CoStar Group, Inc.

Good afternoon. My name is Bailey and I will be your conference operator today. At this time, I would like to welcome everybody to the CoStar Group third quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. Now, Cindy Akin, head of investor relations, will read the safe harbour statement. Cindy, you may begin.

Thank you, Bailey. Good evening, and thank you all for joining us to discuss the third quarter 2022 results of the CoStar Group. Before I turn the call over to Andy Florence, CoStar's CEO and founder, and Scott Wheeler, our CFO, I would like to review our safe harbor statement. Certain portions of the discussion today may contain forward-looking statements, including the company's outlook and expectations for the third quarter and full year 2022 based on current beliefs and assumptions. Forward-looking statements involve many risks uncertainties, assumptions, estimates, and other factors that can cause actual results to differ materially from such statements. Important factors that can cause actual results to differ include, but are not limited to, those stated in CoStar Group's press release issued earlier today and in our filings with the SEC, including our most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q under the heading Risk Factors. All forward-looking statements are based on the information available to COSTAR on the date of this call. COSTAR assumes no obligation to update these statements, whether as a result of new information, future events, or otherwise. Reconciliation to the most directly comparable GAAP measure of non-GAAP financial measures discussed on this call include EBITDA, adjusted EBITDA, adjusted EBITDA margin, non-GAAP net income, non-GAAP net income per diluted share, and forward-looking non-GAAP guidance. are also shown in detail in our press release issued today, along with a definition of those terms. The press release is available on our website, located at costargroup.com, under Press Room. As a reminder, today's conference call is being webcast, and the link is also available on our website under Investors. Please refer to today's press release on how to access the replay of this call. And with that, I would like to turn the call over to our founder and CEO, Andy Thorne.

Thank you, Cindy. Good evening, everyone, and thank you for joining us for CoStar Group's third quarter 2022 earnings call. This is our 97th consecutive earnings call. Total revenue for the third quarter grew 13% year over year on a constant currency basis to $557 million, coming in at the high end of our guidance range and above consensus estimates. We delivered exceptional results in the third quarter with annualized net new sales bookings of $76 million, a 62% increase over the same quarter in 2021. This is our second highest quarterly net sales bookings number ever. Adjusted EBITDA was $153 million for the quarter, exceeding the high end of our guidance range and consensus estimates. As a result, we're raising our full year outlook for both revenue and adjusted EBITDA. Apartments.com surged, turning in the highest sales month ever in September and its second highest sales quarter. Year-to-date, net new sales for Apartments.com are up 192% over the prior year. Apartments.com revenues were $190 million in the third quarter, increasing 11% over the third quarter of 2021. We are now back to double-digit revenue growth and expect the growth rate to improve in the fourth quarter. Tight multifamily market conditions have been a headwind for Apartments.com, but are now shifting and may, in fact, become a strong tailwind. Vacancy rates rose to 6.1% in the third quarter, an increase of 40 basis points from the last quarter. This is the fourth consecutive quarterly increase in the vacancy rate, and we are now only 40 basis points below the historical long-term average vacancy rate. Unit absorption rates dropped to 52,000 units in the third quarter from 67,000 units in the second quarter. This is the lowest absorption rate in the past 11 quarters. At the same time, though, unit deliveries increased from the second quarter to 122,000, which is the higher end of historical averages. With the number of units under construction nearing all-time highs and absorption moving towards all-time lows, vacancies are expected to rise further in coming quarters, which we believe will increase the demand for advertising. The Apartments.com sales force delivered absolutely outstanding results in the third quarter. Good work, Page and team. Our gross sales productivity per rep was 91% versus the same quarter last year, reaching an all-time high. With 60,000 apartment buildings on the platform, we have now reached an all-time high for participation. Given that we are still very early with relatively low market penetration in this opportunity, we continue to hire aggressively and have increased the sales force by 26% since the end of last year. We plan to continue growing the team over the next year or so until we have doubled the sales force. Our nationwide ad campaign has delivered over 12 billion media impressions and led to an all-time high in consumer brand awareness. Apartments.com continues to provide the highest quality consumer traffic to our customers. We believe that a specific purpose site such as Apartments.com delivers higher intense leads. We also believe that third-party lead analysis shows that our leads convert to leases at significantly higher rates than any of our competitors. Overall, I'm extremely pleased with the strong performance of our Apartments.com marketplace and sales team and have increasing confidence in our ability to return to 20% revenue growth. Revenue for CoStar was $213 million in the third quarter, representing a 17% increase over the same quarter a year ago on a constant currency basis. CoStar sales results increased 55% in the trailing 12 months compared to the trailing 12-month sales in the same quarter a year ago. We surpassed 180,000 subscribers in the third quarter and continue to maintain high renewal rates at 93%. Our consistent double-digit revenue growth and high renewal rates for CoStar are a result of ongoing product