This post originally appeared on The Basis Point: How Zillow Makes Money On Its Mortgage Business
We’re doing research on Zillow this week for a couple large pieces forthcoming on how they make money and serve customers.
It’s important to understand Zillow’s changing business model as they add home buying, selling, financing to their media and advertising model, which has been their main focus.
It’s no longer just Zillow connecting you with real estate agents and lenders when you want to buy, sell, or finance a home.
Now they’ll buy your home from you, sell a home to you directly, and finance a home you buy from them.
The mortgage financing is key to their direct home buying and selling strategy because they believe it makes the process super easy.
Think about getting out of an Uber or Lyft and having to reach for your wallet.
Shouldn’t it be the same for mortgage?
It’s not about the payment for the house. It’s about the house.
That’s the deal.
But to see if it’s all going to work, you have to get into the weeds of their financials.
So below are some excerpts on Zillow’s mortgage business model from SEC filings.
Before August of 2018, Zillow mainly made money in mortgage by selling leads, ads, and software services to lenders.
Then they acquired a mortgage lender which formed the basis of their own mortgage bank called Zillow Home Loans.
Now analyzing Zillow mortgage revenue is getting more complicated.
So these SEC notes are for the nerds, including The Basis Point team.
We use this wonkier stuff to supplement and add credibility to our core content which is super simple and consumer-friendly.
That’s why created this Research feature to share nerdy stuff we’re doing behind the scenes.
Enjoy, and stay tuned for some cool Zillow stuff coming tomorrow.
Mortgages revenue primarily includes marketing products sold to mortgage professionals on a cost per lead basis, including our Custom Quote and a portion of our Connect services, and on a subscription basis, including a portion of our Connect service. Zillow Group operates Custom Quote and Connect through its wholly owned subsidiary, Zillow Group Marketplace, Inc., a licensed mortgage broker. For our Connect and Custom Quote cost per lead marketing products, participating qualified mortgage professionals typically make a prepayment to gain access to consumers interested in connecting with mortgage professionals. Mortgage professionals who exhaust their initial prepayment prepay additional funds to continue to participate in the marketplace. For our Connect subscription mortgage marketing product, participating qualified mortgage professionals generally prepay a monthly subscription fee, which they then allocate to desired geographic counties. In Zillow Group’s Connect platform, consumers answer a series of questions to find a local lender, and mortgage professionals receive consumer contact information, or leads, when the consumer chooses to share their information with a lender.
Consumers who request rates for mortgage loans in Custom Quotes are presented with customized quotes from participating mortgage professionals.
For our cost per lead mortgages products, we recognize revenue when a user contacts a mortgage professional through our mortgages platform, which is the amount for which we have the right to invoice. For our subscription product, the opportunity to receive a consumer contact is based on the mortgage professional’s relative share of voice in a geographic county. When a consumer submits a contact, we contact a group of subscription mortgage professionals via text message, and the first mortgage professional to respond receives the consumer contact information. We recognize revenue based on the contractual spend recognized on a straight-line basis during the contractual period over which the service is provided. This methodology best depicts how we satisfy our performance obligation to subscription customers, as we continuously transfer control of the performance obligation to the customer throughout the contractual period.
Beginning in the fourth quarter of 2018, mortgages revenue also includes revenue generated by Zillow Home Loans, Zillow’s affiliated mortgage lender. We elect the fair value option for our mortgage loans held for sale, which are initially recorded at fair value based on either sale commitments or current market quotes and are adjusted for subsequent changes in fair value until the loans are closed. Net origination costs and fees associated with mortgage loans are recognized as incurred at the time of origination. We sell substantially all of the mortgages we originate and the related servicing rights to third-party purchasers in the secondary mortgage market within a short period of time after origination.
Mortgages revenue also includes revenue generated by Mortech, which provides subscription-based mortgage software solutions, including a product and pricing engine and lead management platform, for which we recognize revenue on a straight-line basis during the contractual period over which the services are provided.
For our Mortgages segment, other income includes interest income earned on mortgage loans held for sale.
For our Mortgages segment, interest expense includes interest on the warehouse lines of credit acquired as part of the acquisition of Zillow Home Loans. Each warehouse line of credit provides for a current and maximum borrowing capacity of $50.0 million, or $100.0 million in total. Borrowings on the warehouse lines of credit bear interest at the one-month LIBOR rate plus an applicable margin, as defined in the credit agreements governing the warehouse lines of credit.
Mortgages revenue was $27.0 million for the three months ended June 30, 2019 compared to $19.3 million for the three months ended June 30, 2018, an increase of $7.7 million, or 40% . The increase in mortgages revenue was primarily a result of the addition of revenue generated by Zillow Home Loans, Zillow’s affiliated mortgage lender, which we acquired in the fourth quarter of 2018.
Mortgages revenue was $54.3 million for the six months ended June 30, 2019 compared to $38.3 million for the six months ended June 30, 2018, an increase of $16.0 million, or 42% . The increase in mortgages revenue was primarily a result of the addition of revenue generated by Zillow Home Loans, Zillow’s affiliated mortgage lender, which we acquired in the fourth quarter of 2018.
Cost of revenue was $4.4 million for the three months ended June 30, 2019 compared to $1.2 million for the three months ended June 30, 2018 , an increase of $3.2 million. The increase in cost of revenue was primarily attributable to our October 2018 acquisition of Zillow Home Loans, and includes a $1.9 million increase in headcount-related expenses, including share-based compensation expense and a $0.5 million increase in mortgage loan processing costs. We expect cost of revenue to increase in absolute dollars in future years as we continue to incur more expenses that are associated with growth in revenue and expansion of Zillow Home Loans.
We expect our sales and marketing expenses to increase in absolute dollars in future periods as we continue to expand the Mortgages segment.
We expect our technology and development expenses to increase in absolute dollars in future periods as we continue to build new website functionality and other technologies that will facilitate the origination of mortgages in Zillow Home Loans.
We expect general and administrative expenses to increase over time in absolute dollars as we continue to expand our mortgage business.
The October 31, 2018 acquisition of Zillow Home Loans also continues to have a significant impact on our liquidity and capital resources as a cash intensive business that funds mortgage loans originated for resale in the secondary market. We primarily use debt financing to fund the mortgage loan originations. On June 28, 2019, Zillow Home Loans amended and restated the warehouse line of credit previously maturing on June 29, 2019. The amended and restated credit agreement extends the term of the original agreement for one year through June 27, 2020, and continues to provide for a maximum borrowing capacity of $50.0 million with availability under the warehouse line of credit limited depending on the types of loans originated. As of June 30, 2019 , we have $30.1 million of total outstanding borrowings on warehouse lines of credit to provide capital for Zillow Home Loans with a total maximum borrowing capacity of $100.0 million.