Zillow Group Inc

NASDAQ:ZG

Earnings Call Transcript 2019-Q2

[Operator]

Good day, and welcome to the Zillow Group Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded.

I would now like to turn the conference over to RJ Jones, Vice President of Investor Relations. Please go ahead.

[Raymond Jones, executive]

Thank you. Good afternoon, and welcome to Zillow Group's Second Quarter 2019 Financial Results Conference Call. Joining me today to discuss our results are Zillow Group's Cofounder and CEO, Rich Barton; CFO, Allen Parker; Zillow Brand President and Co-Head of Zillow Offers, Jeremy Wacksman; and President of Media and Marketplaces, Greg Schwartz.

During the call, we will make forward-looking statements regarding future financial performance, operations and events. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee these results. We caution you to consider the risk factors described in our SEC filings, which could cause actual results to differ materially from those in the forward-looking statements made on this call.

The date of this call is August 7, 2019, and forward-looking statements made today are based on assumptions as of this date. 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 through the Investor Relations section of Zillow Group's website. A recording of the call will be available later today.

During the call, we will discuss GAAP and non-GAAP measures. We encourage you to read our financial results press release, which can be found on our Investor Relations website as it contains important information about our GAAP and non-GAAP results, including reconciliation of historical non-GAAP financial measures. In our remarks, the non-GAAP financial measure adjusted EBITDA is referred to as EBITDA, which excludes other income, depreciation and amortization expense, share-based compensation expense, acquisition-related costs, interest expense and income taxes. We have posted our quarterly shareholder letter and financial tables on our Investor Relations website. We will open the call with brief remarks, followed by live Q&A.

I will now turn the call over to Rich.

[Richard Barton, executive]

Thanks, RJ. Greetings, everyone. Thanks for joining us today.

A few weeks ago, my wife and daughter were in DC, and their trip happened to coincide with the 50th anniversary of the Apollo 11 moon landing. They strolled out onto the mall that evening and discovered that the whole 555 feet of Washington Monument was being used as a screen for projecting images and video from that historic day. Tens of thousands of people were watching. The pictures they texted me were a reminder of what wondrous goals we humans can achieve through cooperation, cleverness and big dreams.

In our own slightly more mundane way, we at Zillow Group are dreaming about our own moon landing. We're in the early stages of a bold expansion from solely a residential real estate media company into the trillion-dollar TAM opportunity of streamlining and enabling the real estate transaction itself. It would be hard to find a more complicated snarl of a consumer experience than selling and buying a home and all of the messy swirls around that transaction. We are finally bringing modern technology to this giant business, and the possibilities and our progress are exciting.

There are many increasingly coordinated efforts underway across the company to drive this expansion, but the big new thing is Zillow Offers. July marked the 1 year anniversary of when we sold our first Zillow-owned home, and I'm really pleased to share today that we reported nearly $250 million in revenue for our Homes segment in Q2. I want to commend our whole team, not just the Zillow Offers team, on going from 0 to $1 billion run rate -- to a $1 billion a year run rate in revenue just in 1 year.

The demand signal we are seeing for Zillow Offers continues to impress us. During the quarter, requests from sellers to receive a cash offer nearly doubled to almost 70,000. In the same period, we purchased more than 1,500 homes, up 71% from Q1. And we sold close to 800 homes, nearly twice the number of homes as last quarter and more than 4x what we sold in all of 2018.

In Q2, we stepped on the gas, launching 7 markets, a rate that we plan to match in Q3. On Monday, we launched Nashville, bringing our total live Zillow Offers markets to 15, giving another group of consumers a new way to sell their home without hassle and uncertainty.

We're also increasing the number of markets we expect to be in to 26, adding Jacksonville, Cincinnati, Oklahoma City and Tucson to our plans by early to mid-2020. With every new market, our team learns and applies the insights lessons and data to move faster and gain efficiencies as we scale.

In addition to participating directly in market-making with Zillow Offers, we are pushing down funnel towards the transaction in our Premier Agent business. We are transitioning our lead generation model into one built on partnerships in which we deliver high-touch customer service and seamless transactions where success is shared and mutually rewarded. The partnerships we're building with local brokers and agent teams in connection with Zillow Offers reflect the goodness that comes from aligning the Zillow customer with the highest-performing and client-focused professionals in every market. We are applying these lessons to the future of Premier Agent.

During our Q1 call, we announced plans to expand our Premier Agent Flex model to ZIP Codes in Connecticut and Colorado. Under Flex, agents pay no upfront costs and only pay us a little success fee when they close a transaction with a Zillow lead. While still early, the signals we are receiving in these initial test markets are favorable. Our agents indicate they are receiving quality, high-intent connection, and Zillow consumers report high levels of engagement from their Flex agents. Given these positive indicators, we have decided to expand the Flex test in Q4 to 2 of our established Zillow Offers markets: Phoenix and Atlanta. We believe testing in these markets will allow us to increase our insights and learnings while also experimenting with other lead monetization programs that can work in conjunction with Zillow Offers and Premier Agent.

The evolution of our businesses and industry partnerships coincides with the tectonic shift in the industry at large driven by technology. Our optimal partners are the best of the best agents who combine their local expertise and professional smarts with advanced proprietary Zillow technology to anticipate and deliver on the high expectation of our shared customers in today's on-demand, always-on world.

