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

Good morning, everyone. My name is Brendan Lynch. I cover several of the REIT subsectors here at Barclays. I'm joined by Emma Giamartino. She has been with CBRE since 2018, originally focused on M&A and became CFO in 2021. Prior to that, she was with Verizon in a corporate development role and prior to that [ Nomura ]. Emma, thank you for joining us.

Thanks for having me.

Yes, my pleasure. Maybe we could just start looking at CBRE as an institution. They've been in the real estate business for over 100 years. Maybe you can compare and contrast this cycle to some of those at the best?

Yes, absolutely. It's a question that we think about a lot and that we're obviously asked a lot. And every cycle is different. This cycle is obviously very different than COVID. It's different from the great financial crisis. And we don't focus a lot on COVID because we view that as an anomaly, it was a pandemic. There was a time period where we were all wondering if anyone would ever leave their house or go back to the office. And then the recovery because rates went down to 0, the recovery was much more extreme than we'd expect in this instance. But going back to the great financial crisis, where we spent a lot of time thinking about how this is different from that. I think we all know that this scenario is -- this downturn is much less severe than what we saw in the great financial crisis but it's also very different. So we're expecting rates to be higher for longer. We're not expecting there to be a severe recession that's going to drive rates down to 0 and drive a significant recovery coming out of this. So it's likely that this recovery is going to be further delayed than what we were expecting earlier this year. But the biggest difference for us as a company is that we are very different, and we're very different in 3 primary ways. So first, if you go back to the GFC, we were very highly levered going into the GFC. And so all the focus was around delevering, coming out, making sure that we were generating cash, getting our balance sheet into great shape. Now we're at virtually no leverage. We're generating a lot of cash. We're very confident in how we're going to perform coming out of this recovery. So it's a very different place. In terms of our -- the resiliency of our profit streams, if you go back to the GFC, probably less than 20% of our EBITDA was in lines of business that grow or are stable through a downturn. Now we expect this year to have over 50% of our EBITDA come from those lines of business. So it's a dramatically different place. And then in terms of our leadership team, we have a highly experienced, very professional leadership team that's able to manage costs and flex with the business in a way that we weren't able to do going back to the GFC. So it's a much different environment. And one of the thought exercises that we put ourselves through is what if we took the company that we have today with close to $30 billion of revenue across hundreds of lines of business and hundreds of markets. And you put that back through the environment in the GFC. Even in that scenario, you know that our business would perform and be more resilient than we were through that downturn.

There's certainly a lot of transition over the past 15 years. Maybe you could touch on some of the economic factors that drive the various components of your business?

Yes. So the big one is interest rates. We have our lines of business that are most sensitive to interest rates are our capital markets business. So our investment sales business, our loan origination business and then our development business and the parts of our investment management business that benefit from co-investment or carried interest. All of those businesses, when there's uncertainty around rates, they tend to pause or be delayed. So what we're seeing within capital markets today is that as rates have been volatile and there's uncertainty around it, that transaction activity has slowed significantly. The rest of our business is not significantly impacted by rates. Our outsourcing business valuations, property management, the recurring part of our investment management business, those are our more resilient lines of business, even leasing is less impacted by interest rates and is more impacted by the state of the broader economy, which is in generally good shape right now.

You certainly positioned the business to weather economic cycles efficiently. The stability that comes with some of those transitions in businesses, does that have any cost -- is there a trade-off to having resilience in your business?

Yes. It's an interesting question. It's not one that I get asked a lot. And I think you don't have the high highs and -- but you also don't have the low lows. And so really, I think all that stability gives us is the greater level of confidence and a greater benefit. So we're able to invest in this time when a lot of companies aren't able to. It gives us confidence in our cash flows. It really allows us to weather and come out of this downturn even stronger and with higher growth and to increase to widen the gap between us and our peers than we've even had before. I don't see a tremendous amount of downside.

Great. Maybe we could touch on the Advisory Services business. What do we need to see for the CRE capital markets to return to normal?