investments that broaden the capabilities of CoStar and allow us to reach new customers. Integrating STR hotel data opened up hospitality investors as customers, while our new lender product makes 6,000 medium and large lending institutions great prospects to become customers. We literally have dozens of major potential product enhancements on our product roadmap, which will continue to deliver revenue growth opportunities for the next decade or more. The next product enhancement on the CoStar roadmap involves adding information on 12,600 commercial property investment funds that invest almost $3.6 trillion in commercial properties around the world. These investment funds hold over 70,000 commercial properties. Over the past year, our research team has been linking the investment fund property information to properties in CoStar and adding properties in countries that are currently not in our data sets. Approximately 70% of the investment fund properties are in the United States, Canada, and the UK, while the remaining 30% expand our property coverage throughout the rest of the world. For the first time, these fund investors will have new detailed analytics on their property portfolios through CoStar. They'll be able to access information like historic sales comps, leasing history, pricing, vacancy rates, and other important details to help understand their portfolios better. In addition, brokers and owners looking to sell properties will be able to query the investment fund data to determine which funds still have dry powder and are looking to invest in properties that are similar to theirs. I believe this new investment fund capability unlocks significant potential revenue opportunity. The investment fund product is scheduled to release in CoStar in the first quarter of 2023. We believe that there is significantly more revenue opportunity ahead for CoStar, so we're continuing to grow our CoStar sales force to better capture that opportunity. We've added over 50 new sellers so far this year and plan to continue to expand both in the U.S. and internationally. As we add to our sales teams, we've seen productivity levels increase as well. Average gross sales per rep are higher this year than any single quarter in the past five years. With our strong product development capabilities and continued investments in our sales team, I'm confident in our ability to sustain strong double-digit growth in CoStar for many years. LoopNet third quarter revenue was $59 million, up 13% over the prior year on a constant currency basis. Net new sales bookings for LoopNet in the third quarter are up 99% over the third quarter of last year. Just one percentage point shy of being up 100% year over year. We'll try harder next time. Our sales team, Our sales team is now producing consistent, strong sales results every month. Over the past six months, we've produced more net sales bookings than we did in all of 2021. I'm very encouraged by the progress that Dave Millay and his team are making as we grow our dedicated LoopNet sales force, which is now three times the size it was from the beginning of the year. We have now surpassed 100 dedicated sales reps. The result is that dedicated LoopNet sellers now account for roughly half of all the LoopNet sales and the CoStar sales force is delivering the other half. This is an improvement from a year ago when our dedicated LoopNet sales team produced roughly one third of LoopNet sales. In the long term, we want to free up the CoStar sales force to focus more effort on CoStar as it approaches a billion dollars in revenue. Traffic to our LoopNet network of sites reached a high in the third quarter, averaging approximately 13 million unique visitors per month. We now hold the number one keyword rank across 130,000 commercial real estate search terms and sort to the number one position 97% of the time across 10,000 of the highest performing U.S. commercial real estate search terms. Our Space for Dreams media campaign has proven very successful, delivering over 200 million impressions across TV, social media, and the web in the third quarter. We continue to expand LoopNet internationally with plans to launch loopnet.co.uk across the United Kingdom in early November. Following our successful launch of LoopNet in Canada in the first quarter, we believe there are significant brand efficiency revenue profit advantages in operating a multinational property marketplace. We estimate the potential revenue for digital commercial property advertising in the UK to be well north of $100 million, which up to this point is largely untapped. LoopNet.co.uk will bring together the market-leading traffic position of Riala with a proven international LoopNet brand. We intend to redirect traffic from Riala to LoopNet and Sunset Riala. It's been a very successful site. As our CoStar clients in the UK are renewing their annual CoStar contracts, our sales force is working with them to add LoopNet advertising to their service. Today, many of the listings on Riala have been free in order to build traffic, but our goal is to convert many to paid on LoopNet over the course of the next 18 months. Following the launch of LoopNet in the UK, we'll turn our attention to rolling out LoopNet in France, Spain, and Germany in 2023. We're really excited to deliver the first multinational commercial estate marketplaces, and we believe it will have huge appeal. We believe that the LoopNet opportunity is in excess of $1 billion as we extend across Europe. Our 10X digital auction platform performed very well in the third quarter, despite a significant slowdown in overall CRE sales volumes due to the disruption caused by surging inflation and the rapid increase in interest rates. While CRE transactions were down in the market by almost $30 billion in the third quarter, the volume of properties brought to the 10X platform increased 88% over the prior year. Consistent with prior quarters, over 80% of the assets brought to the platform through 10X are still market-rate performing assets, and less than 20% of the assets are distressed properties. I expect a significant increase in distressed properties in the