We're already moving in this direction. We're using data and customer feedback to select our broker partners in Zillow Offers markets, and our machine learning algorithms are already helping to identify the Flex agents most likely to close deals with the highest satisfaction levels. The future of these partnerships is key to our seamless real estate transaction experience vision.

As you'll note in our quarterly letter, the Q4 Flex expansion into Zillow Offers markets is expected to shift some revenue and EBITDA from 2019 into future periods, which Allen will discuss in more detail. We confidently make these short-term trade-offs to accelerate our learnings about the long-term potential of Flex, but it's still early. We're spending this amount of time talking about Flex with you because it is part of our strategic move towards the transaction and because it will affect revenue recognition and some expense recognitions.

Our core Premier Agent business continues to perform well. We're seeing positive feedback from agents and consumers on the new lead validation and distribution process, which is driving more connection and higher customer satisfaction.

Let me switch gears to Mortgages. It's been less than a year since we acquired Mortgage Lenders of America, which we rebranded as Zillow Home Loans during Q2. Our strong Q2 performance reflects our fulfillment of the pipeline that originated on the legacy MLOA platform. As we transition from MLOA to Zillow Home Loans, we are building new proprietary technology to streamline and integrate home loans as our payments platform for Zillow Offers. We're already testing the initial version of our digital mortgage software, but the full rollout is taking a bit longer than expected. As we continue to build out the test -- to build out and test our own platform, we've slowed loan officer hiring until we feel we have the technology and operational infrastructure foundation that we need to scale, which you'll see reflected in our updated outlook. This in no way affects our excitement about the future of this segment. Loan originations are an essential part of our ability to deliver an integrated transaction experience for our customers. We're making solid progress, and the long-term expectations for our Zillow Home Loans business and other transaction-related adjacencies remains unchanged.

So we are on our way with our own exciting little moon mission to transform, streamline and integrate the shelter transaction. Zillow is in a hard-earned but lucky position relative to this massive opportunity. No other company in real estate comes close to our brand awareness, our audience size, technology, data science, industry partnerships and operational know-how to get it done. No other company has all of the vertical businesses required to provide consumers with a seamless integrated transaction experience woven together with technology and operations.

We have the best team of adventurers. And every day, we add people to the mission with more smarts and new skills to enable success. We are also lucky to have a group of supporters on the ground, you, our investors, who support and believe in the dream but who hold us accountable. We treat your investment in our team and mission with respect, and thank you for your support.

I'm now going to turn the microphone over to Allen.

[Allen Parker, executive]

Thanks, Rich. I'm going to quickly summarize a few key financial results.

Overall, we met or exceeded our revenue expectations for all segments and EBITDA was generally in line with our expectation for each segment. In Q2, we reported revenue of nearly $600 million. That's up 84% year-over-year and exceeded the high end of our outlook. Much of this growth in revenue was driven by our Homes segment, which was nearly $250 million, growing 94% sequentially and, as Rich noted, is continuing to outperform expectations.

Internet, Media & Technology, or IMT, segment revenue grew 6% year-over-year to nearly $324 million and exceeded our Q2 guidance range. Premier Agent revenue was in line with our expectations at $232 million, up 50 basis points compared to a very strong Q2 2018.

Before we take your questions, I want to take a moment to provide some comments on our outlook and highlight one item you'll see in our results this quarter as well as update you on my priorities as CFO. I'll start with the outlook.

Zillow Offers momentum is expected to continue. Demand for this service from consumers is strong, and we have accelerated our rollout into new markets throughout the year. We are anticipating Homes segment revenue to grow 44% sequentially at the midpoint of the guidance range for Q3. We have updated our IMT and Premier Agent full year 2019 revenue guidance ranges. At the midpoint of the guidance range, we expect IMT revenue growth of 5% in 2019 and Premier Agent revenue growth of 1% for the year. Our changes in outlook are primarily driven by the expected impact of our decision to expand the Flex test. This means that a portion of previously expected Premier Agent revenue for markets where we are expanding our test is now expected to shift from Q4 into future periods to correspond with closing of Zillow attributed transactions.

The impact of the Flex test on Q3 and full year 2019 EBITDA in our IMT segment is twofold: first, flow-through to EBITDA from a portion of Premier Agent revenue that will shift from Q4 into future periods, as I just described; second, we expect to recognize additional commission expense in Q3 and full year 2019 due to the shortened estimated life related to the existing capitalized sales commissions. Additional details of the accounting treatments related to Flex are included in our shareholder letter. These adjustments do not have any reflection on the health of our Premier Agent marketplace, which has stabilized.

As Rich mentioned, some of the integration of Zillow Home Loans and development of our mortgage software will require more time than we originally anticipated, so we had slowed the pace of hiring loan officers until we have the operations and infrastructure in place to support scaling. As a result, we've adjusted our full year outlook accordingly. These changes position us well for 2020.