So it's really all about interest rates, both stability in rates and then also a path to those rates coming down over time. It doesn't have to be near term, but just any sort of understanding of what's happening in the short term or the long term, and we'll start to see that transaction activity come back. What we saw in the past quarter even or the past 6 weeks since we announced earnings is that rates went up 40, 50 basis points, and that created a lot of challenges in the market. Transactions just weren't happening. So we talked to our multifamily team, and they were saying in Q2, deals were getting done at a 5.25%, 5.5% cap rate. Cost of debt was pretty much the same. And so deals were happening. But as rates -- the cost of debt went up to 6%, sellers aren't willing to sell at a 6% cap rates, buyers aren't willing to take on negative leverage. So deals is just being delayed and that bid-ask spread widened again even though it had closed. So that's just really a testament to the fact that as long as rates are going in directions that we're not increasing and they're volatile, it's really hard to get deals done. It's really hard to underwrite.

You touched on some of the subsectors there. Maybe you could talk about what you're seeing in terms of different regions and different capital markets activity.

Yes. So it's changed a little bit. What we talked about through the first half of the year is that the U.S. has been performing the worst. I think we all know that. APAC generally has been performing the best. Japan has been performing very well. China, a little less so. And then EMEA through the year -- through the first half of the year have been performing slightly better than the U.S. What we've seen in the past 6 weeks is that's deteriorated and [indiscernible] performing pretty much at the same level as the U.S. So from an investment sales perspective, activity is down about 50% year-to-date across both the U.S. and Europe.

Maybe we could switch gears a little bit and talk about the recruiting of brokers. You kind of alluded to having the balance sheet strength to go out and make changes in difficult environment. Maybe you could talk a little bit about the recruitment of brokers and assets going?

Yes. So we're seeing more and more inbounds from brokers, I would say, and it's changed somewhat from what we were seeing even a year ago. Given that activity has slowed, this is a time when brokers can look up and think about what platform they want to be on, where they're going to have the greatest opportunity to grow their platform going forward. So they're looking to think about, do I want to be on a platform that has greater financial health. Do I want a better brand? Do I want to be with a company that I know is going to invest in the resources provided to their brokers? And so we're having more and more conversations about that. And actually our Head of IR, he actually has been brought into a number of [ tough ] conversations to talk about the financial health of our company, of our cash flow or our balance sheet. It's actually really becoming a part of the conversation in terms of where brokers want to be. So the big change that we've seen over the past year and even the past few months is that more and more brokers and their teams are coming to us to initiate conversations about coming over to our platform.

Maybe just going back over the past couple of years, the pandemic, was -- has the talent pool among the brokers changed? Have people left the industry because it's become more challenging?

We haven't seen that significantly. The top tier of talent has remained and probably even extended their tenure in the industry, and it's really about building out that new talent base, especially in industrial multifamily probably in [indiscernible] office.

I know office is a huge topic of conversation and get a lot of questions on this. Maybe you can point to some of the areas where you're seeing strength and also where you're seeing some weakness?

Yes. So this story is pretty much unchanged. We're seeing the greatest strength at the top end of the market. Top 10%, 20% of office assets are performing very well. Those Class A, extremely high-quality assets have some of the highest demand they've ever had. Rents are increasing. Some of the spaces have record level of rent. Demand in where there's a large number of those Class A assets is very high. So for example, in the Town East, occupancy is at 90%. The tenants in the market is -- has almost recovered entirely. I think broad-based, 80% -- we're at 80% of where we were pre-pandemic in terms of tenants looking for new office space. In New York, it's over 100% of what it was pre-pandemic. So that demand is growing, and we're starting to see that pickup in activity. On the bottom end of the market, in the Class B and Class C space, especially the bottom of [ 12% ], there's a little happening, and it's very unclear what the future of that space will be. For us as a company, we don't -- we spend most of our time with that Class A space. So office leasing mix up at about 50% of our leasing revenue and 2/3 of that office revenue is for Class A space. So we're focused on that higher end in the market. I don't want to say -- I don't want to imply that we're not impacted by what's happening at the lower end, but we are benefiting from what's happening at the higher end.

