Zillow Group, Inc. Q3 FY2021 Earnings Call

Good afternoon. My name is Ailee, and I will be your conference operator today. At this time, I would like to welcome everyone to the Zillow Group Third Quarter 2021 Conference Call. Please note, this event is being recorded. Thank you. I would now like to turn the conference over to Brad Berning, Vice President of Investor Relations. Please go ahead.

Thank you. Good afternoon, and welcome to Zillow Group’s third quarter 2021 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 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 future 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 remarks, followed by live Q&A. And with that, I turn the call over to Rich.

Thanks, Brad. Good afternoon, everyone. We appreciate you joining us today. This afternoon, we announced financial results for the third quarter and, most notably, our decision to wind down our Zillow Offers operations, which will unfortunately involve a reduction in our workforce of approximately 25% over the next few quarters. This decision was not taken lightly, especially considering the hard work and commitment from the Zillow Offers team. But ultimately, we determined that further scaling up Zillow Offers is too risky, too volatile to our earnings and operations, too low of a return on equity opportunity, and too narrow in its ability to serve our customers, a tough but necessary determination. Before getting into the results for the quarter, I'd like to explain our logic. As you've heard numerous times from me on these calls, our vision is to help people unlock life's next chapter. We are uniquely well positioned to deliver on this vision, given our audience, our brand, and our profitable and growing core business. In service of this vision, we are innovating on products and services that allow us to evolve from a search and find company to one that is directly helping our customers transact and move. We call this Zillow 2.0, and it firmly remains our vision today. We've made many investments towards Zillow 2.0, one of the biggest being Zillow Offers as a way to provide a compelling product offering for home sellers. When we decided to take a big swing on Zillow Offers 3.5 years ago, our aim was to become a market maker, not a market risk-taker. And this was underpinned by the need to forecast the price of homes accurately three to six months into the future. We used historical data and countless simulations to test this belief. We set unit economic targets that required us to stay within plus or minus 200 basis points in breakeven, holding ourselves accountable to these levels publicly with you all. Yet in our short tenure operating Zillow Offers, we've experienced a series of extraordinary events: a global pandemic, a temporary freezing of the housing market, and then a supply/demand imbalance that led to a rise in home prices at a rate that was unprecedented. We have been unable to accurately forecast future home prices at different times in both directions by much more than we modeled as possible, with Zillow Offers unit economics on a quarterly basis swinging from plus 576 basis points in Q2 to an expected minus 500 to minus 700 basis points in Q4. Put simply, our observed error rate has been far more volatile than we ever expected possible and makes us look far more like a leveraged housing trader than the market maker we set out to be. We could blame this outsized volatility on exogenous black swan events, tweak our models based on what we've learned, and press on. But based on our experience to date, it would be naïve to assume unpredictable price forecasting and disruption events will not happen in the future. Because of the price forecasting volatility, we have also had to reconsider what the business would look like at a larger scale. We have offered sellers a fair market price from the start, but we've also been clear that the business only becomes consistently profitable at scale. With the price forecasting volatility we have observed and now must expect in the future, we have determined that the scale would require too much equity capital, create too much volatility in our earnings and balance sheet, and ultimately result in a far lower return on equity than we imagined. We have also experienced significant capacity and demand planning challenges, exacerbated by an admittedly difficult labor and supply chain environment. The combination of these factors has caused a meaningful backup in our processing of homes in the Zillow pipeline, which we announced two weeks ago. We judged future significant volume volatility to be a tough impediment to ramp a scaled operation, and any interruptions in the supply chain, like we recently experienced, will result in increased holding times, further increasing our exposure to volatility and lowering our return on equity. A final factor in this wind-down decision is that to date, we have been able to serve only a limited number of customers. We've been able to convert only about 10% of the serious sellers who ask for a Zillow Offer, and we have tended to disappoint the roughly 90% who didn't sell through us. Given our hard-earned position at the top of the seller funnel with 220 million-plus average monthly unique users and the popularity of the Zestimate, there are better, broader, less risky, and more brand-aligned ways of enabling all of our customers who want to move. So, these are the essential components of our wind-down logic. Our price forecasting accuracy was far more volatile than we planned for and was further exacerbated by unpredictable black swan-type events. And that volatility contributed to operational volatility and cash flow and balance sheet volatility that is beyond the tolerance level that we are comfortable with moving forward. Lastly, we believe this is an opportunity to refocus and more broadly address a wider audience of customers with more asset-light solutions. Of course, the natural question is, what's next? Before I get there, it's worth highlighting how strong our core business is, which has thrived while we ported its profits into our Zillow Offers iBuying operation. Over that investment