Now I'd like to discuss an item that impacted the Homes segment cost of revenue included in our 2Q -- our Q2 results. We recorded an inventory valuation adjustment for an immaterial amount during the quarter. This adjustment represented less than 1% of our inventory balance at period end and was the primary driver of the increase in our Homes segment cost of revenue as a percentage of revenue in Q2 compared to Q1. Like any company that maintains physical inventory, we expect to incur these adjustments going forward as a regular course of business. This is anticipated as part of managing our portfolio of homes and the adjustment as well within our expectations.

As of the end of Q2, only about 4% of homes held in our inventory were greater than 60 days past their underwritten hold time with the vast majority of those homes under contract to be sold.

Finally, during this time of transformation at Zillow Group, my priorities as CFO are clear. I remain focused on establishing processes and mechanisms in support of 3 things: scaling our new businesses; execution within our IMT segment in order to fund investments in our new segments, along with additional growth opportunities; and implementing discretionary cost discipline and operational excellence across the company as we scale.

It's exciting to be in the middle of such a significant evolution both at the company and within the industry. And as we execute on our strategy to fundamentally change the home transaction for consumers, we are confident our long-term targets remain well within our reach.

With that, operator, we'll open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Angela Newell of Macquarie.

[Benjamin Schachter, analyst]

It's Ben Schachter. I just wanted to talk -- there's a lot of issues in the near term to discuss, but really let's focus on the long term and the iBuyer market specifically. I just want to understand how you're framing the long-term TAM, specifically for the marketplace of buying and selling homes and how that's changed or evolved over time. And then related to that, how are you thinking about the size of the long-term TAM for all these ancillary businesses, mortgage, title, insurance, et cetera?

[Jeremy Wacksman, executive]

Yes. This is Jeremy. I'll take that one. I mean long term at scale, we think this is a really, really big market, and that's why we're investing so aggressively. That's why we're accelerating our market rollouts we've announced to new markets.

I think our buy box, as we talked about today, would cover half the homes in the country around if we were available everywhere, and we seek to reach and expand the types of homes we buy over time. And ultimately, at scale, when you're offering something like Zillow Offers, this really should be the way every homeowner starts to think about selling, not just requesting an offer from us, but eventually looking at a standing offer we can make to them as a way to think about their selling options whether with us or not. So we've given a 3- to 5-year target. That's around 60,000 transactions a year run rate. That's a $20 billion business. That's just 1% of the market transactions today. We clearly see the opportunity as far, far bigger than that. That's a step along the way.

And when we're able to deliver a service like this to this consumer, that opens up on top of the Zillow Offers business all these adjacent opportunities. So mortgage and title and escrow inside the transaction itself as well as the knock-on services that you might get around the transaction.

[Operator]

Our next question comes from John Campbell of Stephens.

[John Campbell, analyst]

Just wanted to touch back on the Flex Pricing. We've obviously -- I think we've heard a lot of positive feedback from agents just kind of doing the pilots. That seems like a pretty big opportunity for you guys, so we're happy to see you kind of lean on it. But my question, first, could you guys talk a little bit more about the revenue impact? How is that accounted for in the backlog? And then any sense for the kind of estimated conversion rates in early stages of the pilots? And then secondly, are you guys starting to kind of mix in any of the sell side or listing leads into Flex yet?

[Greg Schwartz, executive]

It's Greg. I'll kick that off -- the business part of that, and then Allen will take you through the modeling. So Flex, you're right, is looking pretty promising. We've got some leading indicators, right? So it takes some time to mature a real estate lead. So the leading indicators you're asking about that we're getting through here is, first, customer satisfaction. Our consumers are really pleased with the experiences they're getting by working with these Premier Agents. That's increasing in our Flex program.

The second is the important appointment rate, do consumers actually want to meet and do they successfully meet with the real estate agents, the Premier Agents that we match them to. That's an important leading indicator to downstream transactions. That's looking really positive in these 2-state test we're doing right now in Connecticut and in a smaller of Colorado. So that's looking pretty good.

And then are we getting our Premier Agents to engage in these. And we measure that by -- are they touching and interacting with these consumer connections in our app. And nearly every one of these connections is being touched in our Premier Agent app, and that is a very unique thing for real estate. So, so far, the leading indicators are really good from these small-scale tests, and I'll let Allen talk about...

[Richard Barton, executive]

Did you talk about some stat, Greg?

[Greg Schwartz, executive]

I did.

[Richard Barton, executive]

Okay.

[Allen Parker, executive]

And this is Allen Parker. With respect to the impact on revenue, as we called out in the shareholder letter, the impact of accelerator increasing the number of tests in the Phoenix and Atlanta area has the effect of taking revenue we previously thought we would recognize in Q4 and pushing that out into future periods. So our outlook now reflects the impact of increasing the size of our Flex testing. And so when you think about that range, it's the primary -- it's the significant change -- a primary change to our revenue outlook is related to this Flex testing. And not only does it affect revenue as we push out from Q4 to future periods, that revenue falls through to EBITDA. And then we also have to accelerate -- our capitalized sales commission costs accelerate the amortization, which has an impact of increasing costs in Q3 and the rest of 2019 for those 2 new markets.

[Richard Barton, executive]

This is Rich. It's -- the accounting for this is unfortunate, but not why we're making these decisions. We're making these decisions because this is a better customer experience, and it's a better -- at least in our testing so far, it looks to be a better business model. And so we are making these decisions because we think it's the right thing for customers and for the business for the long term.

