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Realogy Holdings Corp (NYSE:RLGY)
Q3 2017 Earnings Conference Call
Nov. 3, 2017, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Realogy Holdings Corporation third-quarter 2017 earnings conference call via webcast. Today's call is being recorded, and a written transcript will be made available in the investor information section of the company's website later today. A webcast replay will also be made available on the company's website. At this time, I would like to turn the call over to Realogy Senior Vice President, Alicia Swift. Please go ahead, Alicia.

Alicia Swift -- Senior Vice President

Thank you, Amy. Good morning and welcome to Realogy's third-quarter 2017 earnings conference call. On the call with me today are Realogy's Realogy's Chairman, CEO, and President, Richard Smith; President and Chief Operating Officer Ryan Schneider; and Chief Financial Officer, Tony Hull.

As shown on slide three of the presentation, the company will be making statements about its future results and other forward-looking statements during this call. These statements are based on current expectations and the current economic environment. Forward-looking statements and projections are inherently subject to significant economic, competitive, and other uncertainties and contingencies, many of which are beyond the control of management. Actual results may differ materially from those expressed or implied in a forward-looking statement.

For those who listen to the rebroadcast of this presentation, we remind you that these remarks made herein are as of today, November 3, and have not been updated subsequent to the initial earnings call. Important assumptions and other important factors that could cause actual results to differ materially from those in the forward-looking statements or specified in our earnings release issued today, as well as our annual and quarterly SEC filings. Also, certain non-GAAP financial measures will be discussed on this call per SEC rules. Important information regarding these non-GAAP financial measures is included in our earnings press release.

Now, I will turn the call over to our Chairman, CEO, and President, Richard Smith.

Richard Smith -- Chairman, Chief Executive Officer

Thank you, Alicia, and good morning everyone. And thank you for joining us this morning. Before I delve into the third-quarter results, I'd like to recap the news we announced two weeks ago regarding our leadership transition plan. Following a comprehensive search, we are very pleased to announce that Ryan Schneider has joined us as President and Chief Operating Officer, and upon my retirement, effective December 31, Ryan will be appointed CEO. Ryan joins Realogy after nearly 15 years of senior leadership at Capital One; he most recently served as President of the Card Division, its largest business, and drove its growth and success. He brings a wealth of experience in leveraging big data, rigorous analytics, and new technology, all of which will bring a new perspective to our industry and company.

The transition to Ryan is well underway, with the four primary business units now reporting directly to Ryan, and the balance of the transition will occur by December 31. So, let me turn it over to Ryan. Ryan?

Ryan Schneider -- President, Chief Operating Officer

Thank you, Richard. Let me start by saying that I am both humbled and excited about joining Realogy. I see incredible potential to drive Realogy's growth with exciting new ways to use data, analytics, and technology to enhance our primary strategy of serving agents. Realogy's scale and resources are unmatched in the industry. That's a credit to Richard and the senior management team, who have built this company to be the industry leader for residential real estate services in the United States. I am incredibly excited to hit the ground running and work alongside a great team of business leaders and talented employees, who are committed to serving Realogy's affiliated real estate agents, franchisees, customers, and clients. Together, I know we will drive results.

Richard Smith -- Chairman, Chief Executive Officer

Thank you, Ryan. And now, let's turn to the third quarter. I'd like to provide you with a summary of the items we're going to highlight on today's call.

We faced a number of challenges in the quarter. Our revenue growth of 2% was affected by the continuation of persistently low inventory, and the hurricanes that constrained the level of transactions, and our operating EBITDA was adversely affected by higher commission costs at NRT, and lower employee relocation volume at Cartus.

Having said that, our combined home sale transaction volume was up 4% for the quarter. That's approximately 170 basis points higher than the statistics reported by the National Association of Realtors. This improvement over NAR is the result of our progress on the strategic initiatives we discussed on investor day, which we believe will drive higher absolute revenue and profitability over the next several years. In particular, we have seen solid progress in agent recruiting and agent retention, especially at the top two quartiles of our company.

In contrary to what we experienced in the third quarter, in October we saw strong [inaudible] activity at both NRT and RFG, indicating the potential for improved transaction volume trends in the final quarter of this year.

Now, let's address some of the puts and takes that we saw in the quarter. Combined volume growth at NRT and RFG came in at the low end of guidance, and NRT volume growth was a percentage point below the low end of our guidance. The lower volume is attributed to the results of the hurricanes, particularly as it relates to our large NRT operations in Houston and Florida, and the persistently low inventory, which is limiting growth in transaction volume.

Commission splits in the quarter were higher than we anticipated for three reasons: relatively high growth in NRT volume in its higher-split west coast operations, NRT's successful recruiting and retention efforts, and the incremental transaction volume from acquisitions. With significant operations in Florida and Houston, TRG also felt the effects of the hurricanes, and Cartus continues to face the challenge of denying employee relocation activity as an increasing number of its largest corporate clients initiate fewer international and domestic employee relocation assignments.

Of the primary contributors, we're pleased demand has returned to pre-storm levels in the affected markets we serve for NRT and TRG. The overall increased commission splits were a result of intentional efforts by NRT to be more competitive for the best talent as we focused on gains in market share. And greater-than-expected volume growth in NRT's west coast operations was encouraging, although it pushed overall commission splits up slightly more than expected, as west coast agent splits are higher than the east coast. And the across the board slow-down in Cartus's core business will be addressed in 2018, as we expect to take steps to align Cartus's cost structure with the new level of relocation activity.

If you recall from investor day, we made it clear that we are focused on strategies that increase company-generated leads, and that work is progressing nicely. We also continue to work on strengthening our technology and marketing tools for agents, and building a world-class training program, all of which are designed to increase the long-term productivity of our existing agents and attract new agents by strengthening the sales agent value proposition.

Over the last several quarters, we committed to a strategy of improving our share in key markets through targeted agent recruiting, and we are delivering on that commitment. The success of our recruiting efforts can be measured in two key metrics: agent count, and agent retention. NRT's agent count grew 4.5% in the last 12 months to more than 50,000 agents. The retention rate of NRT's first and second quartile sales agents slightly exceeded 94% at the end of the third quarter, which is at our historical high-water mark.