period, we expect IMT segment revenue to increase 57% from a reported $1.2 billion in 2018 to $1.9 billion in 2021 at the midpoint of our outlook range. Further, we expect IMT segment adjusted EBITDA to increase by nearly 3.5 times from $240 million in 2018 to $833 million in 2021 at the midpoint of our outlook range. So, we start the what's next conversation from a position of strength because of how the core business has performed. As we move forward, we remain focused on the same key areas, all with the end goal of helping turn dreamers into movers. First and foremost, we are going to continue to create engaging experiences that attract people to our apps and sites in droves on a daily basis. Most prominently, we believe our ability to continually improve the Zestimate to be fundamental and foundational to our top-of-funnel audience and brand advantage. As those that dream with us start to shop with us, we will continue to evolve our capabilities to make our shopping experience more digital and less friction-filled. Now that ShowingTime is officially part of Zillow Group, we will go to work on solving another pain point for home shoppers and agents: the cumbersome process of scheduling a tour. The touring opportunity is spiritually similar to the opportunity we pursued with our Connections program back in 2018. Removing friction and streamlining communication between home shoppers and agents was one of our first steps towards a better and more integrated home shopping experience. We expect ShowingTime will help us enable another. Coupled with the frictionless shopping experience must be capable partners, internal operators, and seamless tools and technology to service our customers. For our Premier Agent business, that means continuing to work with high-performing partners to convert our high-intent shoppers into movers. For Zillow Home Loans and Zillow Closing Services, that means continuing to enable integration on our moving platform. Zillow 360 is an example of the potential golden path for our customers: a seamless move through shopping, connecting, selling, buying, financing, and closing, a single place for all customer moving needs. The change necessitated by today's announcement is the evolution of how we will help a customer sell her current home. Before today, the selling option was overly focused on Zillow Offers and was able to serve only a small number of our available customer set. Going forward, we will have the ability to plug in multiple, more scalable solutions to offer better customer choice. Instead of a sole focus on solving the seller's pain point by purchasing from her ourselves as the primary through Zillow Offers, we will expand our view and explore marketplace selling solutions that give her certainty and convenience while addressing the broader opportunity. In solving for her move, however, we plan to focus on solutions that are asset and capital-light for Zillow. We can still offer choice, simplicity, speed, and convenience. We will be open-minded about our exploration into providing these sell solutions ourselves and/or through partners. Both are interesting. And rather than having to buy her home to help her sell, we are now simply going to help her sell. We are confident our current and future technology platform and tools will enable us to deliver an increasingly integrated digital and seamless experience via our own services and through partners. We continue to be in a competitively advantageous position due to our audience, our brand, and our healthy and profitable core business. We see opportunity in using our learnings from Zillow Offers, our tools, and our capabilities to broaden our seller focus beyond only iBuying. Further, we look forward to using these same tools and services to increase conversion and attach rates in our large home buyer funnel. For perspective, Zillow overall still only participates in a mid-single-digit market share of transactions today, despite being used by almost every shopper, dreamer, renter, financer, and mover in the country. The opportunity continues to be very large to drive growth with higher conversion and to increase the depth, number, and integration of the services we offer our customers. Before I close and hand it over to Allen, I'd like you all to know how personal this is for me. I am the founder and first investor in Zillow 16 years ago and am the largest individual shareholder. I distinctly remember brainstorming to come up with the name of the company with my co-founder, Lloyd, and then buying zillow.com for $8.95 on GoDaddy all those years ago. It weighs heavily on me that our strategic decision to wind down the Zillow Offers operation after 3.5 years involves having to let about 25% of our great colleagues go over the coming quarters. I'm sorry for how difficult and disruptive this will be. I am grateful to them. They have worked hard and will be missed. We are committed to providing a smooth transition for those affected. The decision was tough but absolutely necessary, given the capital risk and volatility that is now obviously inherent to the Zillow Offers iBuying business. After careful assessment and volatile earnings, instead of doubling down on a single capital-constrained risk-heavy solution, we will focus on the broader problem of helping people move and we continue the mission of having solutions that can be accessed by everyone moving, not just a narrow set of folks who have to negotiate with us as the primary buyer, leaving most unsatisfied when we can't come to terms. We are lucky to have a strong and growing core Marketplace business from which to invest moving forward. We are lucky to have a courageous team that has helped us on our journey and the strong culture of innovation that encourages taking big swings but also is clear-eyed when we miss. We are lucky to have a deep untapped well of opportunity for innovation in our massive user base, partner network, and trusted brands. And finally, as a shareholder, I am lucky to have fellow investors who will appreciate both the necessity and the opportunity in this decision. Thank you. I will now turn the call over to Allen for his comments.