[Operator]

Our next question comes from Mark Mahaney of RBC Capital Markets.

[Michael Chen, analyst]

This is Mike Chen on for Mark. I was just wondering if you could expand a little bit about Flex in Phoenix and Atlanta. In the shareholder letter, you mentioned about the lead monetization opportunities and programs that you're working on. So any color on how that dynamic would work between Zillow Offers and Premier Agent?

[Greg Schwartz, executive]

Yes. So you're right, we're optimizing Phoenix and we're optimizing to another really strong Zillow Offers market, of course, Atlanta. There's a few things that it allows us to do. It allows us to experiment with additional lead types and lead distribution. And the lead distribution part is super important. We just launched what we're calling the performance pacing algorithm, the PPA. And what that is, is using an autonomous model to make optimal matches between buyers and real estate agents that are able at that moment and familiar with that particular type of home in that particular area. And we expect to see some pretty significant conversion gains from that.

[Richard Barton, executive]

As to -- the quality of those agents factors into this algorithm, too.

[Greg Schwartz, executive]

Yes. You bet. The algorithm is driven by expertise in the market, past transaction history and then customer experience scores, CSAT scores, and then if they're engaged at that moment and accessible to us. So we're going to see some pretty awesome wins in customer experience, which we believe will throw -- flow through to gains in transaction volume and conversion rates. Again, the test we're doing in a few smaller metros, in Connecticut and Colorado, are low scale. That's the reason why we're going to the 2 strong Zillow Offers markets, so we can get a big strong signal to work off of. And we're feeling pretty good.

[Operator]

Our next question comes from Ryan McKeveny of Zelman.

[Ryan McKeveny, analyst]

So I have a question on the valuation adjustment inventory. And I guess just thinking about the kind of possible adjustments going forward, can you talk about that process of kind of managing so-called tail or the relative underperformers in inventory, I guess those homes that are kind of sitting longer than the underwritten hold times. And outside of just kind of commentary on that process that you look at, I'm curious as you look at the finished goods inventory on the balance sheets, so I think it was $379 million in the Q, is there a way to break apart what percent of that was acquired maybe in 1Q '19 versus 2Q '19 just to have kind of a better sense of that aging process within the inventory, I thought that would be very helpful.

[Jeremy Wacksman, executive]

This is Jeremy. I'll take that. So I mean a couple things. You're right, it's a way to think about the tail, and it's a good marker of how we think about pricing the portfolio. As we price, there's going to be distribution of homes in each market and across Zillow Offers. Some are going to outperform in the head. Some are going to take a little longer in the tail. And so you'll see the value adjustment as a reflection of that.

Allen gave you a stat. Less than 4% of our inventory is late by 60 days as a kind of way to think about the sizing of it. That's probably the best way for you to actually think about the age, too. We're not breaking out the age of our inventory by segment -- or sorry, by market or by time frame.

[Ryan McKeveny, analyst]

Okay. And I guess the follow-up, I mean -- so the 60 days past underwritten hold time, of the 4%, I mean is there a way to frame what percent is kind of any time late relative to the hold period? Or maybe said another way, what is the average underwritten hold period?

[Jeremy Wacksman, executive]

Yes. I mean the best way to think about it is it's going to vary by market by price point. That's why relative to underwriting, this is probably the cleanest metric and thinking about the value adjustment as a reflection of any changes to the inventory on balance is the way we'll reflect it.

Our underwriting will have a unique target of appreciation cost and hold time for each home. And then the pricing will balance the portfolio in a market and across the market to sell for our financial performance results. So each home is unique in what it's expected to do and then obviously where we see it flow through and actually do.

[Operator]

Our next question comes from Lloyd Walmsley of Deutsche Bank.

[Gregory-T. Vlahakis, analyst]

This is Greg Vlahakis on for Lloyd. Two if I may. So I think Allen had mentioned that a majority of the Premier Agent guide down was attributed to the Flex. But just curious, what were some of the other factors that were the cause there? And then I guess continuing on Flex, since it seems like things are going better than expectations and it's a better business decision, how should we think about this in the context of the long-term IMT guide that you provided? And I guess if things are going better than expected, why not raise this long-term guide for IMT?

[Allen Parker, executive]

Yes. So with respect to the -- we took the top end down from [ 9 30 to 9 15 ]. As I mentioned, significantly all of that was due to the revenue effect of Flex and moving Q4 into future periods. So there's not really much of anything to call out there. All of the key input metrics for the Premier Agent business continue to stabilize, and we're excited about that. And so there's no real story other than Flex with respect to Premier Agent and IMT. And I'm sorry, the second part of your question?

[Richard Barton, executive]

Long term, how does it affect our long-term -- how do we feel about the IMT through the...

[Allen Parker, executive]

Yes. So 3- to 5-year targets remain -- we still feel very confident, as I mentioned in my opening remarks, that they're well within reach.

[Richard Barton, executive]

Yes. We don't think we were -- what was the IMT 3- to 5-year guide, $2 billion.

[Allen Parker, executive]

Yes. $2 billion with $600 million of EBITDA.

[Richard Barton, executive]

Yes, it still feels appropriate.