While we are successfully addressing the market share concerns which we pointed out late last year, the cost of doing so -- especially when compounded by the geographic mix being skewed toward the west coast -- the splits increased slightly more than anticipated. For the year, we estimate that NRT's commission splits will be in the rage of 70.25%-70.5% as NRT field management balances trade-off between market share and split rate.

In 2018, NRT management is tasked with the objective of slowing the rate of increase in commission splits, and agent productivity gains, which are compensated at a much more favorable split to the company in the third and fourth quartile of our agent population. On the franchise side of our business, we continued to use technology to enhance our value proposition. The Zap platform is at the forefront of our efforts to help tour franchisees and agents improve their performance. Zap will be deployed to substantially all eligible franchisees by year-end. We continue to see an uplift in productivity from agents who are actively engaged in using this app-integrated application suite, and thus our shift from deployment to training and engagement.

In franchise sales, our team continues to build our base of brokers and agents, adding approximately $92 million in gross commission income in the third quarter, and $265 million year-to-date from new franchisee sales and related agent recruitment initiatives.

In our relocation and affinity businesses, a key contributor to our lead generation strategy, Cartus generated referral opportunities that resulted in approximately 24,000 home sale closings in the quarter.

In addition to welcoming Ryan Schneider to our senior leadership team, we continued our focus on adding depth and strength to our executive ranks. In August, we appointed Nick Bailey as President and CEO of Century 21 Real Estate. Nick most recently served as a Vice President of Broker Relations with the Zillow group, and has extensive real estate experience as a leader in franchising, brokerage, management, and technology. Also in August, Roger Favano was named as NRT's Chief Financial Officer. He brings more than 25 years of financial leadership experience, mainly at General Electric Capital. And Cartus appointed Mark Sonders as a Senior Vice President of Global Sales and Marketing. He joins the company with over 20 years in B2B sales and strategic business development roles.

While operating EBITDA underperformed compared to the same period last year, we continue to invest in the growth of the company. We are making solid progress in our strategic initiatives and agent recruiting efforts, as evidenced by our strong retention and growing agent count. We are steadfast in our focus on our strategic goals, namely to drive sustainable organic growth in each of our business units by strengthening the services we provide to our affiliated agents, which, long-term, we believe will result in improved agent productivity and higher volume and revenue growth across realty.

I'd like to highlight the tremendous cash flow characteristics of our business. Year-to-date, we have generated $406 million of free cash flow, of which we returned $215 million to stockholders in the form of share repurchases and dividends. Since the inception of our share repurchase program in February of 2016, we have repurchased a total of 13.5 million of our outstanding shares for 394 million in the aggregate, bringing our total share count to 134.6 million shares, and that's as of November 1st.

Before we move on to Tony's report, permit me to comment on the GOP tax plan. The Tax Cuts and Jobs Act, introduced yesterday by the House Ways and Means Committee, is the first of many steps expecting in reaching agreement on tax reform that will create economic growth for our nation. As written, the industry at-large is opposed to the bill's treatment of the mortgage interest deduction and state-local taxes. That said, we're optimistic that a compromise position can be reached that keeps the value of homeownership strong while also contributing to a stronger economy. Although much work remains, we're pleased to see the House Ways and Means Committee hard at work on this important piece of legislation, and we fully expect to be deeply engaged in the work that should result in legislation that both Realogy and the industry will support.

With that commentary on that GOP tax legislation, let me turn it over to Tony.

Tony Hull -- Chief Financial Officer

Thanks, Richard. Before I discuss the Q3 results, let me address the changes to our guidance for 2017. Our 2017 operating EBITDA is now expected to be in the range of $725 million-$735 million, which reflects higher commission splits due to greater relative volume in NRT's west coast operations, as well as anticipated initiatives designed to attract and retain agents, and the impact of lower global relocation buy among Cartus. An estimated $12 million reduction in EBITDA is due to natural disasters in the third and fourth quarters, and an estimated $8 million charge related to changes to our senior leadership.

This guidance incorporates the fourth quarter transaction volume on slide five, which shows Realogy's Q4 combined home sale transaction volume is expected to increase in the range of 4-6% year-over-year, with sides between flat and up 1%, and 4-5% coming from price growth. Broken down by business, we expect 3-5% transaction volume growth at RFG and 7-9% growth at NRT.

On slide nine, for the full year, we currently expect that Realogy's combined home sale transaction volume will increase in the rage of 6-7% year-over-year, and by business unit we expect RFG to have 5-6% transaction growth and -- transaction volume growth -- and NRT to grow between 7 and 8% in 2017. At those volume levels, full-year revenue is expected to be between $6.1 billion and $6.15 billion, and free cash flow is forecasted to be between $505 million and $520 million.

Turning to slide seven, I will review our third quarter 2017 result in greater detail. Revenue of $1.7 billion is up 2% compared to the third quarter of 2016. Operating EBITDA was $258 million. The combined effects of hurricanes in Texas and Florida impacted results by approximately $7 million, mostly at NRT and TRG. Net income for the quarter was $95 million, compared to $106 million last year, due to lower operating EBITDA. Adjusted net income per share was $0.71, compared to 75% -- $0.75 in the third quarter of 2016.

Turning to slide eight, a discussion of the drivers of our business. Our overall home sale transaction volume growth was 4% year-over-year in the third quarter.

RFG's transaction volume increased by 5%, with a one-point decline in sides being offset by 6 points of growth in average sales price. The hurricanes had about a 0.5% impact to sides at RFG. The third quarter also had one less business day than the same period last year, which equates to a 1% reduction in sides. Excluding these two factors, sides growth would have been up 1% at RFG during the quarter, which reflects continued inventory restraints across most price points.

On a geographic basis for RFG, buying gains in the west were the strongest at 8%, followed by the northeast being up 6% due to price. Volume in the south increased 2% and included a gain of 3% in Texas and a 2% loss in Florida for the quarter. Volume in the Midwest increased 1%.

