CBRE Group, Inc. (CBRE) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us today at the Goldman Sachs Financial Services Conference. We're excited today to have with us CBRE at the conference. From CBRE, we have Leah Stearns, CBRE's Chief Financial Officer. Leah, thank you for joining us today. As a reminder, for those participating, if you have questions, please submit them via the questions window on your screen. We'll do our best to incorporate them into our conversation. With that, Leah, again, thank you very much for being with us today. A pleasure to have this conversation and host this conversation with you.

Thanks for having me, Rick.

Leah, for those that are not that familiar with CBRE, would you maybe just take a few minutes to introduce CBRE, talk about key strategic areas of focus and what makes CBRE unique among the other commercial real estate services firms?

Well, just to start out, CBRE is the largest commercial real estate services company in the world, and that encompasses market-leading positions across several lines of business within our advisory segment. Good leasing, property sales, valuations, property management. We also have a market-leading position in outsourcing as well as U.S. property development. And so it's a business that has grown to a fairly significant size, scale and capabilities that are ultimately -- ultimately our geographic diversification is unrising. So it's something that, I think, has really proven to be a key milestone or cornerstone of our business, and why we've proven to be more resilient in 2020. Our platform today serves the largest owners and investors and occupiers of real estate globally. And we believe that by providing this integrated and comprehensive set of solutions, we can generate significant synergies from these extensive offerings. The CBRE today is grouped into 3 segments. We have Advisory Services, they provide turnkey advisory and brokerage services to our clients. We also provide financing solutions and loan servicing for debt and structure plans. And they also provide property, project management and valuation services for those occupier investment [indiscernible]. Our next segment is Global Workplace Solutions. That's the outsourcing solutions business that serves the largest global occupiers of real estate, both on an enterprise and on a local basis. And finally, we have our Real Estate Investments segment. It leverages our balance sheet as well as our industry knowledge and expertise to deploy capital into real estate investments. This encompasses both our global investors and our Trammell Crow Company development business. So over the last decade, commercial real estate has really been a beneficiary of 3 key secular tailwinds. We've seen rising institutional ownership of real estate, and that has certainly driven demand for commercial real estate services. Occupiers of real estate are increasingly turning to outsourcing. And so they want well-trained and professional services to optimize and protect the overall portfolio into real estate. And ultimately, the commercial real estate services industry has been under a tremendous amount of consolidation. And that's brought together global platforms, and that has really, I think, set the area part. We have led that, and we have lead into it. And today, we've [indiscernible] largest scale relative to our peers. And I think that certainly has proven to help us in terms of our overall resilience. So I think that combined with our balance sheet, it really has set us apart. We came into 2020 with the lowest leverage of our peer set. And today, in addition to our investment-grade credit rating, we have about 0.2 turns of leverage and over $4 billion of liquidity with no near-term maturities. So we're positioned to really lean into the recovery and begin to allocate capital to further extend our leadership position across real estate services.

So Leah, maybe on those 3 tailwinds and that last point on the balance sheet, maybe talking -- speak to a little bit about how you see consolidation playing out? Or where do you see CBRE looking to further grow the business or to further consolidate the business?

We have pockets of our business where we may not necessarily have global breadth and presence. So I would say looking at the Telford acquisition that we completed in the U.K. around multifamily property development, that was an example of where we had a very well-established world-class operations in the U.S., and we wanted to expand our Trammell Crow capabilities into a market where there was a significant opportunity as it relates to not just property development, but specifically within multifamily, there's a big gap between the supply and demand for multifamily product in London, in particular. And so we believe that Telford as an organization could do more and be more profitable and grow faster, being part of the CBRE platform and portfolio of services. And we believe that together, we can begin to expand our development business more broadly. So that's the type of opportunity. If I could phrase it or summarize it efficiently that we would look to, to really go out and expand on the world-class services that we have today and either take them to new asset classes or verticals or new geographies [indiscernible] further enhance our global capabilities [indiscernible].

And are there any particular geographies where you see that CBRE isn't particularly at scale that you'd like to lean into?