Maybe some of those changes that you alluded to, do you see those as more structural? Or are they temporary changes that just need a little -- a couple of more years to working selves out?

So there's the temporary, which is what we expect to see in any cycle as occupiers are looking for opportunities to save costs. Is there uncertain about what the future is? Are they uncertain about what they're going to do with their employee base, whether they're looking to expand or contract? That's naturally embedded in what's happening with office leasing. But you also have the structural component, which I think most of us don't know the answer to. The return to office is a constant discussion. We've been talking about how the mandates are increasing, post Labor Day. We're now a few days post Labor Day. And any of us know if that's really happening. One of the things that is increasing the uncertainty is we were talking about a mild recession at the end of this year. Now we're talking about likely a soft landing or somewhere between the soft landing and a mild recession maybe next year. And the impact that's having to, in my mind, to the return to office is that it's not shifting that power dynamic from the employees to the employer and allowing them to give more -- provide them -- the employers with more leverage to get employees back to the office. So it's still remaining -- it's very uncertain, and we'll have to see how it plays out probably over the next year. I feel like we had the same exact conversation last year. We were talking about return to office post Labor Day, and that didn't happen. So we'll see.

At Barclays, we've had a few iterations of come back to the office, and we'll probably have a few more.

Are you in the office?

I am in the office, for I'd say, 4 days a week.

Good.

Maybe you can talk a little bit about the urgency for leasing among some of the companies that are driving the push to return to the office, amenitized base and high-quality space is kind of a driver there. And I'd imagine they're recognizing that the current situation is not going to exist in perpetuity, so they want to take that space while it's available. Maybe you could talk a little bit about that.

Yes. So it's both timing and then also the quality of space. So that demand, like I said, for that higher quality space with the amenities that can bring employees back in a location that is close to employees' homes. So reducing the amount of time it takes to commute. The demand for all that space is extremely high and many occupiers may be taking smaller space, but they're paying higher rents to be in that location where they know they can have a higher likelihood of getting their employees back. And occupancy in that space, when we've seen in our own properties, in those locations where it's a very high-quality space, it has amenities, great meeting areas. That's -- and it's close to our employees' homes. That's where they're coming back on a consistent basis. And that's broad-based across that plan.

Let's talk a little bit about flex space. What trends are you seeing there? And how is the demand for flex is evolving? And how is the flex space itself evolves?

Yes. So as you can imagine, it's very similar to what's happening with traditional office. The flex space, and we have a very strong relationship and investment in industrial. So we're seeing what's happening across their portfolio. And what they're seeing is that in those locations that are very high-quality space and in a central location whether that's close to a central community hub or it's close to employees' home, that's where they're seeing the greatest demand. But there's a sweet spot. So employees will be willing to go a little bit farther for that really great space. And we're willing to go to a less space that's not necessarily as high quality as they like, but it's very close to their home, whether it's walking distance or biking distance. So their industry itself is focused on finding that balance and of those locations and building a number of new units, and they're performing very well across their portfolio. [indiscernible] is that flex and I probably can't answer that question without talking about WeWork briefly. But they're obviously constantly in the headlines, and we're constantly asked how our -- how Industrious and our investment is performing compared to WeWork. And for us, they're very different stories. WeWork has a very different business [indiscernible]. They signed a lot of [ leases ], very long-term leases that everyone knows that they're trying to work out of. And Industrious is a very different business model, focused on asset light, focused on -- almost all of their units are revenue shares or profit shares or management agreements where they don't have that large lease liabilities which allows them to have the flexibility to weather COVID to weather sort of downturn.

Great. Let's talk a little bit about Global Workplace Solutions. You alluded to earlier about the resilience of your business and GWS is a part of that. Why does GWS continue to grow kind of regardless of the economic cycle?