NRT finished the quarter up 4% in transaction volume due to an increase in average sales price. The hurricanes had a more noticeable impact on NRT, accounting for a 1% impact to sides, mostly in Florida markets where NRT derives about 8% of its revenue during this time of year. Excluding the hurricanes, we estimate volume would have been up 5% at NRT. The high-end recovered through the first half of the year and has stabilized in the third quarter. NRT's volume in the $2.5 million and above price segment grew 4% year-over-year, which consists of a 12% increase in sides, offset by an 8% decrease in average sales price.

The strongest geographic market for NRT in terms of volume growth was the west, with 11% growth, driven by strong California growth. Volume in the Midwest region increased 2%. The south region was flat on volume, which included a 2% decline in Houston. The northeast region was down about 1% in volume.

Turning to other drivers, average broker commission rate, or ABCR, at RFG was down one basis point to 2.49, and ABCR at NRT was down one basis point to 2.45%. Net effective royalty rate for RFG was 4.42%, down eight basis points for the quarter, and in line with our previous estimates, which continues to reflect the success of our top 250 franchisees, who pay net royalty rates below 6%. For full-year 2017, we continue to expect the royalty rate to be approximately 4.40%.

NRT commission splits increased approximately 209 basis points year-over-year, to 71%. The increased in Q3 split rate was a result of higher transaction volume; a geographic mix of business skewed toward markets like California, which command higher splits; and the impact of heightened retention and recruiting efforts.

Turning to slide nine, let's talk about business unit operating performance in detail. At RFG, revenue increased 4%. The growth was from higher net domestic affiliate royalties, increased royalties from NRT, and greater international revenues. RFG's operating EBITDA increased $5 million, principally due to the higher revenues.

NRT revenue increased 3% or $36 million in Q3 of 2017, about half of which was due to the year-over-year impact of acquisitions. NRT operating EBITDA decreased $16 million to $64 million, primarily due to $53 million of increased commission expense, which more than offset the increase in revenue. Breaking down the $53 million, higher split rates due to targeted recruiting and retention efforts resulted in $25 million of increase. Higher volume drove $16 million of the increase, and acquisitions completed since the second quarter of 2016 added $12 million to the total. Looking at commission expense change in another way, regionally the 11% increase in volume in the west was associated with 70% of the $53 million increase in commission expense.

Cartus revenue decreased $5 million in Q3, primarily due to a decrease in international and other revenue. Operating EBITDA decreased $4 million as a result of lower revenue, partially offset by a $1 million increase in employee-related costs.

TRG's revenue decreased $10 million, and operating EBITDA was lower by $3 million year-over-year. The revenue decrease was driven by reduced refinance activity, including the impact on its underwriter, partially offset by higher resale revenue. EBITDA includes $2 million of costs associated with the start-up of operations of the Guaranteed Rate Affinity joint venture. And as a reminder, the Guaranteed Rate venture will be included in TRG's EBITDA, whereas the PHH joint venture numbers are reported at NRT.

Corporate expense before restructuring, likely to see an early extinguishment of debt in the third quarter, was $3 million greater than the third quarter of last year, due to higher expenses relating to investments and technology development, professional fees supporting strategic initiatives, and higher employee incentive compensation rules relative to last year.

With regard to our joint venture, the company has completed the first three out of five phases of the sale of PHH Home Loans Assets to Guaranteed Rate Affinity. The remaining two phases are expected to be completed in the fourth quarter. After giving effect to the establishment of Guaranteed Rate Affinity and the liquidation of Realogy's interest in PHH Home Loans in early 2018, the company expects to realize net cash proceeds of approximately $20 million.

Slide ten provides guidance for specific cash items below operating EBITDA. In particular, corporate cash interest expense for the year is expected to be approximately $165 million. Cash taxes are expected to be between $10 and $15 million, and full-year capital expenditures between $95 and $100 million. Finally, working capital is expected to be a contributor of cash between $55 and $60 million, which includes dividends of approximately $30 million in the wind-down of the PHH Home Loans joint venture in the third and fourth quarters.

Based on the expected operating EBITDA range for the year, we expect that the company will generate between $505 million and $520 million in 2017. We intend to use a significant portion of our half a billion dollars of our expected free cash flow this year to return capital to our shareholders, predominantly through share repurchases, because we believe Realogy remains a great investment and we have great confidence in our plan, opportunities in the market, and our ability to execute.

Lastly, as you know, Richard will be retiring at the end of the year, and this will be his last appearance on our quarterly calls. I want to take this opportunity to personally acknowledge Richard Smith for his strong and ethical leadership of our company for the last 20-plus years. During the toughest times of the financial downturn, Richard was at his finest, working tirelessly to bring our company through the storm and back on solid footing, to position us for our IPO five years ago. It is largely due to his vision, execution, and resolve that Realogy has grown into the great company that we are today. Richard, you've established a culture of accountability and respect and built a strong foundation upon which we are well-positioned for continued growth and success. On behalf of all the Realogy employees, we thank you for your leadership through the years, and all the best in the future.

Now, we'll move to Q&A.

Questions and Answers:

Operator

At this time, we will be conducting our Q&A session. In order to ask a question, please press star then the number one on your telephone keypad. We ask that you limit your questions to one question with one follow-up, and then you may reenter the queue to ask additional questions as time allows. Your first question comes from the line of David Ridley-Lane, with Bank of America Merrill Lynch. David, your line is open.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Sure. Appreciate the detail on NRT agent growth. Wondering if it would be fair to think that the productivity of those net adds are close to the overall average of NRT? Or, could the revenue contribution be a bit higher if you're targeting more productive agents? Thank you.

Richard Smith -- Chairman, Chief Executive Officer

David, these are agents that are at the high end of their game, so they are very productive, to begin with, but we fully expect that they will be more productive with us. So, you're correct in your assessment.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

And then, I know it's early in your planning, but any thoughts on the trend of commission split in 2018?

Richard Smith -- Chairman, Chief Executive Officer

So, the way to look at it is -- as you know, we played catch-up. We were, I think in that regard, underperforming the market because we were working very, very hard to keep the agents' splits as favorable to us as possible for about three years. So, this year we've been playing catch-up. We fully expect that to start stabilizing, and as you heard me say in 2018 NRT management has the goal and objective of slowing the rate of growth and stabilizing the agent split, and I think we're gonna do that, principally, through increasing the productivity of the agents in the third and fourth quartile. We have good experience in that regard, and we have a high degree of confidence in our ability to make them more productive, thus offsetting the increase in split rates.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Alright, thank you very much.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

You're welcome.