[Operator]

Our next question comes from Ron Josey of JMP Securities.

[Ronald Josey, analyst]

Just wanted to ask on 2 things, really. First on just Premier Agent retention. I think you said in the letter return to historic norms. Can you just update us on how you're doing with acquiring perhaps those agents that might have been lost during the transition last year and then just overall just conversion rates with PA 4?

And then on Homes, with service fee, I think, in the 7.5% in the quarter, I think for -- that sort of compares to maybe 7% prior. Can you just talk about what's driving that fee? I know it's a range, but is it maybe going into newer markets, consumers perhaps willing to pay more for the convenience? Any sort of insights on the fee would be helpful.

[Greg Schwartz, executive]

Yes. It's Greg. I'll pick up the first half of that. Yes. As we noted on Premier Agent, we're on a forecast, so we returned exactly where we thought we would be now. So we're pleased about that. The real driver of this -- and again, the normal retention, we're right on it, is the step we made on connections that the fewer higher-quality connections between these great real estate professionals and consumers that need to be served, that was the big bet we made. And it's flowed through. Our Premier Agents are now coveting high-quality live connections. We're pleased about that.

The other big bet we made, and both of these are important for our Flex transition, the Best of Zillow. The Best of Zillow bet was we would make a selective group of the finest real estate professionals found anywhere. We'd have a measure that's incredibly high scaled. Millions and millions of consumer -- elements of consumer feedback now on this thing. And a reminder, Best of Zillow is it's a 5-star rating system that happens at multiple times during the relationship between consumer and professional. And we're holding agents -- our Premier Agents to high standards. So that's what we implemented and positions us wonderfully for Flex. And that's been our focus to date.

On returning customers, these folks come and go based on their lives because these are small business people. And so we've always been pretty consistent once these connections were recognized as valuable with books flowing back to us. So we feel pretty good about that. But the team is focused on Flex and what's ahead. Do you want to take the second half of that? There's a financial question there.

[Jeremy Wacksman, executive]

It's Jeremy. I'll get that. I mean, yes, it's market and buy box and home mix, so we're getting into more markets, each market and even ZIPs within market and home types have different underwriting inputs, right, from carrying holding costs to taxes and fees, and those will get rolled up into the fees. So you'll see that vary as we go, especially as we're opening more markets and as we spread.

[Operator]

Our next question comes from Jason Helfstein of Oppenheimer.

[Jason Hoffman, analyst]

This is Jason Hoffman on for Jason Helfstein. As you're entering all these iBuyer markets, how should we think of inventory and economics for iBuyers trending throughout the rest of the year? We saw a slight uptick from 1Q to 2Q. But how should we think about that in 3Q and 4Q, if you don't mind?

[Jeremy Wacksman, executive]

Yes. This is Jeremy. So the unit economics we're targeting continues to be the same, so plus or minus 200 basis points return before interest. And so you saw a similar performance between Q1 and Q2 and well within that range, and you'll see us -- we expect to continue to perform at that level.

[Allen Parker, executive]

Yes. And this is Allen Parker. I was going to say in terms of economics overall, we have talked about we expect to see trending improvement in our EBITDA margin as a percent of revenue. That may not be linear. But if you look at our range, we were at negative 22.7 in Q2, and we have a range of negative 18.9 to negative 23 in Q3 based on our guidance ranges.

[Operator]

Our next question comes from Jason Deleeuw of Piper Jaffray.

[Jason Deleeuw, analyst]

Just wondering on the seller fee, how much of a factor is that on the home seller acceptance rate? And then there's also been more talk about iBuyers offering the Instant Offer and then plus a traditional agent kind of listing price, what they think the home seller would get through a traditional sale for the house. How important do you think that would be to the iBuying process? And is that something that Zillow is taking a look at?

[Jeremy Wacksman, executive]

Yes. This is Jeremy. So I mean consumers are super sensitive to fee. So as the fee varies, you'll see acceptance rate change. But that's relative to their alternative, right? So when we're pricing in a fee, many of those costs are costs they would incur no matter how they sold. And having that conversation with them and explaining that to them is something that we're still working through and they're still learning as they get into the selling process. So when fee moves, it moves but it's about what is the move relative to in terms of alternatives. And then Greg, I don't know if you want to take the listing...

[Greg Schwartz, executive]

Sure. Seller leads have been a topic of some interest. We think we have a good long-term opportunity in developing a business adjacent to Zillow Offers, but there's some invention to happen here. Of course, it's confined just to the Zillow Offers footprint, which is still a pretty compact footprint. And the thing we have to get -- sorted out in our product iteration is folks covet this beautiful, amazing Zillow Offers' instant experience. And we have to figure out how to cross-sell them -- when they don't fit our buy box typically, cross-sell them into listing with the Premier Agent. We're working our tails off on that. And there's promise, but it's not this year.

[Operator]

Our next question comes from Brent Thill of Jefferies.

[Alexander Giaimo, analyst]

It's Alex Giaimo on for Brent. Just based on the color you provided in the letter, it seems as if recent Premier Agent feedback has been positive, but the full year guide still implies just 2% growth. So if you can just remind us what you think the TAM is for that business, that would be helpful, and how much runway you think is still available in the PA business.