We do -- you always want to maintain and ensure that we're pacing at #1 or #2 market share in terms of our transactional lines of business. There are always opportunities for us to increase our positioning as it relates to market share. So that's an area that we certainly lean into from an investment perspective. But there are other areas, whether it's an example of -- we've expanded our facility management services beyond just office, we're now in data centers, life sciences, and other verticals that can allow us to differentiate the product and the experience that our clients receive from CBRE. And so as we look at ways to further expand, whether it's our facility management, offerings or project management offerings, those are the types of areas that I think we would certainly look to. I would also point to the resilient asset classes that have proven to really stand out as a result of COVID or on the [indiscernible] of COVID, are areas where we would also look to particularly to build up our capabilities that will have tailwinds coming out of this. That is certainly another area that we're particularly focused on.

Okay. Maybe just shifting, and I'm going to circle back at some point on the other 2 tailwinds. But maybe just to touch base on any operational update that you can provide. Seasonally, the fourth quarter is the strongest of the year. We've seen a rise in case counts around the country. How are you seeing sort of things shape up? Or how are things changing as a result of that increased case counts in the fourth quarter? And do you anticipate the -- a normal seasonal pattern in the fourth quarter?

Fourth quarter is typically -- as you said, it is our strongest quarter in terms of transactional equity. But it is important to remember that we have built a more resilient business. And so the underlying predictability, whether it's from our outsourcing business or our recurring asset management fee business within global investors or build-to-suit key development business within Trammell Crow, there is a more consistent level of profitability that we do generate today than we have in the past. But certainly on the transactional side, Q4 is a critical quarter for us. We detailed on the Q3 call that we expected sales and leasing to be down between 30% to 40%, and that was a continuation of the trend that we saw in Q3. I think part of that is an expectation that we are seeing characteristics that are supportive of a recovery on the transaction side relating to sales sooner than leasing, which is actually the opposite of what we saw in the great financial crisis. So from a sales perspective, there's a tremendous amount of dry powder. If we think about overall capital that's been allocated to real estate that has not been deployed, it's north of $300 billion today. And I think that in addition to just real estate continuing to provide in service an attractive asset class with a strong relative yield for investors that will continue to be a pocket of opportunity for us to monitor. I think that's also been -- we have seen transactions trade -- assets trade in 2020, particularly where there's been a strong credit tenant or strong rent roll with credit, strong credit tenants and longer lease durations. So those income streams continue to be highly attractive for investors. And we think that's a theme that we'll continuously develop as we get up to the other side of the company.

Yes, we heard from the commercial real estate panel yesterday that there seem to be a lot of focus on those asset classes that have been more stable, multifamily, specifically suburban multifamily, industrial, et cetera. Where are you seeing -- are you starting to see any shifts in perhaps transactions and interest in any of the other asset classes, i.e., office or some of the more challenged like retail?

Well, we did mention on the call that we are seeing more resiliency in the secondary and tertiary markets and also with the smaller transactional sizes. It's the large one-off transactions that happen in Manhattan, North San Francisco that have really fallen away. And I think part of that is because occupiers have -- large global occupiers have lots of options, and they also don't have an immediate need to bring people back into the office. So they may have multiple offices in certain cities, whereas smaller occupiers that have smaller floor sites are really not provided the same flexibility because they really only have one location that they're managing and they haven't a handful, and those are not as compensated. So from our perspective at CBRE, we've watched those parts of our business on the transactional side being more resilient. We certainly recognize that as we get to a post-vaccine world, and hopefully, as employees feel safer coming back to the office, that will hopefully be a catalyst for us as we see those larger leasing transactions come back, but we're being overly cautious right now just in terms of our expectations, given the fact that it has been such a challenging year for leasing.

Maybe shifting. One of the strategic areas of focus for CBRE over the last few years has been growing that recurring revenue bucket and that more resilient revenue stream. Can you talk about how you see that progressing over the next few years? Which parts of the business? Is it loan servicing, is it property, facility management, investment management, where you see perhaps the areas of opportunity? And how should we think about the mix of business in terms of recurring versus some of the more transactional businesses as you go forward?