Operator

Your next question comes from the line of John Campbell. John, your line is open.

John Campbell -- Stephens, Inc -- Analyst

Hey, guys. Good morning, and first off, Richard, it was great getting to know you over the years, and congrats on a long and storied career. And then, Ryan, welcome, looking forward to working with you.

Richard, or maybe Tony, it sounds like the Cartus business -- it sounds like that's facing a bit of a sustained headwind, and you guys could be looking at right-sizing that business next year. Am I drawing the right conclusion from that commentary?

Richard Smith -- Chairman, Chief Executive Officer

You heard me say almost that exactly. There are -- we don't know if the volume is just seasonal or cyclical, but it's there. So, we're going to adjust the cost structure. One of the principal advantages we'll have, and we're fully engaged in this, is we think technology's gonna have a big impact on Cartus's service delivery. There's a project underway to determine to what extent that technology can, sort of, smooth out the experience and reduce costs. So, it's a big project for '18, senior management at both Realogy and Cartus are fully engaged, and we will address it just as we said we would

Tony Hull -- Chief Financial Officer

You know, I'd also add to that that one of the very critical functions of Cartus within our business is delivering leads that have a 70%-plus chance of converting to the agents of our franchisees and NRT's agents. The goal is to increase that amount. Those come partially from corporate clients, but more of those leads come from our large Affinity clients, and we think there's a great opportunity to increase that number substantially that come from our Affinity clients, and that really adds to the retention and recruiting of agents, because those leads are highly sought-after. They're obviously much more effective and profitable than leads you get through any source on the internet. So, that's really the reason for the integration of that company, and in our business, it's proved incredibly effective in that regard, to gain franchisees and to attract agents, and we have a great opportunity to increase that in the future.

Richard Smith -- Chairman, Chief Executive Officer

Let me just -- Tony's absolutely right, and let me just make one additional point. It is a critical component of our tool of assets. It helps us recruit agents, retain agents, and it also helps us recruit and renew franchisees. So, we're just gonna right-size the cost structure to be more flexible going forward, and I think that's gonna be accomplished. But Tony's right to underscore the importance of Cartus as one of our key assets in our toolkit.

John Campbell -- Stephens, Inc -- Analyst

Okay. And then I know it's probably pretty early in that assessment, but if you ran the first nine months of Cartus revenue at the same margin of the first nine months last year, I think that equates to about $7 million or so of additional EBITDA this year -- or, I guess, of EBITDA headwind. That business has ran at close to 25-or-so% margins in the past. It looks like it's probably closing in at 22-23% this year. Do you think that -- just off the top of your heads -- that you get back to kind of that margin level? Is that a good way to think about it next year?

Richard Smith -- Chairman, Chief Executive Officer

Yeah, no, I think you're right in that assessment. It's been pretty predictable over the past five years. We've looked at the trends. It's reliable, predictable. It's been a solid contributor of both revenue and EBITDA in spite of the downturn, so -- but we can definitely improve, and as I said, it's gonna be through better technology and that's well underway.

John Campbell -- Stephens, Inc -- Analyst

Okay, and then just quickly on this -- there's a lot of moving pieces to the EBITDA this quarter, and then I guess what's implied in 4Q guidance. I'm sure I can get to this conclusion eventually, but maybe if you could help us just kinda short-cut it, and give us an idea about what is, kind of, truly one time that doesn't roll over next year? I know you've got the $8 million of the legal settlement, last quarter, it sounds like there's $8 million of CEO transition costs, there's the $12 million of hurricane activity. Anything else I'm missing there as we get into next year?

Tony Hull -- Chief Financial Officer

I think there's some benefit from the wind-down of the PHH joint venture in the fourth quarter, but we feel very good about that that's gonna be replaced next year from earnings from our Guaranteed Rate Affinity joint venture. So, I think -- I guess that's not one-time as a result of that comment, but it may be a little more squished into Q4 this year, then we'll see more spread out next year. But again, that's ramping up next year so probably the best results will be in the third and fourth quarter of 2018 for that joint venture. So, I think those two things are -- I think you're right. Those two things are the largest items of note in the fourth quarter in the forecast. The 8 and the 12, yeah.

John Campbell -- Stephens, Inc -- Analyst

Okay, thanks, guys.

Operator

Your next question comes from the line of Jason S. Deleeuw with Piper Jaffray. Jason, your line is open.

Jason S. Deleeuw -- Piper Jaffray & Co. -- Analyst

Good morning and Ryan, I want to offer my congrats and looking forward to working with you. And Richard, it's been nice working with you and I just wanna wish you all the best.

The first question is on the -- I guess when I look at the NFT-RFG combined results, the operating EBITDA declined 5% year-over-year this quarter. It had been growing even with the ramp-up in commission splits, so I guess -- what's kind of the thinking on looking at the segments combined? Can we expect to get back the EBITDA growth as we kind of recalibrate the commission splits? Just kind of your thoughts. Are those two segments combined -- is that still how we should be looking at the business and assessing the strategy here for the recruitment?

Tony Hull -- Chief Financial Officer

Yes, it is. I think -- I know what happened in the third quarter, is we -- our success in recruiting happened to benefit the west coast more than anywhere else. We were up 11% on the west coast this year, and the rest of the markets -- forgetting the south for a second because there were some hurricane impacts -- the Midwest was flat; New England was flat. We actually, in terms of sides at NRT, we actually outperformed the NAR numbers in both of those, but we're talking about -- they reported -1-2%. NRT was up 1 or 2% in those markets. So, we definitely outperformed but we did substantially better in the west coast than we had anticipated. So, again of that $53 million increase in splits, $37 million or 70%, was due to the west coast being up 11% and kind of flat-ish for the rest of the country.