[Allen Parker, executive]

Yes. So this is Allen Parker. I'll take that. I mean I guess what I would say is that with the guidance that we gave, the implied -- at the top end of the guidance, the implied growth rate for Premier Agent in Q4 is about just under 3%, but that is impacted by the Flex adjustment that we described. I think that we expected with this recurring revenue and the churn that we saw last year that we would have to build that back up. We would see more significant growth had we not done the Flex transaction. As Rich mentioned, it's the way we recognize revenue.

But in terms of long-term TAM and growth, I would just look to our long-term targets. We still believe that within 3 to 5 years, IMT can be a $2 billion business at a 30% EBITDA margin.

[Greg Schwartz, executive]

And the principal part of this is when we do a transaction model, we're doing a transaction model with the finest real estate professionals in the land and [ we have a ] much larger TAM to address with this new Flex program as we get to it. So there's a bunch of upside on the bids. We've just got to get everything lined up, and we've got to get some full data back from these higher-scale tests in these 2 important geo markets. And then we'll be to it.

[Operator]

Our next question comes from Brad Berning of Craig-Hallum.

[Bradley Berning, analyst]

Just to follow up a little bit more further on that thought process. Maybe you can touch a little bit upon the Flex TAM of how you see it versus kind of the traditional advertising Premier Agent TAM and what is the margin profile on Flex likely look at versus the historical kind of PA business. Just kind of curious if you can help us think that through.

[Greg Schwartz, executive]

Yes. I'll talk to you about like the top line economics of it, and then Allen can hit the margin profile if he wants to. The way to think about this is we've been limited by the advertising budgets, which is -- by advertising budgets of the credit cards of these great small business people, these agents. Who have had to pay upfront. Who have had to pay upfront and take the financial risk. And so they were looking for pretty strong economics and returns. And even when they were wildly profitable, multiples profitable, they derisked those decisions when prices went up on them.

When we moved towards -- we moved to Flex, let's be clear, the economics -- the take on an average transaction improves for our company. So we take a bit more because we're capitalizing the transaction. And we think by providing better lead distribution or connections to the right professionals and a better experience with Best of Zillow, where we can drop folks that aren't providing amazing experiences to consumers, will drive well more transactions. So the economics on a per transaction basis improve for us. We've talked about this -- roughly it's a 35% referral fee is the industry standard. We'll see where we settle in. So that's great. And then we'll drive more transactions.

So this should have really good leverage for us, and it aligns us with the incentives with both consumers and the real estate.

[Richard Barton, executive]

And it doesn't appear on the income statement, but once again, I'll bring up customer satisfaction. It's a better -- we think it's a better customer experience this way, and that matters. That is an input to growth.

[Allen Parker, executive]

And with respect to the margin profile, we're not currently giving any guidance outside of our current outlook. We've got a lot to learn about Flex. But again, as Rich mentioned, we're super excited about a lot of the elements starting with the customer. And we think the rest will work itself out to the positive. And I would just still direct you to our long-term targets with respect to the curves over the next 3 to 5 years.

[Operator]

Our next question comes from Tom Champion of Cowen.

[Thomas Champion, analyst]

Maybe one more in Flex. I'm just curious if you could close the loop on why Phoenix and Atlanta and why it's important that those were Offers markets as well. Can just clarify that? And then maybe switching gears to Offers, really impressive markets growth and transaction volumes. I'm just curious if you could share any thoughts around scale and maybe volumes where individual markets become profitable. Any comments around that would be really helpful.

[Greg Schwartz, executive]

Yes I'll pick up the first. This is Greg. Why Phoenix and Atlanta? The brand is pretty hot there. We've got great agents working with us there. They partnered with us there. And we're iterating on the seller lead opportunity and the buyer lead opportunity there.

[Richard Barton, executive]

It's a more controlled laboratory for testing.

[Greg Schwartz, executive]

Yes. You bet. So that's why those 2 important markets and they're large enough markets that it's going to give a strong enough signal. And on this signal -- the strong signals we're seeing from the data that we've shared, these leading indicators are based on a few midsize metros in Connecticut and Colorado. And these 2 big areas will give us a really strong signal. Jeremy, you want to...

[Jeremy Wacksman, executive]

Yes. On offers and kind of how we think about markets as we go, yes, we're scaling quickly and we're adding more. And we're just now starting to come up on even being able to see year-over-year on the first couple markets. So it's still early, and it's going to be a while before we can really think about sort of market composition and market-by-market dynamics.

The only thing I can say is obviously scale is an input to that long-term target on profitability, too. So the scale platform that we get both in each market and across the market and be able to grab the data and get the best demand signal provide stronger offers and drive costs down are what going to drive the whole business. That's going to be true in our big markets and it's going to be true across the platform.

[Operator]

Our next question comes from Brian Nowak of Morgan Stanley.

[Brian Nowak, analyst]

I have 2. Just to throw another one at Flex. So I just kind of want to make sure we understand. So if you look at sort of your initial markets where you're testing this, are you saying that your per home transaction monetization, so the revenue you're generating per home that is actually sold through the platform is actually better through Flex than the old PA, just to kind of -- to clear that up and then just so we understand how it trends over time.

