Zillow Group, Inc. Q3 FY2020 Earnings Call

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. 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. An 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 climb 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 and hear 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 wind, maybe even mightier than the first, is the technology tailwind. Across every industry, there has been a COVID catalyzed and dramatic increase in 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 two-thirds of our Zillow Offers home purchases are closed digitally with a remote notary. We are investing our dollars 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 continues to invest in Zillow because we are such an effective partner providing a 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 timeline 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 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 four times 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 team's nearly two 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 the 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 meaningful 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 life's 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, would never leave his home state of Minnesota. Health issues forced him to rethink that, and they decided to move closer to their family. They used Zillow Offers to get a fair cash offer, and they moved on their timeline. 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.

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 a 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 action 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 resale 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. 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 rigor 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.

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.

Thank you. I appreciate it. There’s a lot to discuss, Rich, and congratulations on a successful quarter. I want to take a broader look at the growth in the IMT business and PA specifically, along with the positive guidance suggesting accelerating growth in Homes. Allen, could you share your thoughts on how you are balancing growth with investments? I mention this in light of the IMT growth we saw in the third quarter and anticipate for the fourth quarter, especially with margins reaching 47% this quarter and projected at 44% next quarter. How do you view maintaining consistent profitability amid this growth and the forthcoming investments? I know we'll have many other questions, so I'll pause here for now.

Thank you for the question, Ron. We're very focused on inputs, which are currently trending positively, and our teams are executing well. Our reported Q3 margins of 47% reflect the potential of our business model under steady-state conditions, but we see significant growth opportunities ahead. We believe we're in the early stages of this transition, and there is room for advancement in this segment, which we plan to invest in as needed. The measures we can take are under our control, and while we are cautious, we aim to accelerate investments while maintaining operational rigor to foster sustainable, profitable growth. It might be helpful to consider the implied annual margin rate as a more accurate representation of our future direction, particularly regarding required investments. However, we will be flexible in our approach to investing in this opportunity at Zillow.

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

Thank you for the update. I wanted to follow up on your comments regarding the sustainability of the strong growth you've been experiencing. It seems you believe that the general market strength can continue. Could you elaborate on what gives you that confidence? Also, regarding the technology transformation you mentioned, such as digital closings and virtual tours, do you think the pandemic will lead to lasting changes in how brokerages and agents operate? Specifically, I'm interested in whether the anticipated compression on agent commissions could become more significant as technology disrupts the industry and how that might affect your business.

Thank you, Tom. The key question is how sustainable our current trends are, and we've devoted a lot of thought to that. From my perspective, it does feel sustainable. While we can't predict the future and face significant uncertainty, which might lead us to a more pessimistic view, the trends driving our growth seem substantial rather than fleeting. Take the move from offline to online, for instance. This shift was already in progress and has just accelerated, making it hard to believe we could revert to previous patterns. The concept of the great reshuffling encompasses not just relocation but a broader reorganization of our lives, with changes in how we perceive home also playing a role. Moving decisions are inherently slow processes. Despite record transaction volumes—over 6.5 million units annualized in September—and increasing top-of-funnel traffic, we’re actually seeing a year-over-year growth of 40 million new users, which I wouldn't have thought possible a year ago. This surge in users is a precursor to increased transactions as people begin their moving journeys. Companies are gradually understanding what a cloud-based organization looks like and embracing a distributed workforce, moving away from outdated office cultures. As they adapt, it will lead to more moving decisions. While it's a complex situation filled with risks, it’s also quite exciting, suggesting a lengthy evolution ahead. Thus, I believe there's a solid foundation for sustainability in these trends. Regarding the pandemic's impact on brokerage operations, you are correct that it’s changing how we all conduct business, particularly in relation to technology use. The industry is experiencing a significant technological leap, which alters our operations with agent partners and affects the entire brokerage landscape. There has been ongoing speculation about margin compression, but we observe that agents are increasingly valued as consultants, which is why we continue to collaborate with them. Thus, we do not anticipate significant upheaval in that regard.

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 one or two or three defining characteristics of this period, whether it'd be low inventory or higher transactions rate or high prices? What is the one or two or three 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 entirely sure I understood the second question, but let me address the first one and then you can clarify it. Regarding the three variables you mentioned, the most notable ones in the market appear to be the surprisingly low inventory, which is a significant point, and the record levels of home price appreciation that haven't been observed in some time. These are the main highlights. However, what I find most crucial and interesting is the days on market. Although it's a bit less enticing as a headline, it is the most significant factor. It's currently down to 12 days, and new data may have recently updated it to just over 11 days. Brad may have more insight on that. This average of 12 days has decreased from around 29 or 30 days a year ago, which is a considerable shift. This reduction in time on market, multiplied by the inventory, is a straightforward way to understand the dramatic increase in transactions. This suggests that demand is incredibly high, with properties selling quickly and prices rising, which inevitably attracts more supply to the market. That's my perspective on it. Now, about your second question regarding the trends 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? 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 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. What you're seeing in terms of the 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 can recognize you, but we can't hear you clearly. Your connection seems to be an issue. Let's focus on another question for now, and then we'll circle back to you if that's okay. Operator, can we move on to the next question?

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 two 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 of 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?