So, another way of looking at it is, if the west coast had been up 6% -- which would have been nice, still -- and the rest of the country had been up 6%, you wouldn't have seen -- you would have seen a much more attractive combined EBITDA growth on the revenue growth. And we saw -- the west coast really outperformed, which is a great news story, I think going forward I'd like it to continue at 11%, but I think in the future we'd probably see growth in other areas that have more favorable splits, catching up to the west coast, and that would be something that could potentially take pressure off of splits going forward. but for the quarter, the west coast strength really kind of skewed the results. Which is -- I don't want to say a high-class problem, but it's great to see that we're really making huge strides on the west coast and we expect to play catch-up elsewhere, and that will be great for the combined growth.

Jason S. Deleeuw -- Piper Jaffray & Co. -- Analyst

Got it, thanks for that. And then just thinking about the split strategy -- is there gonna be any recalibration in terms of the split levels being offered, or any change in which geographies or parts of the country you want to target?

Richard Smith -- Chairman, Chief Executive Officer

Good question. We think we've accomplished what we intended to accomplish in virtually every market we serve, so that balancing act between market share gains and splits, for the most part, has been accomplished. Now, we'll be very selective as to which markets we wanna grow. We'd like all of the above, but the focus clearly will be on the most profitable markets from a split perspective, so you'll have to monitor our performance in 2018 but I assure you we are focused on the most profitable components of those markets.

Jason S. Deleeuw -- Piper Jaffray & Co. -- Analyst

Great. Thank you.

Operator

Your next question comes from the line of Tre Marsh from Evercore ISI. Your line is open.

Steve Kim -- Evercore ISI -- Analyst

It's Steve Kim over at Evercore ISI. Thanks very much guys, and let me also add my congratulations and also a farewell to you, Richard.

My first question relates to the splits, and I wanted to make sure I got this right. We know that there's naturally a bit of seasonality to your splits. For example, your splits have never gone down, sequentially, into 4Q, at least as far as I can tell. I think some of that relates to the timing of the year, when your splits are sort of -- when the clock starts, so to speak, on the commissions and so forth. But was wondering if you could just help me understand: is there anything in the hiring process that you recently underwent, with these very productive agents, that is gonna make the split trajectory -- as we'll see on the P&L, perhaps, more stable through the year? Or, is it gonna continue to be seasonally weighted to the back?

Tony Hull -- Chief Financial Officer

Again, we expect splits to be 70.25-20.5% for the year, and that's reflecting our latest forecast, I think some of the back-end increases that you note -- or back-half increases that you note -- are due to the fact that certain agents get split improvements as they do more volume during the year, so you sort of see that. We don't try to predict and smooth out that effect, so you see that in -- that's why you see this trend of increases. But again, the full year, based on what we see today, we expect the commission splits to be 70.25-70.5% for the year.

Steve Kim -- Evercore ISI -- Analyst

Got it, OK. So, that sounds like this dynamic is gonna continue next year, and that's what I was just trying to clarify.

Second question relates to some numbers. I apologize if I didn't quite catch all of these quick, but the change in your EBITDA guidance from where it was last quarter, I believe is roughly $35 million. Correct me if I'm wrong here, but I think you indicated $12 million was due to natural disasters, $8 million for the management transition costs, and that would leave about $15 million, I assume from the recruitment efforts and the higher splits and that sort of thing. And then parsing that $15 million, I think you had indicated there was just naturally higher volumes, I guess, than you expected last quarter. Your recruitment efforts, and then the western markets, I think you said was 70% of the commission costs. I just want to make sure that I got those pieces right. 12 million for natural disasters, 8 million for management transition, 15 for higher splits, and then within the 15, 70% of that was due to the western markets. Do I have that right?

Tony Hull -- Chief Financial Officer

Yeah. So, the 15 was mainly due to the shift in -- that we saw in the third quarter to more west coast volume, and so you're exactly right on that. And then the other factor was some of the activity we're seeing, the reduced activity we're seeing from Cartus clients pretty much across the board, especially on the international front. They just seem to be on pause for this year to see how things shake out in Washington and for whatever reasons, but I think, I believe it's temporary and I think that that was the other thing that contributed to that decline.

Steve Kim -- Evercore ISI -- Analyst

Excellent thanks very much, guys.

Operator

Your next question comes from the line of Mike Dahl with Barclays. Your line is open.

Mike Dahl -- Barclays Capital, Inc. -- Analyst

Hi, thanks for taking my questions. And Richard, I'll add my congrats as well. Tony, sorry but I guess I'll keep beating the horse a little bit here on the splits in the west coast. I think what I'm still struggling to understand is, if you think about the shift to the west, clearly, it's a higher split rate but the compensation is higher average price, and so I guess my perception had been it's still and EBITDA-positive transaction in terms of the dollar value that goes to you, even if it's lower margin percentage. So, is this truly something where you're now losing money on these west coast transactions, or you're saying this is relative to where you thought the volume would come from, that that's the change? Because I think that's what is not really adding up, is why it would really be a negative in absolute terms.

Tony Hull -- Chief Financial Officer

It's the latter. It's really that the geographic mix, at the same shift -- at the same time as we put in place retention and recruiting efforts. So, it's the combination of those things, kind of had the overall effect of -- not having the desired results, but the positive news is that we have completely -- maybe completely is too strong a word, but -- the issue that we were concerned about last year, which was market share attrition, is largely behind us. I think we've gotten the plane stabilized and ready to start gaining altitude, and there's gonna be some bumps along the road in that effort, but I think we're well on our way to our ultimate goal of increasing overall revenue and profitability of the company.

So, I don't think -- this one, we just sorta had a double -- two impacts at once, and one we didn't expect is that the west coast would grow 11% and the rest of the country, because of inventory constraints, would be sort of as -- the rest of the country, forget the hurricanes, was soft. Look at the national statistics. It was just this inventory constraint thing, finally really caught up to us in the third quarter. So, again, if we'd seen a different picture in the Midwest and the Northeast, the results would've been very different for the quarter. But we didn't, and it happened when we've been successfully improving, by leaps and bounds, our market position and our retention of agents. So, to me, it's a one-time glitch, and it's -- but we're heading in the absolute right direction to increase revenue and EBITDA levels.