Thank you, Rich. You've heard a lot about Zillow Offers, but we should not lose sight of the strong core business results we continue to produce in Q3. Zillow Group reported Q3 results for our IMT and Mortgages segments as well as Premier Agent revenue within or above our previously provided revenue and EBITDA outlook ranges. Premier Agent revenue growth of 20% year-over-year remains strong. IMT segment EBITDA margin of 43.1% was better than expected. Our Mortgages segment revenue grew 30% year-over-year to $70 million, exceeding our outlook range. Moving into more detail, Q3 IMT segment revenue was $480 million, growing 16% year-over-year and 43% on a two-year stacked basis compared to Q3 of 2019. Our IMT segment revenue growth continued to benefit from our Premier Agent business. We continue to execute on making better connections between our high-intent customers and high-performing agents, driving higher monetization. Turning to other revenue within our IMT segment, our Rentals business decelerated primarily due to a difficult comparison in Q3 as a result of abnormal seasonality in 2020. Rentals revenue also underperformed our expectations as we incurred headwinds related to high rental occupancy rates, which tempered advertising demand. IMT segment EBITDA was $207 million in Q3, exceeding our outlook. The IMT segment EBITDA margin outperformance was driven by increased operating efficiency, as well as less than previously planned second half overall Zillow brand marketing spend. Mortgages segment revenue increased 30% year-over-year in Q3 to $70 million, and Mortgages segment EBITDA was a positive $5 million compared to the midpoint of our outlook range of a loss of $9.5 million. Total loan origination volume was up 115% in Q3 year-over-year and up 25% sequentially from Q2, driven by growth in our loan originations business. Purchase loan origination volume was up 119% and refinance loan origination volume was up 113% year-over-year. Now to address a few more details in our Home segment and Zillow Offers business. We reported Q3 Home segment revenue of $1.2 billion, below our outlook range of $1.4 billion to $1.5 billion. We reported Q3 Home segment EBITDA loss of $381 million, below our outlook range, impacted by $304 million of an inventory write-down. The revenue miss was primarily driven by capacity constraints as we overestimated our ability to quickly scale operations in addition to industry-wide renovation labor supply constraints. This resulted in a shift in home closings into Q4 that were previously expected to close in Q3. For clarity, I want to provide some additional details behind the inventory valuation process and the recognition and timing of losses. For inventory on our balance sheet, at period end we compare our cost basis, our purchase price of inventory and other capitalized inventory costs to the estimated net realizable value, our estimated future selling price of those homes less estimated cost to sell. This resulted in the recognition of a $304 million inventory write-down included in Home segment cost of revenue in Q3. We expect to recognize additional inventory losses in Q4 of approximately $240 million to $265 million. These estimated losses primarily relate to homes that were under contract to purchase as of the end of Q3 that we expect to acquire during Q4 and that we expect to resell for less than purchased. The Zillow Enterprise remains in a strong position with more than sufficient liquidity to weather the impact of home purchases in Zillow Offers in Q4. We ended the quarter with $3.2 billion in cash and investments. We expect the net effect of the wind-down of Zillow Offers to be at least cash flow neutral in the aggregate. We believe the wind-down will leave us in a strong position to invest in more scalable customer solutions that are less capital intensive as we execute our Zillow 2.0 vision and make strategic long-term investments. Our expectation is that we will be a positive earnings and positive cash flow company with our revised product strategy once the wind-down is complete. In addition to what I just discussed, we expect the following in relation to our wind-down plan. As disclosed in the Form 8-K we filed earlier this afternoon, in addition to the inventory losses we expect to record in Q4, we expect to record additional pretax charges of approximately $175 million to $230 million related to the wind-down of Zillow Offers operations, primarily in Q4 and in the first half of 2022. These charges are expected to include certain employee retention and termination costs, cost to exit contractual obligations, including borrowing and lease arrangements and write-offs of long-lived assets. We expect unit economics to be between negative 500 to negative 700 basis points before interest expense in