Yes, and it's also not just recurring, it's also that they're less cyclical. So they're being driven by some of those key tailwinds that we have thought to capitalize on at CBRE. And so as we think about the secular growth trends, for example, facility management, which is benefiting from the trend towards outsourcing, we continue to believe that, that is especially compelling, particularly given the fact that for third-party outsourcing, real estate -- the penetration for using third-party outsources is still extremely low. I think the statistic that we reported in the past is that the overall FM market is estimated to be around $1.9 trillion by 2024. And I think we're somewhere in the mid- to low-single digits in terms of overall penetration globally for that industry. So there's a tremendous amount of opportunity for us to grow that business. And that, again, is the more recurring and less cyclical part of our cash flow. So that, we think, provides a really compelling value proposition when we compare that or combine that with the capabilities and the breadth of capabilities that we offer to clients. And I would just say, in addition to that, as we think about the growth that's anticipated in that recurring contractual revenue source, we do expect that will ultimately grow over time. The contractual revenue sources that we have today are contributing about 2/3 of revenue in 2020, and that's up by about 500 basis points from 2017. So I do expect the contribution from those revenue sources to grow, but we are going to be balanced in how we go after it. We are and continue to have is a big part of our business tied to transactions. But I think the key conclusion from this is we will allocate capital to the highest [indiscernible] and we will ensure that we're using the appropriate risk-adjusted hurdle rates to guide up. And as a result of that, if we're looking at contractual revenue sources, those may have a lower discount rate, whereas more volatile transactional services may have a higher discount rate. Net net, we'll look at building a portfolio of businesses that can grow at a very attractive level for investors to ultimately drive the highest total shareholder return in the industry.

And just on that consolidating and the outsourcing trends, how is the pandemic accelerated that or has it? And are you seeing a lot of those occupiers want to outsource or the landlords outsource the third-party management of their properties?

I think from the occupier side, global occupiers have been more cautious in terms of making decisions. They are leaning in and assessing outsourcing as an opportunity. But I think there's still a key question out there as to exactly how they're going to use real estate when they come back and then they [indiscernible]. And so while outsourcing continues to be a very hot topic across real estate teams in Corporate America, the decision making has been quite partially on the pause. I think until there is more certainty around the timing and the magnitude that employees will come back into the office. But what we -- and where we have seen stronger demand and growth within the facility management business has been in our local business, and there's a shorter sales cycle. You're not transitioning significant square footage or multiple different locations. It's typically one -- in one location in the city, or in our data center FM business, which is a nice pocket of growth for us that we have within our outsourcing business. So we continue to believe that outsourcing and the opportunity for outsourcing, particularly given the market size, will be a tremendous opportunity for CBRE in the future. And we think that business while it may not be a double-digit grower on the top line in 2020, we do expect long-term that, that will be a double-digit growth for CBRE.

You mentioned capital allocation, maybe just -- maybe walk us through how you're thinking about capital allocation within the business. I think in one of our prior conversations, we discussed share buybacks versus acquisitions versus reinvesting in the business. Can you just talk a little bit about how you're thinking about capital allocation?.

Sure. So we have a very straightforward process to capital allocation. Our -- currently, our balance sheet is in great shape. We took a pause from our share repurchase program earlier in the year, predominantly because we just didn't know how the pandemic would play out and we didn't know how long or severe the duration of the impact would be. And so we have -- while we've put the share repurchase program on pause, what it has allowed us to do is really build out a tremendous amount of capacity from an investment perspective. And so we sit here today with over $1 billion -- about $1.5 billion of cash, close to 0 leverage. And when we think about looking forward, the ability to use leverage to a modest extent to further grow the business given that position. And therefore, we need to think about and make sure that we have the appropriate framework in place to allocate that capital over the next 12 to 18 months. At the end of the day, to make it as simple as possible, we compare the investments that we would make into any M&A and to a share repurchase program. So we make sure that there is a comparable use of capital that we are forcing each transaction [indiscernible]. But underlying each M&A assessment is a very detailed approach at looking at the underlying risks associated and cash flows associated with each transaction and making sure that we have the appropriate cost of capital and corresponding hurdle rate that we would expect for any investment to make. So we are deploying that framework across the business. And we work very closely to finance corporate development, and the business to make sure that we're pursuing the right type of opportunities that will increase the capabilities that we provide to clients for the right price and in a disciplined fashion. And at the end of the day, if we can't find those or those transactions are not brought to fruition, we do have a share repurchase program to use and leverage.

And as you look at leverage and as the company gets more recurring revenue over time, are there thoughts to the strategy on leverage and the leverage range that you'd be comfortable with? i.e., would it go higher? Is the recurring revenue goes higher?