Richard Smith -- Chairman, Chief Executive Officer

Let me add one -- Tony is absolutely correct in that assessment. There's one additional comment I would make and that's sort of a holistic view we have of the west coast operations. You've got to remember, in absolute dollars, they're paying a substantial contribution to the franchise side of our business through royalty payments. And it also happens to be one of our most profitable title and closing escrow services markets, and the higher-cost agents on the west coast are material contributors to that as well. So, take all that into account -- California's a very profitable market for us.

But Tony's right to point out that the mix of business was much stronger to the west coast than we anticipated

Mike Dahl -- Barclays Capital, Inc. -- Analyst

Right, got it. And that's what I thought regarding California being profitable, which is why I didn't understand the change in the guide related to that part. But I think that's helpful. It also leads to my next question: when you talk about stabilizing the plane and setting it to gain altitude here, to the extent that you've been successful on some of these recruiting initiatives, what are you seeing in terms of competitive response? Because clearly, and we've talked about this in the past, you're responding to what some competitors were doing over the past couple years. You're been successful; now what are you seeing from those same competitors?

Tony Hull -- Chief Financial Officer

From what I've heard from NRT management, the selective and spotty reaction to us doing this, and there's nothing large-scale that any of our competitors are doing, or honestly can do. This is all about us using data to attract -- to go after the best agents, and it's not just -- and then giving them a very small, or relatively small transition payment to get them through the pain of going from their old brokerage to NRT. But it's really hit a nerve and it was incredibly successful. We doubled -- we more than doubled our recruiting in, in this past 12 months, vs. a year earlier. So, we've gone from our normal recruiting of about $250 million a year of GCI, we're gonna be almost $600 million of GCI this year. So, with very minimal outweighs relative to our overall capital structure and our abilities, and we get the agents -- we have an agreement with the agents to stay with us for three years, so it's very sticky, and it's been just very successful.

Again, the numbers are -- it's a one-year payback on this upfront investment. We obviously amortize it over three years, during the life of their contract, but this sort of targeted recruiting effort has been just very, very successful and it really has shown that the NRT management can -- we reversed the problem, and we'd like to get some credit for it. We took a problem that was very severe a year ago, and we turned it around. NRT management turned it around in one year, and I think that -- to me, gives me a lot of confidence in when we need to tweak things and fine-tune things, and as Richard mentioned focus on things that take some pressure off splits for 2018 and beyond. They are the team to do it; they've proven themselves able to do it, to turn on a dime. So, I think it's been a really impressive effort by management in NRT.

Mike Dahl -- Barclays Capital, Inc. -- Analyst

Thank you.

Operator

Your next question comes from the line of Kevin McVeigh with Deutsche Bank. Kevin, your line is open.

Kevin McVeigh -- Deutsche Bank Securities, Inc. -- Analyst

Great, thanks. I wanted to -- can you give us a sense of what would cause EBITDA to come in at the high versus the low end of the range? What the factors there are?

Tony Hull -- Chief Financial Officer

What would cause the low end is -- if NRT transaction volume for the fourth quarter is forecast to be between 7 and 9%, and I think if we came in at the low end of that 7-9%, that would probably be the most impactful in terms of hitting the low end. Right now, we don't see that. We see -- we're -- not to -- we feel pretty confident about the mid-to-upper end of that, and the opens we saw in October, to be it was almost lights-on-lights-off, looking at the opens, between a kind of sleepy third quarter, and all of a sudden in November, in terms of the opens we see, it was a lights-on situation. So, it was a big shift, and NRT saw a lot of the same trends in terms of things really revving up in the third quarter -- I mean in October. So, I don't know how that's gonna play out in November and December, and what's gonna close, and what's not gonna close. Our cancellation rates are extremely low. So, again, I think that bounds the range of the guidance.

Kevin McVeigh -- Deutsche Bank Securities, Inc. -- Analyst

Would you -- and obviously the bill only came out yesterday, but would you expect a spike in activity, given the uncertainty around any changes in tax law? To the extent that it would take effect in '18? Or is that not factored into this guidance?

Richard Smith -- Chairman, Chief Executive Officer

Listen, we have no idea what's gonna happen in terms of the tax law, except that what's been proposed is not gonna get passed into law. The industry is not supportive, and I think it's gonna be almost impossible to get a vote out of the House that would be supportive of the legislation as it's written. So, let's assume for a moment that it becomes far more favorable to the industry, and also to the national economy. I don't think the market's gonna suddenly spike. I don't think anything's waiting on this. I think some may have hit the pause button. So, we need to wait and see. I think the market's completely overreacted to proposed legislation, and we'll see how it plays out. But we spend a lot of time in DC, so we fully appreciate the process, and I don't see a spike one way or the other in response to this until something becomes law.

Kevin McVeigh -- Deutsche Bank Securities, Inc. -- Analyst

Super. And then Richard -- or Tony, can you remind us, when can you be back on the market from a buyback perspective?

Tony Hull -- Chief Financial Officer

In a week.

Kevin McVeigh -- Deutsche Bank Securities, Inc. -- Analyst

Thank you.

Operator

Your next question comes from the line of Bose George with KBW. Bose, your line is open.

Bose George -- Keefe, Bruyette & Woods -- Analyst

Hey, good morning. Can you give us any updated thoughts on how you think the market overall is positioned for next year? You noted positive trends in October; any view on how that continues?

Tony Hull -- Chief Financial Officer

Well, we put in the -- on page 17 of our earnings deck, we put in the five forecasters view as of October, of what next year looks like. The average was a 7% growth in volume, so that's pretty much same as we saw this year. Obviously, we would expect strongly that we are gonna outperform because we're continuing to do the targeted recruiting, which was very favorable to NRT this year in terms of their volume increases. And RFG is -- our franchisees, we've launched a program with them to sort of mimic that program, so we'd expect to see some of the benefits of that in terms of agent growth. And obviously, everything we're doing on value proposition in terms of learning and technology is rolling out both to NRT and to our franchisees, so we would expect that, also, to help us exceed whatever happens in the market. Just like we exceeded in the third quarter by 170 basis points.

Bose George -- Keefe, Bruyette & Woods -- Analyst

Okay, great. And actually, just in terms of the inventory constraints that you noted, which has been limiting the activity in '17 over '16, do you feel like some of these forecasts might be positive in terms of overcoming that? Because it does seem like '18 over '17 expectations, in the forecasts, are pretty strong.