Q4 as informed by our Q3 inventory write-down and Q4 outlook. As a result of homes already under contract but not yet purchased as of the end of Q3, we expect to continue to grow our inventory balance during Q4 and then expect inventory to begin to decline in future periods. We expect to sell most of the remaining homes inventory primarily by the end of Q2 2022, with a small number of homes remaining thereafter. This implies that we will invest cash and inventory during Q4 as our inventory balance grows and we'll begin to see cash flow back to Zillow as our inventory levels decrease through the first half of 2022. Turning to our outlook for the fourth quarter. In our IMT segment, we expect 13% year-over-year revenue growth in Q4 and 50% growth over Q4 2019 at the midpoint of our outlook range. Within IMT segment, we expect Premier Agent revenue to be between $354 million to $362 million, up 14% year-over-year and up 53% over Q4 2019 at the midpoint of our outlook. We expect Q4 IMT EBITDA margin to be 42% at the midpoint of our outlook, roughly flat sequentially from 43% in Q3. Our outlook includes our plans to continue to invest in staffing and technology in Q4 to drive our 2.0 vision, including things like touring, bundling products such as Zillow 360, expanding 3D photos and floor plans along with continuing to invest in integrating Zillow 2.0 products. Separately, we closed our acquisition of ShowingTime on September 30, which will be included in our IMT segment results beginning in Q4. We are beginning to integrate ShowingTime's platform and are excited about the opportunity to better serve our customers and partners. We plan to invest further in innovating ShowingTime's solutions to better serve the entire industry. In Q4, we expect our Homes segment revenue to be between $1.9 billion and EBITDA to be a loss of $348 million at the midpoint of our outlook range. As I mentioned earlier, we expect to record an additional loss in Q4 of between $240 million and $265 million, primarily related to the homes under contract to purchase as of the end of Q3 that we expect to purchase in Q4. During Q4, given our resale capacity constraints, we expect our inventory balance to grow and then decline beginning in Q1 of 2022. We expect there could be a wide array of results in Q4 for our Homes segment as we work to free up operational and renovation capacity and pursue various resale strategies as we seek to protect the value of our assets and optimize our wind-down while respectfully managing our people. We expect our Mortgages segment revenue to be between $47 million to $52 million in Q4, which is down sequentially from Q3. Our Q4 outlook reflects slower industry refinance activity from the recent move in interest rates, slight compression in gain on sale spreads and slower growth in purchase originations impacted by the wind-down of Zillow Offers operations. As a result of lower sequential revenue and continued investments to grow mortgage originations, we expect Mortgages segment EBITDA to be between a loss of $16 million and $11 million in Q4. While we are in the midst of 2022 planning, we wanted to share that we are focused internally on continuing to drive secular growth faster than the industry. We do want to highlight that during 2021, our Premier Agent business has outgrown the industry in each quarter and expect the business to continue to do so in our Q4 outlook. While there are near-term cyclical pressures on some of our other Marketplace businesses, we are hard at work with initiatives to drive growth regardless. We are also well-positioned with our strong traffic in our other IMT marketplaces to benefit as rental and new construction supply-demand imbalances normalize and when these advertising pressures subside. We have a large audience, but a significant growth opportunity with only approximately mid-single-digit market share of industry transactions. Progress on improving connections and showings, as well as the customer dream, shop, buy, sell, rent, and finance experiences are among the numerous tangible initiatives we are delivering to continue to drive secular growth to connect more high-intent customers with a growing mix of high-performing partners. As we look forward, my priorities remain focused on innovating and executing on behalf of our customers and partners, and I look to ensure an orderly wind-down of Zillow Offers operations, right-size our cost structure, and improve productivity to drive a profitable, scalable, and positive cash flow company, drive prioritization to invest in sustainable topline growth opportunities across the company, including new integrated services that are more scalable, less subject to earnings volatility, and more capital efficient. And with that, operator, we'll open the line for questions.