Thank you, Brad. I’ll address the first part of your question. To clarify, we mentioned in my prepared comments the change that affects Q3 and also has implications for Q4 growth. This change relates to our adherence to accounting guidance, as we now have more historical data to estimate the value of the leads we provide to our Flex partner agents at the time of transaction closure. Specifically, any leads we delivered to our agents in Q3 had their estimated value recorded in Q3, while any leads provided in Q4 will have their estimated value recorded in Q4. There's a lag effect from leads delivered since the launch of Flex that haven't closed yet, which will continue to be recognized on a cash basis as the transactions finalize. We estimate this results in a 400 basis point impact on revenue growth in Q3 and around 200 basis points in Q4, related to leads delivered before Q3. Moving forward from Q3, we expect this issue to resolve, and it will no longer significantly affect our numbers. Our revenue recognition based on MBP and postpaid Flex will align more closely in the future. This should eliminate the fluctuations we've been experiencing, which is a positive development. Regarding the second part of your question about what we’ve learned from Flex, it’s still early in the process. We’ve been operating for over a year now and have identified multiple successful monetization models that enhance the customer experience while collaborating with our partner agents, whether under MBP or Flex. Both MBP and Flex are reflected in our Q4 guidance, showing ongoing and accelerated growth, which we are pleased with. We are dedicated to testing and refining our approach to maximize customer satisfaction, improve conversion rates, and increase revenue per lead, employing various monetization strategies to achieve these goals.

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, I'll address the first part, and maybe I can cover both. We're no longer considering this in the way you're asking, because the accounting change frees us from the complexities of Flex that Allen described. Our focus is on optimizing the customer experience and partner experience, ensuring customers get what they truly want, which is the transaction. Ultimately, this leads to increased revenue and profit per customer through the prime business model and the advantages we gain from integrating various elements of the transaction for a single customer. We appreciate having a variety of business models and will continue to innovate and optimize them. We're viewing this as an optimization challenge, and our direction is progressing positively as reflected in the results. Regarding Homes, we see our recent decision to bring some of the ZO-owned Homes transactions in-house as a move to streamline the customer experience. Given our high volume and low uncertainty, the transactions are straightforward and require minimal involvement. We are a major player in this space, aiming to enhance customer experience and reduce costs, which is the essence of this decision, even with the relatively small number of transactions involved. Did I miss anything on that, 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.

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 the mix of buy-side and sell-side leads? And I don't know, two 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.

Thank you for the question, Lloyd. This is Allen. Regarding partner leads, we believe that as we develop our platform, there are numerous opportunities for additional revenue streams, including our closing services and partner leads. We are still in the early stages, but we are optimistic about the long-term potential. As Rich mentioned, DCS achieved a 98% attachment rate on purchase transactions for ZO-acquired homes this quarter. Our Mortgages business is performing exceptionally well as we enhance our operations, and we see potential to provide a streamlined service in that area. We are making progress in understanding how to collaborate with our customers along the entire funnel regarding partner leads. While I don't have specific statistics to share, we are transitioning from a pause to opening up in 25 markets, and there are many fluctuations at the lower end currently. However, as we add more adjacent services, they strengthen each other positively. We're improving at connecting these services, which makes us confident about our position given the current environment, our platform, and our offerings. We are excited about where we stand and the opportunities that lie ahead.

That was great, Allen. I want to emphasize our focus on ecosystem economics. We are exploring various adjacent opportunities and believe our business advantage lies in our low customer acquisition costs combined with the extensive traffic and strong brand we've built over the years. This allows us to increase transaction volume and maximize spin-off transactions. We see a significant long-term opportunity ahead. Regarding Rentals, we're excited about the results from the Rentals team. We have a large top-of-funnel presence and strong demand for rental shopping, and the team is effectively turning that interest into results. While there is some talk about migration from cities and increased interest in non-urban areas, the overall demand remains high across the board, including Rentals. The housing market is atypical but remains healthy, and this applies to the Rentals segment as well.

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 is 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 a 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.

The team is truly putting in the effort. We believe the situation is adaptable. The way we assess and define this has likely evolved, making it challenging to articulate, but it is certainly a flexible transaction. Thus, the net revenue for the seller is important. Consequently, we are concentrating on reducing every single line item to enhance the unit economics, including customer acquisition costs, where we hold a strong advantage. I wanted to mention that regarding inventory levels, we are pushing as much as we can, as rapidly as possible. There are no obstacles holding us back apart from execution. We are diligently working on this.

Yes. We have utilized approximately $114 million of our $1.5 billion capacity. With our warehouse facilities, we believe we are well positioned on the balance sheet in terms of cash. Currently, that is not a limitation. We are careful in our underwriting, but we are eager to resume buying homes again and innovating for our customers.

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

Okay. I appreciate the clarification. Just to confirm about the revenue recognition for Flex, it seems that we're accelerating revenue recognition to the present instead of deferring it to the future. This means we won't be comparing to the same figures 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.

We now recognize MBP revenue related to the leads we provide to our partner agents in the current quarter. This change aligns with accounting guidance and requires us to recognize the estimated value of the leads we provide to our Flex partners at the time of delivery.

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 resale learnings allowed us to accelerate the resale 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 are 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.

In response to your question about increasing awareness of Zillow Offers, we have dedicated significant effort over the past 15 years to establish a strong and trusted brand, currently attracting 236 million average monthly users. Many of these new users visit our sites and apps to check home value estimates. We serve as a key resource in the real estate industry, akin to Bloomberg. When users view estimates for specific homes linked to Zillow Offers, we can effectively market this service and boost awareness, which remains our primary strategy. While transitioning customer perceptions from an information service to a transaction-oriented platform presents challenges, we are eager to tackle it, seeing it as a logical progression. I’d like to conclude by noting that this year has accelerated the shift from offline to online interactions, reshaping our approach to living and working. Our third-quarter results demonstrate Zillow Group's capability to leverage these trends in the short term, while also focusing on the significant long-term opportunities ahead. With our trusted brand, technological expertise, and skilled team, we are making progress. Thank you for your partnership as we evolve towards Zillow 2.0, and we look forward to our next conversation. Thank you.

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