quarters to come. Clearly, the commercial property transaction market is in a period of disruption, with buyer and seller expectations not yet on the same page. Buyers are quick to recognize price drops, but sellers are slower to accept reality. The result is an overall drop in sales volume across the board. As expected, we're seeing a drop in the rate that properties brought to the platform actually end up selling, what we call the trade rate. The 10x trade rates rose to highs of 75% in the fourth quarter of 2021 and have since dropped 27% to around 55%. Nevertheless, 10X continues to be a more effective way to sell properties because in the same time period, we saw traditional offline trades drop from 42% from a 43% trade rate to a 55% trade rate. The 10X platform trade rate went from outperforming offline sales by 74% in a stable market to outperforming offline sales by 120%. in a dislocated market. We believe the buyer-seller dislocation is a near-term event that will resolve itself over the next two to three quarters. Generally, once buyer and seller's expectations align again, sales volumes increase and distressed sales grow significantly. Currently, distressed sales rates are at multi-year lows, but believe they will significantly climb in the intermediate term. In 2008, the year of significant economic dislocation, there were only about 2,300, I'm sorry, about 2,900 distressed commercial property sales, and distressed sales took years to peak with about 16,000 distressed sales in 2012. Year to date, similarly to 2008, there's only been about 2,178 distressed sales. I would not be surprised if the number of distressed sales property sales quadrupled over the next few years, creating significant revenue opportunity for 10X. We've made a major investment to integrate 10X into CoStar and LoopNet, and we have dramatically increased the size of the 10X sales force. In the next few months, we'll complete all those integration efforts of 10X, enabling significant scale efficiencies. I believe the platform has never been stronger and is ready to handle a surge in activity. Regardless of where we are with the economic cycles, we're building 10X for the long term. I'm confident our 10X digital platform will become the industry standard for fast, efficient property transactions, both for performing and distressed assets. Regardless of the economic cycle, 10X will be ready. Our residential business continues to perform well with third quarter revenue of $19 million. Registered agents for our HomeSnap Pro and ProPlus products have grown to over 958,000 at the end of the third quarter, an increase of 23% over the same quarter last year. We're getting close to a million registered agents. Registered agents for CitySnap are also growing rapidly. We now have approximately 70% of the Real Estate Board of New York agents registered to use CitySnap and we only launched the product a little over three months ago. Traffic to homes.com continues to grow, with average monthly unique visitors for the third quarter up 52% compared to the third quarter of 2021. Sites visits to homes.com were up 83% of the same period last year, according to Google Analytics. The greater increase of visits to visitors shows deeper engagement with the site, I'm encouraged by the rapid improvement in consumer traffic. We do have a long way to go, but we're tracking just where we were with traffic growth on Apartments.com at the same time. And Apartments.com was a very successful launch. According to Comscore, September 2022 over September 2021, homes.com visits grew 27%. While in the same time period, Zillow fell 22%. and realtor fell 30%. As we communicated before in previous earning calls, our residential product strategy is centered around a homes.com marketplace that advertises the home as opposed to just advertising agents. We believe consumers that search for properties for sale in a marketplace like homes.com have higher intent than consumers who are served home for sale ads randomly across social media or the internet. Our objective is to partner with the 1.5 million agents in the United States in support of your listing your lead approach and enable consumers and any agent to collaborate digitally throughout the home buying or selling process. We're focused on building complete coverage of residential listings throughout the United States, as well as developing unique proprietary content by leveraging the skills and capabilities of our awesome nationwide research organization. Overall, we're making great progress developing homes.com across all these strategic areas and are looking forward to showcasing a number of our agent-focused product features at the upcoming National Association of Realtors convention in early November. In fact, I believe we have a big product release Thursday or Friday of this week if you want to check out some of the incremental upgrades at the end of the week. With rising interest rates and a rapidly cooling residential property market, I believe now is the perfect time to invest in a marketplace that's designed to help consumers and their agents advertise and sell properties faster and at a higher price. Deteriorating market conditions may well create a tailwind for our business model. The majority of HomeSnap's revenue is from reselling social media and search engine advertising to agents. We believe that this revenue, while it's good revenue, is less strategic, less durable, and just plain less of it than the potential revenue generated by a potentially successful, high-intent marketplace like Homes.com. This is a lesson we've learned from our experience with Apartments.com, 4Rent, LoopNet, and other marketplaces we operate. In the coming quarters, we're going to de-emphasize selling HomeSnap Concierge and HomeSnap Pro+, and temporarily shift those selling resources to our marketplaces, Apartments.com and LoopNet. Our sales teams will gain new skills and become even more well-rounded sellers across multiple marketplaces. After a brief transition period, we believe that we will generate more revenue overall with a shift in Salesforce allocation. As we have communicated previously, When