Our first question today comes from Brad Erickson with RBC Capital Markets.

Hi, thanks. So, a couple of questions. One, I recognize, Rich, you've explained things in the shareholder letter a few minutes ago. But I think people really want to understand just the mechanics maybe a bit better of what went wrong here, particularly in the bidding. So, let's start there, and then I have a follow-up.

Yes. Hey Brad, thanks for the question. Fundamentally, we have been unable to predict future pricing of homes to a level of accuracy that makes this a safe business to be in. We hadn't modeled this kind of pricing market nor supply market to even be possible when we got the business going. And we've seen all this volatility in both directions right now in the wrong direction. And we're still at a scale that is small compared to what it needs to be. And so as we put our minds in the state of, all right, we've got these new assumptions that we’d be naïve not to assume will happen again in the future, we pump them into the model and the model cranks out a business that has a high likelihood, at some point, of putting the whole company at risk, not just the business, but in the more normal case, just causes a ton of volatility in earnings, which is not a great look for a public company. That's basically what it boils down to. There's capacity issues, et cetera, that we can talk about, that we've had internally and externally on the backdrop of a really tight environment. What it boils down to is our inability to have confidence in pricing in the future, enough confidence to put our own capital at risk that we don't have to.

Got it. And then I guess the follow-up is you mentioned looking to expand solutions to work with sellers in different ways, despite no longer doing iBuying. So I guess the question is, can you just, I guess, expand on some of those tools that you might engage with for those sellers with this new shift in strategy? Thanks.

Most sellers in the market, even those at the early stages of selling, show up in our apps. They check their Zestimate, start conversations, look at comparable properties, and gather information. We have many engaging touchpoints with these customers, and we've learned a lot about moving from simple interactions to more in-depth conversations. Through Zillow Offers, we've gained valuable insights into this transition. Whether customers come through their Zestimate, a request for prequalification, looking for an agent, or just seeking advice, we have various ways to engage them in deeper discussions. We’re excited to broaden our focus on this segment of customers, rather than just concentrating on one aspect of our iBuying operation. This shift will allow us to think more expansively and take advantage of a wider range of opportunities.

Got it. Thanks.

Yes. Thanks, Brad.

Our next question comes from Ryan McKeveny with Zelman & Associates.

Okay. Thanks for taking my questions. Rich, I want to focus again on kind of what's next for Zillow. So if I just think about the evolution to Zillow 2.0 and the efforts to build a more integrated experience, obviously, the last few years, iBuying has been a big piece of that, longer-term vision of getting the Zestimate effectively to a live bid. And to Brad's question, you mentioned being committed to creating that integrated experience still, solving pain points, doing so asset and capital light. I guess just asked slightly differently, I mean, big picture, Zillow has always been mainly a platform that's monetized the buy side. And I think a lot of people looked at iBuying and said, this is opening up that sell-side opportunity. So maybe it's the same question twice, but how does this play out on the sell side going forward? What's next in that regard? What's the strategy to really drive this so it's not just viewed to be a buy-side monetization vehicle and really capture what should be a significant opportunity on the sell side?