So the way we think about leverage, and we've historically managed in the kind of cyclical way. So coming into 2020, we were at and planning to be around 0.5 turn leverage, given the fact that we were -- felt as though we were approaching although there was no immediate signs [indiscernible] but some form of correction or reversion team. And so because we were in such a solid position coming into COVID, and now we've had a tremendous year in terms of free cash flow generation and managing our working capital, we find ourselves with a tremendous amount of capacity to go out and invest. As we move out of the recession and look at opportunities, we would certainly be comfortable taking our leverage up for a period of time. But investment-grade is a critical part of our balance sheet, it's something I'm committed to. And so then if we think about what are the right thresholds for our leverage and in terms of future growth opportunities, we've certainly seen 2 turns as being something that is digestible and we could deleverage from over time if there was the right opportunity to pursue material acquisitions. And then something in the 0.5 turn to 1 turn in a more normalized environment, absent any strategic M&A is something that [indiscernible].

Maybe just shifting -- and let me pause just for a second and just remind those that are in the audience, if you have questions, please submit them through the question portal. We have about 12 minutes left in our conversation. Feel free to submit them, and we'll work them in. Maybe, Leah, just talk a little bit about the -- how CBRE thinks about the cyclical recovery in the more transaction and leasing businesses. There's been a few of your peers that have talked about 2024, 2025 as kind of time periods where leasing might get back to pre-COVID levels. How is CBRE thinking about the recovery in those businesses?

It's heard today that they -- and we haven't declared what we think we'll be back in terms of the leasing environment. If I go back to the GFC, sales were down 70%, leasing down 30%. And I do think that sales will perform better and really driven by some of the characteristic that I outlined to you earlier around just dry powder and the health and liquidity around the financing environment for real estate. But I do think that leasing -- well, there will be pockets where there will be opportunity like in industrial and multifamily. We have seen strength in that part of our leasing business. But I do think office leasing will be highly dependent on the return to work plan that comes out of this. And so I do expect there will be some [ muted ] recovery ahead of us. We've been very transparent in terms of the level of impact that it had on CBRE this year. And more broadly, our research team put out some details. I think they're looking at, say, 2023 as when leasing comes back. I just think it's too early, and there's too much uncertainty for us to declare that the CBRE [indiscernible] in our leasing numbers will be back to parity.

Got it. Just a question that came in, as we were talking. Can you talk about the cost actions that CBRE has taken. I know that you've done a $200 million cost-cutting program and some others. Are there further opportunities for cost takeouts? And what types of areas do they find those? Did you find the cost opportunities?

Sure. So yes, in terms of cost, we did announce our initiatives that we did in the third quarter. Some of those actions, about $120 million of the $200 million will be benefiting 2020. The rest are effectively being implemented through the fourth quarter, and we'll have the majority of the benefit for 2021. Those are permanent. They are primarily [ discount reductions ]. And so those are areas where we have decided that we need to rightsize our business. We need to look at the underlying demand and the appropriate cost structure to support what we believe to be the growth and client demand coming from 2021 and beyond. There are other parts of our business that have seen temporary and more short-term cost reductions that are compensation related or [ teaming ]. I expect those will emerge back in '21, as demand comes back. So I think there will be more correlation on that. But the $200 million was our initial cut and we continue to look for opportunities to optimize costs across the business. And so we will have an update for investors on that in the fourth quarter call.

And as you think about margins pre-COVID levels, the permanent reductions and temporary cost. Do you see margins able to recover to pre-COVID levels or climb higher than pre-COVID levels, as you go forward?

There will be -- some of the key drivers for that will be the pacing of recovery primarily on the leasing side and on sales side. But those larger transactions they are highly accretive from a margin perspective. And so we certainly believe that the cost actions that we've taken will position CBRE to be more resilient from margin perspective. But I would say there is some contingency that we need to place on [indiscernible] we need to place on the resumption of those large one-off transactions to really get us back to [indiscernible].

Got it. Maybe while wait for any other questions to come in, can you just talk a little bit about how -- your views across the various real estate asset classes and geographies? Maybe touch on -- you touched a little bit on office already. Sounds like CBRE has the view that office will start to come back but perhaps not get back to pre-COVID levels. Maybe talk a little bit about how you're thinking about office and industrial and multifamily?

