about this long term? And if the fee does come down, how much would you expect this to affect conversion rates for home sellers accepting offers? And then what is the plan for inventory levels on the balance sheet during this time of uncertainty? And when can we expect a resumption of going deep into existing markets as a part of Zillow 2.0? And then I just have a very quick one afterwards.

All right. I mean, I guess, I'll start by just saying when we think about the fee, there are multiple elements that are included in an offer and fee just one of them. So I would just caution focusing just on that price number. But there's a lot of different ways to deliver value and price the offer. We feel that we're extremely competitive in our pricing, and we're transparent to our customers on the various elements of the offer. What we're finding is total economics matter to the customers. So we feel we're competitive and well positioned to provide and be flexible in the fee and total offer we provide relative to the environment. Rich called out some of the things that happened in an environment -- real estate environment today in terms of short cycle times and a variety of other things about inventory. So I wouldn't base an average fee as anything that's static for us. We're constantly testing, iterating, we feel we're competitive and well positioned to provide a great offering to our customers, and that's what we're seeing as we ramp back up.

And I guess, I'd just add, the team is really working. We believe it's elastic. It's definitely elastic. How to judge and characterize that probably has changed and it's difficult to characterize, but it definitely is an elastic transaction. So net dollars to the seller matter a bit. And we're -- therefore, we are focused on lowering every single one of the line items to make the unit economics better, including the customer acquisition cost, right, where we have a good advantage. Anyway, I just wanted to hop on there. The inventory levels, when can you expect us to go deep? We're charging as deep as we can as quickly as we can. There's nothing holding us back other than execution. So we're working on it.

Yes. I was going to call it, Rich, that we have -- we've used about $114 million of our $1.5 billion in capacity. With our warehouse facilities, we feel we're well positioned on the balance sheet on a cash basis. Right now, that's not the constraint. I mean we're obviously careful in our underwriting, but we're excited to be back buying homes again and innovating on behalf of our customers.

I mean it's hard to hold on to them because there's so much demand out there. So...

Okay. Okay. Appreciate the color. And then just really quickly on the revenue recognition for Flex. So I mean, basically, if I'm understanding this correctly, it's just effectively pushing up the revenue recognition to now versus in the future. And this will -- and then you'll no longer be lapping in after Q4. Is that correct?

Yes. The impact because we'll have most of the transactions related to leads we provided pre Q3 will have occurred by the end of Q4. The effect after Q4 will be minimal is what our expectation is.

Got it.

It's exactly right. It's -- we now recognize for both MBP revenue related to leads we provide those agents -- partner agents in the quarter. And with this change, which is consistent with accounting guidance and what you're required to do, we are recognizing the estimated value of the leads we provide to our Flex partners, agents, at the time we provide the leads.

Your final question comes from the line of Jason Kreyer with Craig-Hallum.

Two for me on Zillow Offers. With most of the pre-COVID inventory now out of the portfolio, just wondering if you can give us a sense of how we should think about or I guess, how you're thinking differently about buying and selling now versus how you were a year ago? And then piggybacking on that, you had mentioned, Rich, the low awareness of Zillow Offers. Just wondering if you can kind of walk through the game plan for building that up over time.

Allen, you want to start and I'll finish?

Sure. Sure. Thanks for the question, Jason. Yes. So again, we went through this pause. There's an air gap. We are now back acquiring homes. We still feel like there are opportunities related to our cost structure for us to continue to go after, where we're rescaling. We learned a lot over the 2-plus years as we opened 25 markets, and we're able to apply that. I think the most obvious one or one that's easy to see is that our resell learnings allowed us to accelerate the resell velocity and that we started to see as early as Q4 of last year, which helped us get through this uncertainty in a relatively painless way. The team executed really well. So I think we'll continue to push on penetration. But what we're seeing is we think there's opportunities that we can go after both on the acquisition costs by being smarter and machine learning on renovations, on holding costs as we improve the velocity and on selling costs in a variety of areas.

And on your second part, when you were asking about increasing awareness of Zillow. So we've worked really hard and really effectively for a very long time, 15 years, to be lucky. And that lucky position that we're in is to have a really big trusted brand with 236 million average monthly new use right now. And a lot of the reason to those new use, those users are coming to our sites and apps is to check those estimates, is to look at those estimates and to try to get a feel for what their home is worth, what a home they're shopping for is worth, and we are really like the Bloomberg of -- I don't know if that's a good analogy anymore -- we're the Bloomberg maybe of the real estate industry. And so our -- and so we're in a very lucky and advantaged position where when we have Zillow Offer for a particular home and someone comes and looks at there's estimate, we will be moron-ed if we can't merchandise that Zillow Offer service and get awareness in that way is the primary way we market. There will be other activities we undertake to gain awareness and it takes time for customers to transition how they think about Zillow and the Zillow brand from a kind of information-based service that they're using down to a transaction-oriented one, but it's a challenge we're excited to rise to, and we think it's a very logical one. Thank you guys very much. I guess now we can -- should I conclude, yes, we can return to our regularly scheduled program, pick whatever your favorite cable news channel isn't unmuted. So we can see what's happening back in the political race. I'll close by saying this inevitable shift from off-line to online really has been accelerated in this year. And our new home-based life and distributed work that's caused to rethinking of where and how we live. So these third quarter results confirm Zillow Group's ability to capitalize on these forces in the near term, but with a clear eye on the long-term opportunity, which is vast and nascent. So with our trusted brand, our technological capabilities and experienced team of operators we're on our way. We really appreciate your partnership on this journey to Zillow 2.0. We look forward to talking to you soon. Thank you.

This concludes today's conference call. You may now disconnect.