Thank you for the question, Ryan. I’ll provide a different perspective on this. Our goal is to simplify the transaction process for sellers, which involves addressing various pain points for those moving. These challenges begin with the shopping experience on our site, where we have invested significantly in enhancing it with immersive 3D visuals and digital floor plans to help shoppers get a more realistic understanding of the homes. Additionally, we recently acquired ShowingTime, which allows us to create a touring reservation system, addressing the difficulties movers face when arranging home viewings. This acquisition presents a chance to improve that experience significantly and offer services to customers during that process. Furthermore, sellers may need pre-qualification for their next mortgage or assistance with the mortgage process. We aim to streamline document routing, closings, and title and escrow services into a seamless experience. These are just a few steps we’re taking. Our efforts through Zillow Offers and our focus on the selling market have led us to invest in these areas, and our technology enables us to integrate these services uniquely. The challenge of unlocking sellers is complex, especially since many buyers are also sellers, creating a substantial overlap between the two groups. We strongly believe that concentrating on enhancing the transaction process will yield significant growth for us.

Yes, I'll just touch on that, most sellers are buyers. One of their friction points is freeing up equity in their current home. Obviously, iBuying provided an opportunity for that with us as a counterparty purchasing the home, but there are a lot of other proptech and opportunities for us to look at ways to free up that equity and help that seller move into their next home that are less capital-intensive and can provide that seller with possibly more value as they list their home, but with similar certainty or at least less friction. So, we believe that there will be quite a few different calls to action to help sellers as they dream into that next home but just that are not the counterparty of us negotiating with that seller only. And, as Rich mentioned, only about 10% of those sellers actually took our offer.

Got it, okay. Thank you. And my second question, I just want to clarify what you're saying about the overall kind of macro home price environment. So, most of the measures that are out there, of CoreLogic, Case-Shiller or any of the home price indices, generally, it seems to be an environment where price is still going up, albeit at a much slower pace than what had been happening. So I guess to take a step back to the macro side of things, you talk a lot about the volatility and the unit margin swing. I just want to make the make the question, how much of that is related to, again, the forecasting side of things potentially being too optimistic versus a very volatile swing in natural prices within the broader housing market at this point? Thanks again.

Forecasting volatility is the short answer.

As we entered the first half of the year and then moved into the second half, we recognized that we needed to accelerate our acquisition pace following our Q1 performance. Our forecasting processes at that time weren't keeping up with the rapid increase in housing prices. As we transitioned into the latter half of the year, housing prices continued to rise, though at a much slower rate. We still believe the market remains strong, but the rate of increase has significantly diminished. There has been volatility, which Rich mentioned, that was beyond what we typically expect. This contributed to our pricing forecasting accuracy being below our expectations. Essentially, the volatility was higher than anticipated. While I can elaborate further on the write-down, we still regard the assets as valuable, and the market remains strong. However, this volatility led to us agreeing to prices that exceed our expectations for selling those homes after deducting selling costs.

Understood. Thank you for the clarification. Make sense. Thanks.

Our next question comes from Brent Thill with Jefferies.

Thanks. Rich, you're blessed with a really high margin IMT business, and many have asked the sustainability of that margin profile going forward. Can you talk to what this environment does, if anything, to the margin profile of that core business as we head into 2022?

Rich, do you want me to start with that and you can jump in?

Yeah, please, Allen. Thank you.

Yeah. So as we reported coming out of the pandemic in the second half of 2020 and then coming into the first half of 2021, we've seen margins that have been in the 46%, 47% range. I think at the midpoint of our outlook this year, 44% is our margin rate for IMT. 42% is the margin rate for this quarter. We think the 42%, 43% margin rates are durable, tight margins. And that's with a level of investment that still allows us to do some of the things I talked about in my prepared remarks in terms of touring and continuing to drive higher intent customers to high-performing agents. When I look at the IMT business and I look at the growth opportunities, again, we participate in a very small number of transactions. We continue to make progress on connecting these customers to high-performing agents and improving conversion, and so there's a lot of opportunity for growth. We believe we can leverage that growth, which is why I feel comfortable that some of those margin rates are durable going forward. I do think we'll reserve the right, over time, to invest because we're long-term focused, not just short-term focused. But these margin rates of 40% to 42%, in that range, I believe, are durable margin rates for this business. And I believe that the top line, as we mentioned, we believe can continue to grow faster than the industry.