Tony Hull -- Chief Financial Officer

Yeah, I would say from our discussions with some of these economists that what they see for next year -- and again, I'm not smart enough to -- they're economists and I'm not, so I will take -- this is what they're thinking about. They view that there's still a significant amount of pent-up demand. They view that with the wealth in the stock market, the consumer confidence at all-time high levels, and we're starting to see some wage growth across the board. I think that makes them positive on -- a little bit more upside on the unit side of the equation next year than this year, and price, because the supply demand dynamic is so skewed toward the -- I guess in most of the market, there's a lot of demand, and not enough supply. That obviously will help continue price to go up next year. So, I think that's kind of their outlook. Obviously, they understand the inventory constraints, but it's just -- you know, they feel positive about next year.

Bose George -- Keefe, Bruyette & Woods -- Analyst

Okay, thanks. And actually, just one company, specific one. In terms of your excess cash, how does the debt side -- paying down debt, or playing to that -- do you have a target for leverage?

Tony Hull -- Chief Financial Officer

Yes. Our target for leverage is to get down to three times. We're currently at 3.9 times net debt to operating EBITDA -- or, I guess that's adjusted EBITDA, but we're not allowed to -- we don't use that anymore. It's EBITDA as calculated under our credit agreement, so we're at 3.9 times and we are targeting to go down to three times. So, to the extent -- for this year, we're gonna generate more than a half a billion dollars of free cash flow. About 300 million of that is gonna go toward share repurchases and dividends, and about 50 for M&A at this point, and then we're reinvesting in the new joint venture, so that's gonna require about a $55 million investment. But everything left over, which is over $100 million, will be used to pay down debt.

Bose George -- Keefe, Bruyette & Woods -- Analyst

Okay, great. Thanks.

Operator

Your next question comes from the line of Brandon Dobell with William Blair. Brandon, your line is open.

Brandon Dobell -- William Blair & Co. LLC -- Analyst

Thanks, and my congratulations and well-wishes as well. I guess first question: relative to the net royalty rate. You talked a lot about factors that you think can change commission splits, but how do we think about the puts and takes on net royalty right now, given how the market's progressing and the concentration of market share? Is there any -- are there tactics or opportunities to reverse that trend in the near-term? If so, how do we think about the magnitude of what you're gonna do there?

Richard Smith -- Chairman, Chief Executive Officer

This is Richard, and thanks for your comment. You gotta look at the net effective royalty rate in a slightly different fashion. Remember, that's how we incentivize our franchisees to outperform. The stronger their performance, the lower their royalty rate, which we view as a positive, not a negative. So, that said -- what would skew that one way or the other is your top 250, or top 300 franchisees -- if they outperform everything in the market and grow much faster than we anticipate, then you're gonna see downward pressure on that net effective rate, but you've got absolute growth at the top end. So, we wouldn't view that as a negative.

And now, the other offset, as you add franchisees and smaller franchisees become more productive, then you see the mix change a little bit. But those are the two variables we think about when we think about net effective royalty rate.

Tony Hull -- Chief Financial Officer

Brandon, the other point is that we raise, kind of, the thresholds every year, in terms of what qualifies for a rebate. So, that's sort of an annual reset. So, that helps as well.

Brandon Dobell -- William Blair & Co. LLC -- Analyst

Got it, OK. And then I guess final one, as you think about all these dynamics going on with commission splits and geographic exposures, etc., does it change your -- not change your M&A strategy, but maybe within that, what kinds of companies you're more apt to take a look at? Maybe it's a particular geographic region, or a price point, or something like that? Just to maybe offset some of the trends that are going on, or to maybe amplify some of the efforts that you're making to drive the splits in your direction?

Richard Smith -- Chairman, Chief Executive Officer

So, as you know, we're well-versed in tucking acquisitions, so we'll continue doing that. We announced a couple this week; they're very synergistic, we have a very high threshold for return on invested capital, we can do that in our sleep. We continue to focus on those tuck-ins. I don't think you'll see us, although we look at everything, you don't see us doing anything in a material way that would not be synergistic. As long as we continue to stay the course on tuck-ins that are very attractive, a lot of leverage, they look great, they operate great -- you'll see us continuing that in 2018.

Brandon Dobell -- William Blair & Co. LLC -- Analyst

Okay. Thanks a lot.

Operator

Your next question comes from the line of Ryan McKeveny with Zelman & Associates. Ryan, your line is open.

Ryan McKeveny -- Zelman & Associates -- Analyst

Hi, thank you and good morning. And congratulations, Richard and Ryan. Two questions: on the commission split, I guess framing it a bit differently. Tony, you mentioned this year you're likely to add about 600 million of incremental GCI from the targeted recruitment, and when I weighed that against the commentary on the goal of slowing the rate of increase in split next year, do you anticipate the recruitment efforts continuing at the same pace? Saying, that 600 million that'll be added this year, can you give any sense of if you think that's something that continues into next year? Or if you slightly pull back on the recruitment efforts to mitigate the split increasing further?

Tony Hull -- Chief Financial Officer

No, I think we have a program that is highly successful and we're gonna continue doing it. There's a very large pool of agents we would love to have join our ranks, and we're gonna continue to attempt to attract them.

Ryan McKeveny -- Zelman & Associates -- Analyst

Got it. And one more on the west -- I know it's been asked a lot, but maybe another way to frame it -- on California, obviously the volume gains are encouraging but at the same time we know it's a very competitive market with many other competitors expanding there, doing acquisitions, things of that nature. So, curious if you can give a sense of how the actual split within California this year compares to last year, to try to parse out the mix vs. the absolute split actually moving up in that market. Thank you.

Tony Hull -- Chief Financial Officer

Yeah, we don't break it out that way. Obviously, we're very focused on it, but we don't break it out publicly. For competitive reasons exactly.

Ryan McKeveny -- Zelman & Associates -- Analyst

I guess, would it be fair to say that it's directionally similar, higher, or lower? Is there any sense that way, versus the company total split?