And then you talked about sort of the idea that you'll be able to send more leads and more home sales to higher-quality agents. If Flex is successful over time then, do you see a world where you have more leads and more transactions going through higher-quality agents, so the agent count could fall further over time? Is that kind of the way you're thinking about Flex changing the business model?

[Greg Schwartz, executive]

Yes. So 2 good questions. So the economics, I would point out, we're early yet, we just launched the program in those areas in June. So what we believe will occur in a sell and what occurs -- we've got to let this stuff mature a little bit. Two, we're going to plant a flag on that issue, okay?

[Richard Barton, executive]

You just said to me the take rate was going to go up. I just heard that on the call. I took a note. So you can ask me about it later. But the end, it's still pretty small.

[Greg Schwartz, executive]

Yes. Exactly. The end is pretty small, but it's looking pretty positive. It is looking like on a per transaction basis, it should be positive. And then the question on agent count. We intend to have a selection of the most productive agents in the business. Connections allow them to pick up the phone and have a live customer who's been vetted, who wants to talk to them and schedule an appointment, go out and see a house, get connected to them. This is a really important efficiency driver for them, so we expect that the best get bigger. Yes, if that's the question, we certainly expect that to occur.

And the team model is very well suited to this, which we've invested in now for many, many years. A lot of wonderful individual practitioners have now become businesses. Hiring buyers' agents, hiring showing agents, hiring listing agents, hiring transaction coordinators on top of our platform. We expect that to accelerate. And so the total customer counts may decline early, but the number of agents working the volume that we send downstream will probably grow, and each of them will get more of their business from us. So -- but it's early.

[Operator]

Our next question comes from Ygal Arounian of Wedbush Securities.

[Ygal Arounian, analyst]

So a little bit more on Flex. I just want to make sure, maybe understand all the ins and outs. So in the markets that you're in, is it opt-in right now? Are you pushing to -- or is it only Flex? What's kind of the mix in those markets?

And so I understand that you're seeing some early positive signals. Any way to give kind of ballpark framework around how many transactions have actually closed through the Flex model?

And then as we look out to the 3 to 5 year targets, understanding that you're still confident in those numbers or more confident today, how much of that -- there's a big step-up in growth between this year and then the following years, right, that's the assumption if we get to the targets, how much of that is based on Flex working? And how much of it is based on the traditional core PA returning back to kind of like the double-digit growth rate that you've seen?

[Greg Schwartz, executive]

Okay. There are a few questions in there, so I'll pick off one at a time and then you'll help me out a little bit. So the first question is what's the actual dynamics in the markets that are live today and how we roll it out. It's entire market. So get on there. We put our teams on the market. We train up our customers. They go ahead and create a shift from a prepay model to a post-pay model. That hasn't been real hard to stop billing their credit cards, to move it to a post-pay model. We typically run the changes for a month or 2 and we frame the same share of voice they had. And then we let that algorithm that I mentioned, the performance pacing algorithm start to scale up. It has the input it needs from the maturing -- from this maturing set of data, appointment rates, customer satisfaction. And then the performance pacing algorithm starts to do the allocations, overweight or heavy up the best performers.

And so that's how these typical market launches go. That is how Atlanta and Phoenix will launch. And there's a whole lot of dialogue with our Premier Agents before we launch, and they've been very welcoming of this change. So that's been a highlight so far.

A question on transactions. We just launched this in June, and so it's too early in the maturity for me or the team to be comfortable sharing a metric.

[Richard Barton, executive]

So we're not being coy. We're just -- it takes a while for these transactions to happen.

[Greg Schwartz, executive]

Yes. It has to close. It hasn't been 6 months yet, and that's the typical window. So we're not going to plant a flag in yet on what that looks like. And again, it's small scale. And that's why we're going to these larger-scale markets to get a stronger signal. And it's a test, so it wasn't -- the 3 to 5 year model was not predicated on -- yes, okay -- on the success or failure of this.

[Allen Parker, executive]

Yes. We don't have enough information on the test yet to really roll in what we exactly think in the 3 to 5 year. We feel comfortable that the 3- to 5-year targets are achievable, but we'll learn more with this, and we'll come back and explain what we think the impacts could be if it affects it.

[Operator]

Our next question comes from Naved Khan of SunTrust.

[Naved Khan, analyst]

Just looking at the amount of inventory, number of homes that's around 1,500, and I think there are a few things going on you're ramping across -- you're opening new markets and then there is seasonality because, obviously, we are in a peak season. So how should we understand on a sort of like-for-like basis how the inventory increase because of seasonal factors versus it going up because you're in more markets?

[Jeremy Wacksman, executive]

Yes. This is Jeremy. I mean it's both market expansion and just raw growth, maybe even less seasonality. So yes, we're opening more markets. And therefore, every month is an increasing amount of volume in the business. And so you're going to see that continue to build. So we'll -- the inventory will continue to grow while we're scaling because we'll be buying more in every month than we were able to sell from the previous cohort. And we expect that to not just continue, but to continue across the markets that we open as well.

[Naved Khan, analyst]

And then maybe a related question. So in the markets that you're in already with Zillow Homes, how much effort are you spending on brand advertising and what's the plan -- is that going to ramp up? Or do you think you're in a good place?