Well said, Allen.

Can I follow up with Rich? Last quarter, you expressed increasing confidence in the business with each passing quarter. However, this quarter seems to show a shift in that perspective. What specifically changed between last quarter and now that influenced your thoughts? Was there a particular event or two that contributed to this change? Everyone is trying to understand the difference between what you said last quarter and the current situation, and I want to ensure we grasp your perspective correctly.

The significant volatility in our earnings and the substantial markdown on a relatively low volume of units, combined with internal and external capacity and labor constraints, highlighted and forced us to acknowledge the inherent risks in the iBuying operation. It’s quite straightforward. We could address our forecasting issues in many markets and resolve our operational challenges. However, we cannot predict how much capital we will need to raise, deploy, and risk in the future to achieve the scale necessary to offer competitive and fair prices to customers for their homes. While we have provided fair prices as we learned the business, achieving scale economies requires significant growth. The dynamics have shifted considerably this quarter, but if we were to grow 10 or 20 times larger, the current model simply doesn’t support that. Fortunately, our situation is different; we built Zillow Offers on a robust core business, which has expanded significantly while we took risks with Zillow Offers. This strong core position puts us in a favorable spot within the customer acquisition process. That’s what transpired. Logically, it’s not overly complex, but emotionally it becomes complicated due to the impact on our team as we decide to wind things down.

Yes. Thank you for the color.

Our next question comes from Mark Mahaney with Evercore ISI.

I have two questions. First, do you see any changes in the dynamics with real estate agents? Was that at all a consideration in your decision? Regarding the exit from Zillow Offers, do you anticipate that affecting your relationships with professional real estate agents in the industry? Secondly, could you elaborate on the mortgages business and the potential for robust profitability? How do you envision achieving that? Thank you.

Hey Mark. Do you want me to start, Allen?

Yes.

Okay. We have a really large partner network in our agents, Mark, as you know. We have helped them really – have helped the ones who partner with us and get on with our – get on board with our program to really drive their businesses. So we've had great relationships with them. We continue to – some may see this as a sign of one thing or another. But honestly, we're really focused on innovating for customers and bringing new customer solutions to market. And as long as we're doing great things for customers, we know that partners will be there to be with us. So that's kind of how we think about that. The second part of the question, Allen, maybe?

Yes, I can take that, Mark. And I guess what I'd say is that we're glad that we have the ZHL mortgage business and mortgage marketplace business. We built the factory over the last 2.5 years or so initially off of refinancing, and we showed that we can close loans on time and satisfy customers. And we have shown our ability to be profitable with enough volume. Now as we came into '21 and the refi volume slowed down, when the volume goes down by a certain level, we start to see this investment we're making in our loan purchase originations business show through as investment versus profit. But as shown in Q3, $70 million of revenue, 32% of our funded loans were purchased, that's up 600 basis points from the quarter prior. Now 70% of those were leads from the Zillow Offers business. That gives us comfort that financing is a very important part of the moving process and that having a financing factory that could help serve our customers in a variety of ways is a capability that we must have as we think about serving our customers as they move. And that as we get volume, we're able to generate profitability that you would expect from a purchase company or I should say, a mortgage origination company as that volume grows. So we may see a little bit of choppiness as we go into Q4 and Q1, but there's a lot of opportunities for us to present and provide our customers with pre-qualification and eventually pre-approval and to work with our partner base in using our ZHL as the loan origination. And so we're, Rich, you can add anything, but we're excited to have this capability.

That was a very detailed response. To summarize, I want to remind investors that we currently collect a significant amount of mortgage interest from consumers due to our advanced position in the market. We handle only a small fraction of that ourselves through ZHL, while the majority is processed through our marketplace. This strategic setup places us in a strong position to drive innovation.