Tony Hull -- Chief Financial Officer

Well, it's higher than the company overall split. In terms of the impact of the recruiting and retention efforts, the increase in commission split on the west coast was pretty much dead-on with the increase in every other market. So, it didn't require any more increase to have the 11% growth in the west coast vs. what we were providing in other regions.

Ryan McKeveny -- Zelman & Associates -- Analyst

Got it. Okay, thank you.

Operator

Your final question comes from the line of Will Randow with Citigroup. Will, your line is open.

Will Randow -- Citigroup -- Analyst

Hey, good morning. Thanks for fitting me in, and let me start by saying, Richard, that you will be very missed, while we look forward to working with Ryan.

Ryan Schneider -- President, Chief Operating Officer

Thank you, I appreciate that.

Will Randow -- Citigroup -- Analyst

I guess I'll join everyone else in beating a dead horse. You guys are taking a 15 million hit apparently on [inaudible] [00:58:17] so California, at least nationally speaking, didn't grossly outperform. I guess the real question is, is that 15 million gonna hit you next year too when the same thing happens? Because inventories aren't loosening up. And if you take the other side of that, what gives you confidence?

Tony Hull -- Chief Financial Officer

Well, again, we are -- I guess your question is why do you think the rate of increase will decrease next year, vs. this year? Is that your question?

Will Randow -- Citigroup -- Analyst

Yeah, I mean that $15 million hit that you didn't expect incrementally, either that's driven by your spending more on retaining and gaining, if you will, agents, or it's -- and the question is, if it's a three-year amortization, why doesn't it hit next year in addition? I mean, tight inventories are tight inventories. We've been talking about this for years now.

Tony Hull -- Chief Financial Officer

Yeah, I mean part of it is, this year as we've introduced the targeted recruiting effort, is that we start amortizing the transition payment that we make to agents before the revenue starts to kick in, so I think it sorta made it a little more impactful this year than you'll see next year when we're just sort of building on an existing program. And also, again, to the extent that there's a more balanced growth in the various geographic regions, that would sort of automatically take pressure off of splits. And then the efforts that are -- in terms of the strategic initiatives, in terms of getting the third and fourth quartile agent across the country to be more productive, it's kind of the first big program that we're looking at. And also, the overall value proposition, refine, and focus, and improvement that we're offering to all of our agents, should make -- I think should make the economics less of a factor, and really be more productive. If I'm paying a slightly higher split, or if I'm getting a slightly lower split but I can do two or three more transactions than I would've, working for the guy down the street without any of these tools, any of this coaching, any of that, I think an agent's gonna see very quickly that being part of NRT is much more profitable for them than they'd otherwise earn.

Richard Smith -- Chairman, Chief Executive Officer

So, Will, think about this. NRT management turned around the market share issue that had been building for several years in the context of one year -- 12 calendar months, which is remarkable by any definition. That same sort of energy is being shifted to now making the third and fourth quartiles far more productive than they are now. That's a fairly significant offset to paying higher splits to the first and second quartiles. So, we're very encouraged. We think the model works quite well, and they'll execute against that strategy next year, and we have a high degree of confidence in our ability to do that.

Will Randow -- Citigroup -- Analyst

Thanks for that. And Ryan, if you'll allow me, I'm sure one of the questions Richard asked you when you guys were talking about taking this seat -- what your strategic vision was. Now, you highlighted on the call very briefly, data and analytics to drive growth. Can you get any more specific, and how long do you think it'll take you to ramp in the new road? And then again, congratulations.

Ryan Schneider -- President, Chief Operating Officer

Well, thank you. First off, Richard has been incredibly instrumental in growing and leading this company and making Realogy the foremost platform for residential real estate in the US, so I echo all Tony's comments, and all of you and other analysts' comments here. Look, I'm in my second week here. I'm incredibly excited to be here. I've hit the ground running, diving in on strategy, technology, and all of our businesses. As I said in my opening, I really think there's opportunities to use data, technology, and analytics to build on what's been done here, to really drive growth. And so, I'm incredibly focused in all those areas, as well as most importantly, meeting and getting to know the great talent at Realogy. I look forward to sharing more strategic thoughts with you and others in 2018, and I'm incredibly excited to be here.

Richard Smith -- Chairman, Chief Executive Officer

So, he doesn't get the last word on my last earnings call. That's gonna be left up to me unless you have another question. But let me say this: this company is uniquely positioned to capitalize on an enormous store of data in a way that other people haven't even contemplated, because -- in part they don't have the data; they don't have the sophistication; they don't have the reach; they didn't spend billions of dollars building the largest real estate company in the world. We've been able to use all that to attract someone of the caliber of Ryan. So, this is critically important. It's a transformative event for our industry, and for our company. So, in his hands, we're putting a company with a new approach to data, and new approach to technology, just a different thought process, and we think the upside to us is substantial. So, we welcome Ryan and his expertise to the company. Again, I believe it's gonna change how this industry thinks of itself, and we'll be at the lead of that.

Will Randow -- Citigroup -- Analyst

Well, thanks again guys. And particularly to you, Richard, who has spent over two decades building this business.

Richard Smith -- Chairman, Chief Executive Officer

Thank you very much.

Operator

This concludes our question and answer session. I will now turn the call back over to Alicia Swift for closing remarks.

Alicia Swift -- Senior Vice President

Great. Thank you for joining the call today, and we look forward to talking to you over the coming quarter. Thank you.

Operator

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

Duration: 65 minutes

Call participants:

Alicia Swift -- Senior Vice President

Richard Smith -- Chairman, Chief Executive Officer

Ryan Schneider -- President, Chief Operating Officer

Tony Hull -- Chief Financial Officer

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

John Campbell -- Stephens, Inc -- Analyst

Jason S. Deleeuw -- Piper Jaffray & Co. -- Analyst

Steve Kim -- Evercore ISI -- Analyst

Mike Dahl -- Barclays Capital, Inc. -- Analyst

Kevin McVeigh -- Deutsche Bank Securities, Inc. -- Analyst

Brandon Dobell -- William Blair & Co. LLC -- Analyst

Bose George -- Keefe, Bruyette & Woods -- Analyst

Ryan McKeveny -- Zelman & Associates -- Analyst

Will Randow -- Citigroup -- Analyst

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