we have built critical traffic mass for homes.com, we will then reallocate or allocate significant selling resources to homes.com. There is a potentially interesting development in the residential industry I want to briefly mention. We're closely monitoring ongoing antitrust litigation involving residential listing associations, or MLSs, and one that's currently pending in the Western District of Missouri. A class of home sellers alleged that NAR and brokerage defenders created and enforced anti-competitive rules that require home sellers to pay a non-negotiable commission to the broker representing the home buyer, resulting in inflated buyer-side brokerage commissions. To date, the plaintiffs have had some success defeating a motion to dismiss and succeeding in class certification. The case is scheduled for trial in February. If the plaintiffs in this case or other similar cases succeed, this could have a significant adverse effect on residential marketplaces that rely primarily on broker-sharing commission revenue models. Our residential sales strategy should not be impacted as we are focused on a property advertising model. I do not believe a judgment for the plans would significantly adversely impact most residential agents, because most do both seller and buyer representation. And the judgment would just shift fees from the buyer representation business to the seller representation business. More on that in February. The rise in interest rates over the past seven months is certainly weighing on real estate, driving prices down and reducing sales volumes. The slowdown has been broad-based across property types and geographies. Office vacancy rates continue to climb as companies continue to recover from the pandemic, and a significant number but minority of workers continue to work from home. In the third quarter, vacancy rates rose to 12.4%, and that's approaching historic highs. Inflation-adjusted rents are well below normal levels, and rent growth is at a 10-year low. Net absorption has been negative for seven of the last 10 quarters. Office vacancy will continue to rise, and rents will continue to likely experience negative pressure. However, each quarter, millions more office workers are returning to working in person because of the significant advantages of in-person collaboration. According to Castle Security, in January of this year, usage of office space was only about 16% of the pre-pandemic levels. But by last week, office usage had tripled this year to 49%. So from 16% at the beginning of the year to 49% now. That's a pretty fast climb. The trend is obvious. Traditional office using white-collar employment is continuing to grow, which means there's more underlying demand. There's more and more people returning to the workplace, but new office construction starts are very, very low. This suggests that while in the short term the office market will be very soft and there may be significant distress, there may be a significant rebound two to three years out. I believe that CoStar, LoopNet, and 10X can function very well in this sort of volatile economic environment. The story of the industrial sector is very different. Industrial vacancy fell to 3.9% in the second quarter, the lowest rate seen in the sector's history, but ticked higher in the third quarter as developers responded to robust demand. New completions expected in 2023 exceed any annual amount delivered in the last 30 years. Despite these numbers, the sector remains remarkably healthy. Net absorption in the retail sector drifted lower in the third quarter, although slowing demand has outpaced new supply for six consecutive quarters, leading to the third quarter vacancy of 4.3%, the lowest retail vacancy rate recorded. Tight vacancies have given rise to some of the strongest rent growth in history, with the third quarter nominal rent growth at 4.5%. As the Federal Reserve battles inflation, mortgage rates are rising to their highest level in years. Combined with double-digit home price gains over the past two years, affordability has deteriorated to levels not seen in more than 30 years. With buyers being priced out of the market, home sales are tumbling and prices are falling. Despite the market uncertainty, I believe CoStar is well positioned to sustain our revenue growth and profit through a potential economic cycle. We've proven to be very resilient in previous downturns, which I believe is a direct result of our diversified product mix, low customer concentrations, mission-critical products, and a strong, predictable subscription model. We have a loyal and exceptional team of leaders and employees working together in our offices, resulting in the best employee retention rates we've seen in years, if not decades. We're expanding our sales capabilities and geographic reach. unlocking new customer segments and revenue opportunities. Our balance sheet has never been stronger, and we view a downturn as the perfect time to go shopping. More than three decades ago, while I was still a college student, I founded CoStar in a dorm room with an ambitious vision of digitizing the world's real estate. That first year, we realized a paltry revenue of $7,000. But CoStar was in the right place at the right time. There is almost $200 trillion of real estate in the world, and leading that effort to digitize it can unlock massive value. This mission has drawn imaginative investors and energized colleagues who brought life to the vision. Year by year, decade by decade, we've consistently and persistently grown those paltry revenues into the impressive billions. This quarter, we achieved an accomplishment almost no company ever achieves. We made the S&P 500. We're all so proud and grateful to be here. We're here because of a remarkable group of colleagues who are committed to this mission of digitizing the world's real estate, empowering all people to discover properties, insights, and connections, all of which improve people's businesses and lives. Going forward, we are now single-mindedly focused on reaching the S&P 100. At this point, I'm going to turn the call over to our Chief Financial Officer, Scott Wheeler.