Sure. So as you outlined, office is an asset class that I think will be highly dependent on the pace of the return to work. And I would highlight that ahead of -- even before COVID became a reality in 2020, CBRE and our teams were quite vocal about the fact that we believe this was going to be [indiscernible]. So we expected there to be a transitional shift towards more remote working and that the densification that had occurred was certainly leading people to work in more of a distributed and remote basis. So from our perspective, I think office will see a handful of trends develop over the next couple of years. One of them will likely be at the ends of the densification that we saw over the last decade plus. And the other will be the higher percentage of employees that are working remotely. So I think there will be some balance in there in terms of where occupiers come out for their office needs, and we'll have more clarity on that as it becomes more of a safe proposition to bring full workforces back to office. Industrial continues to be what I would consider to be the winner in COVID. Industrial's been the most resilient asset class that we've seen through the year. And I would say that's followed closely by the likes of data centers, life sciences and multifamily. Some multifamily, I would say, is more attractive than [ less. ] As you mentioned, suburban multifamily is an area where we are seeing good opportunity. And so I think from our perspective, those are certainly the stronger asset classes that investors continue to be interested in. Retail, there are pockets of retail like grocery, anchored retail that are performing quite well. But there is certainly some weakness across hospitality and these other targets of the regional asset class that we expect will take longer to recover.

Just as a reminder, we've got a couple more minutes left. If you have any questions, feel free to submit them. Maybe, Leah, could you just talk about one of the areas of the business that being loan servicing and how you think about the loan servicing business as you go forward and the opportunity to grow market share in that business as you go into 2021?

Sure. Loan servicing has been a very resilient part of our business and certainly an area that we've been focused on further diversifying. But it is an area where we do see a significant amount of recurring and some high profitability -- recurring revenue and high profitability [indiscernible]. So it is an area that we are enthused about and seek to continue to increase our exposure to. And it's been an area -- our strong position with the GSEs has allowed us to really build up that portfolio. And now we're looking at ways to further diversify the loan book.

Another question that's come in, just in terms of thinking about the build-to-suit development pipeline that you have. Can you talk about what areas of the market you're seeing the growth in the build-to-suit, and how we should think about that business going forward?

So over 50% of our in-process pipeline is currently build-to-suit, and it's principally industrial multifamily. And for that development pipeline, any office properties are principally [ fused ]. So over -- I think it's an average of 75%, 80% of those office properties are [ fused ]. So we feel really good about the position that our development pipeline is in. And we continue to have record levels of development entering that development pipeline. So it's an exciting time. We're leaning in on the industrial side. We think there's other attractive asset options like multi that we will have further opportunities around. But it's a bit too early to declare anything.

Okay. Maybe just in the last minute or 2, Leah, give you an opportunity to talk about anything that we should have asked that we didn't ask or things that are top of mind as you think about 2021 or things to leave investors with as we go into 2021 from a CBRE perspective?

Sure. I guess I'll just end with this, CBRE has just impressed me, our professionals, our leadership. This has been a year of tremendous challenges, yet we've emerged stronger than ever in my opinion. And I'll characterize that in a couple of ways. So we sit here today, and we have proven that the resiliency that we have invested to build is in place. This business generated double-digit returns in growth over the last decade. Coming into COVID, I think, we knew this was going to be a moment in time where we would like to be able to demonstrate the resiliency and the strength of what we have built. And I think it's just incredible to sit here today and look at a business that many people historically had perceived as an office leasing and sales business, in an environment where employees have been sent home for an extended period of time, and we've performed incredibly well to date. We also are sitting here with a tremendous amount of capacity to then extend our leadership position from a capital perspective. We can put that money to work and have the highest and best use on behalf of shareholders, and we now have a very structured process from a capital allocation perspective to go out and ensure that the diversification continues, the resiliency continues in our business and that we're making significant progress on growing our cash flow stream at a level that we believe will be compelling for investors. So I just think it's a great time to sit here and reflect on where we've been, what CBRE has demonstrated in 2020, and how we're setting up and now looking forward to the future. We've made some really hard decisions about having to separate from certain employees around the business, through those workforce actions that we talked about in the quarter. But it's decisions like that at the right level, that will position us to pivot and to accelerate into recovery. And we're excited to begin to invest in those areas of our business where we think there will be secular tailwinds. So with that, Rick, I'll turn it back to you.

Great. Leah, thank you very much for the time today. Pleasure speaking with you again. And that concludes our discussion with CBRE. Thank you very much, everyone, for joining today. And have a great holiday season Thank you.

Thanks, Rick. .