Hey everyone. My first question is about the challenges in pricing and forecasting. The way you're discussing Zillow Offers seems quite different from past conversations, as it appears to cater to a smaller segment of your customers. Previously, it was a key component of your public offering and an integral part of Zillow 360, with expectations that it would drive partner leads and mortgage purchase originations as Allen mentioned. It seems there might be a gap in the overall vision now that the iBuyer business has been removed. Could you explain why there isn't a gap in the vision? Additionally, with the increased focus on Premier Agent, you've spoken about connecting high-performing agents with high-converting customers. Can you provide more details on what's changed, what's evolving, and how this will continue to benefit us moving into next year? Thank you.

Okay. Hopefully, you took some notes, Allen.

I did. Maybe you could just talk about the first question is, again, what's next, I think.

Yes, we've discussed this a few times, but I’d like to elaborate on a more subtle point. I mentioned this in my script, but negotiating with sellers about their most valuable asset, which holds significant emotional and financial importance to them, and knowing that approximately 90% of them choose to go in a different direction—some quite unhappy with the brand— is not something we're accustomed to or striving for. This is not aligned with the history of our brand. What we are seeing is that our solution may be a bit too narrow. The opportunity isn't that expansive either, which contributes to the situation. You've been looking for us to clearly connect seller leads from these interactions for several quarters. We have stated that we are making progress, experimenting, and enhancing our approach. However, it hasn't yet become a major driver for our business, partly due to the subtle interactions I mentioned. Relying solely on this offering to sellers has proven to be limiting. Our realization is that we need to provide a broader range of options for our sellers, which is where we want to focus. We believe this approach will allow us to serve more people effectively. Furthermore, there's a significant amount of venture capital investment in proptech aimed at tackling similar problems in a more asset-light manner. Therefore, we see considerable potential, but in ways that don't compromise our entire balance sheet.

Yes, maybe I'll take the second part. So it was about, how do we feel about, I guess, higher-performing agents and getting them higher-intent customers, what are the drivers there, I believe? Is that a fair representation of the question?

Yes. It seems like that's a key factor for PA and

We focus on high-intent customers in our Premier Agent business, noting that certain actions taken by customers are stickier than others. For instance, scheduling tours has proven effective, especially as we enhance our touring technology with ShowingTime now part of the Zillow Group. These tour scheduling actions lead to higher-intent customers who can connect with agents more easily and have more meaningful interactions. Additionally, 3D homes and floor plans enable customers to explore various properties and express their preferences, enhancing their intent. Through Zillow 360, we're discussing how to facilitate integrated transactions for buyers and sellers, such as those requiring financing or looking to access equity. As we move into Zillow 2.0, we expect to generate more partner leads from diverse channels beyond our current HDP submits, enhancing conversions. We're improving our ability to monetize existing traffic and transactions while investing in tools and technologies to foster higher-intent actions that connect customers to agents, driving conversion rates and increasing our revenue, either through return on investment from MVP or transaction volume linked to conversion rates. Would either of you like to add something?

That was great.

Our last question today comes from Andrew Boone with JMP Securities.

Hi, guys. Thanks for taking the question. Two, please. So the first, just on Zillow Offers. It felt like it was a key on-ramp for Zillow 360. Can you talk about your vision for Zillow 360 through just PA? And then for number two, Rich, iBuying, to some, felt like a defensive move initially. To that end, where do iBuying fit into your vision of real estate more broadly? And is this now something that's just too narrow for an over base, or is it simply put, as you mentioned multiple times, just not the best use of Zillow's capital? So, kind of, where is the end state of iBuying? Thanks guys.

Hi, Andrew, it's still early for Zillow 360. We've been doing a lot of testing with it. Zillow Offers has been involved, but only to a certain extent. We see a great opportunity in providing various options to help sellers through Zillow 360. We're combining many different elements we've created to enhance this integrated experience. However, since it's still early, discussing it further might be premature. Allen, do you have anything to add?

I would say that our approach has always been broader than just iBuying. ZHL and PA are examples, as well as Closing Services, which we can bundle together. The idea was to combine multiple services, not just iBuying. We have seen improved conversion rates when offering customers integrated services in a package, which allows us to take advantage of lower customer acquisition costs.

That’s what we learned, yes.

Okay. Thank you, Rich, thank you, Allen.

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