[Jeremy Wacksman, executive]

So I mean the story for Zillow Offers is that we have kind of all the demand we can handle, and this big amazing brand that we have spent decade building in concert with the IMT business and the other businesses for our customers is paying great dividends as a place for all of our homeowners to come and start with Zillow Offers.

So we do a little testing here or there to try and figure out how to start to get the marketing machine we have dialed in across these businesses. But by and large, the traffic that we have coming already is the source for Zillow Offers. And frankly, we've been inundated with the demand every time we line up a market. And so our big goal is trying to figure out how to open these markets efficiently, quickly and effectively to actually satisfy the demand.

[Richard Barton, executive]

And that, of course, makes sense not just because we have 194 million new use for the quarter is what we just announced, something like that. So not just because we have a ton of new use. A lot of those are coming because the Zestimate is the first stop on the way to thinking about selling your home. And so we haven't had to exhibit a tremendous amount of cleverness in merchandising. In fact, we haven't exhibited a certain amount -- or that much cleverness, honestly. But we haven't had to in trying to get them to raise their hand and say they like the Zillow Offer.

[Operator]

Our next question comes from Deepak Mathivanan of Barclays.

[Deepak Mathivanan, analyst]

Somewhat related to question, the prior one. So on the 3Q guide for the Homes business, the $80 million EBITDA loss at the high end, how much of the cost is associated with city-level expansion and all the fixed costs, sort of the nonvariable costs associated with it compared to sort of your expectations for contribution margin on a per home basis related to the volume that you are looking to sell?

And then second one, also on the Homes business, now that you're being active in Phoenix and Vegas markets for a while, is the inventory growth sort of continuing to happen at a similar pace where you think market share gains is still very easily achievable in these markets? Or are we now at a point where the iBuying market in itself has reached a reasonable level in these that are all your adopting cities, so it's going to be a little bit more market share dynamic that plays out there?

[Richard Barton, executive]

Let's start with Allen?

[Allen Parker, executive]

So I guess I'll take the first one. I mean I guess the way I would describe it is when you think about our growth and our revenue range, the Homes cost of revenue has fluctuated between 95% to 97% of revenue -- as a percent of revenue. And the 97% high was in Q2, and that related to this inventory value assessment. So I think that what you'll see over time is that number will move back down closer to the 95% and the rest would be the fixed costs associated with building the business and infrastructure that's not part of the cost of revenue of the Home. So I think you can use a range of around 95%. It will fluctuate, but that may be a good estimate at least in the near term on the variable kind of costs related to the Home versus the fixed cost to build.

[Jeremy Wacksman, executive]

And then on the second one, market share gains versus steady state. I mean I think it's important to remember just how early it is. So even though the segment's been around for a couple of years and people have been starting to experiment with trying to sell their home this way, the vast majority of consumers we talk to don't know what this is. And as Rich said, we're not really getting that clever yet about trying to teach them because, frankly, we don't have to and we're inundated with the demand of people coming off our website. But there's a ton...

[Richard Barton, executive]

We're busy building out markets.

[Jeremy Wacksman, executive]

But over time, you'll see market share gains come from more homeowners and home sellers understanding what this offering is, learning about it and trying it out and hopefully converting to it. And we are in a very, very early innings of consumer awareness and understanding of this.

[Operator]

And our last question comes from Heath Terry of Goldman Sachs.

[Adam Hotchkiss, analyst]

This is Adam Hotchkiss on for Heath. When we think about just the turnover in the Homes business, we saw roughly 1,000 homes on the balance sheet at the end of 1Q, and you guys sold roughly 80% of that in 2Q. You've previously talked about the 90-day threshold. How has that evolved over time, particularly as you've entered new markets, the thought process around balance sheet turnover?

And then when we talk to agents, we hear a lot about the value that -- particularly those who were representing homeowners in markets with Zillow Offers and other Instant Offers businesses, the value of essentially using that as a way to create more opportunities and more value for the homeowner. When we think about you being proactive with agents versus agents sort of coming to you in some of these newer markets, how do you think about how those relationships evolve?

[Jeremy Wacksman, executive]

Yes. This is Jeremy. So on the whole time -- I mean I'll point you back to our unit margin target. So we get into more markets, we get into more types of homes. We're underwriting each home to a specific whole time and cost to sell, all solving for that plus or minus 200 basis points before interest. So as markets are in season, you're going to see the whole funds vary across that, but it's really about solving for that unit margins.

[Richard Barton, executive]

And we continue to feel good.

[Jeremy Wacksman, executive]

And we continue to hit that target as we go and feel good about that target.

In terms of -- I think your second question was just around agents in markets where there are things like Zillow Offers, talking about Zillow Offers as an option to sell. I think that's what your question was. At least from our standpoint, we have a great agent partner in each one of these markets that we're working with. They have that conversation as well. And we think that choice is super important, whether they end up selling to us or ultimately listing traditionally, hopefully, with one of our partners, I think that will help contribute to growing awareness of what this is.

As Rich said earlier, most folks are starting their home-selling journey on Zillow, think about their Zestimate. And that button right next to them as a way to think about how to start, we think, becomes a really primary way for them to get their hands and their head around what selling looks like regardless of which path they go down.

[Operator]

This concludes our question-and-answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.