Zillow posts Q3 loss and soft outlook as it pivots to "Zillow preferred"

Quarter recap

Zillow posted a third quarter loss of 70 cents per share on $724 million in revenue, missing investor hopes for roughly $754 million and 16 cents a share in earnings. Shares fell 16% in after-hours trading after the release.

"We grew revenue and outperformed the real estate category during one of the toughest housing markets in a generation," said Jeremy Wacksman, Zillow's CEO, in a statement. In a shareholder letter, Wacksman and CFO Jeremy Hofmann added, "Even as housing conditions deteriorated sharply, Zillow kept growing and outperforming, powered by our brand, audience, value to partners, disciplined cost management, and strong growth levers across our well-diversified business." They wrote, "These advantages are driving our performance through an exceptionally difficult macro environment today and position us to accelerate when conditions improve."

With elevated home prices and rising mortgage costs, the stock has declined roughly 55% this year, pressured by the threat of technological disruption and sluggish home sales, putting it on pace for its worst full-year on record, with records dating to July 31, 2015, per Dow Jones Market Data.

Where the revenue came from

Zillow's residential segment delivered $419 million in Q3, about 58% of total revenue. Mortgage revenue was $70 million, below the $80.9 million consensus, and rental revenue was $220 million, short of the $222.8 million expected.

The company said overall revenue increased 7% from a year earlier in the quarter, while it cited National Association of Realtors data showing the housing market grew 1% over the same period.

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The pivot to "Zillow preferred"

Zillow is transitioning its core agent offering to "Zillow preferred," where agents pay the company after a home sale closes rather than upfront to connect with buyers. Browsing Zillow is free, and the company earns part of its revenue by charging real estate agents who use its platform to reach buyers.

Management says the new approach generates more revenue per buyer connection than the old one. The accelerated shift contributed to lower-than-expected third quarter guidance, and, since the firm recognizes revenue when a home purchase closes rather than at the outset, the model's benefits take longer to show up. Looking to Q4, Zillow expects total revenue between $635 million and $665 million, below the $709.5 million analyst consensus, and it expects residential revenue to decline 9% to 15% year over year.

What this means for your portfolio

Guidance reflects a housing market still pinched by high prices and higher mortgage rates and a business mix that recognizes revenue at closing, which can delay the benefit from stronger unit economics. KeyBanc's team led by Sergio Segura wrote, "We believe a tougher housing backdrop, softer traffic and survey trends, and near-term headwinds from the accelerated Preferred transition warrant a more conservative outlook." They maintained an Overweight rating but lowered their price target to $42 from $48, adding, "However, we view valuation as attractive, while Rentals and Mortgages continue to deliver robust growth despite a challenging market."

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