Yes. So GWS is -- I think about it in 2 major pieces. You've got your facilities management portion or your project management portion. And even with there, it's broken down in 2 pieces. So we'll talk about facilities management first. There has been a long-term trend towards outsourcing real estate and really in the early stages of the path. So we estimate across the facilities management market, I think 30% is that for today, and that's where we increase. But there is a huge opportunity to grow into that wide space to onboarding more and more first-generation clients. And then there's still an opportunity to grow, which we're consistently seeing within our existing outsource client base for us to grow wallet share and take share from our competitors. And the growth in that facility management business typically is split 50-50 between those new first-generation clients and then increasing wallet share within the existing outsource space. And then on the project management side, we've seen a tremendous amount of growth. A big driver of that is our Turner & Townsend acquisition. They are doing -- for those that don't know longer-term portfolio management, project management, program management or base projects globally. They do it for infrastructure clients, for airports, for energy -- for energy clients. And then within real estate, they're doing big projects. They maybe doing data center work. So it's not that without doing small office tenants and out, so it's very -- it's much less affected by a downturn or a slowdown in office leasing.

Maybe you could talk a little bit about the value proposition that you offer to your clients in TWS and what their thought is that they're considering outsourcing?

Yes. So right now, we're getting a lot of inbound from first-generation clients. So corporates, as they're trying to weather this challenging environment, just like we all are, and there's a tremendous amount of uncertainty there thinking about reducing their client base in real estate and their facilities are typically one of the larger components of their costs. So they're coming to us and they're saying, "Can you help us reduce our costs?" And because we provide this service or on a global scale basis, we're able to provide a service to them at a much lower cost than they're able to do it themselves. And then on top of that, the reason that we're winning that service away from clients, not just from other -- from competitors, it's not simply because we're providing a lower cost, that's why the clients first come to us. The reason that we're winning is because we're providing a differentiated service. So either -- whether that's a specific capability that they're looking for like sustainability, like energy management, smart building services, we're providing something that's incremental to what competitors can't provide in addition to providing that lower cost.

What do you think it's going to take to kind of chip away the TAM that you haven't already addressed? It seems like there's -- so a lot of companies that are insourced in these activities. What does it take to convince them?

So a market like this is helpful. It's a good impetus for them to start thinking about that cost base. But it's really about getting in front of them and making that case. A lot of times, you'll see in it with the management change, you have a new [indiscernible] place we'll look for opportunities to cut costs, and that's when you'll see them -- you'll see those clients outsource. I think it's really about getting in front of them and really framing the value proposition. Once those clients do outsource, they almost never bring it back. I think we can't come up with an example of a multinational client taking that work back in-house. So it's really about just penetrating the market and having more and more of those conversations.

Great. Talk a little bit about your REI segment. How are the current market environment -- how is the current market environment impacting development into your investment management business?

So within our development business, we talked about this a lot. We structure those projects to allow us the greatest flexibility to choose in time when we monetize those assets, so that we're getting the best return that we believe that we can get. And we're building high-quality core assets that there is high demand for. So what we're seeing this year is that -- and we've talked about this a lot, we are holding on to assets and the land management has just been just like sellers -- buyers and sellers are doing within the broader capital markets, waiting for the time where we have a little more uncertainty -- a little more certainty around rates where rates are. And as you know, we can get the return that we want. And so it's all about timing within our development business. And once things start to stabilize, we'll start to see a greater monetization of the projects that we have under construction today and then more and more will start to get capitalized over the next few quarters. Within our investment management business, that's relatively unchanged. It's a pretty resilient business. Over 90% of our AUM is in core-plus assets. So we haven't seen a tremendous amount of impact to the valuation of sovereign funds. And then globally across our funds less than -- about 20% or less is invested within office and as that office is high-quality Class A space. So broadly investment management is a resilient business. There is a small bonus that benefits from carried interest and co-investment gains and what we expect to see coming out of this downturn is continued campaigns from that aspect.

On the development portfolio, you've talked a little bit about the types of assets that you have in there and how you're shifting that over time?

Yes. So the vast majority, as you can imagine, of our projects have been in industrial and then second multifamily and then to a much lesser extent office. We are still building office, but all of that is pretty much bill-to-suit or fee work.

Talk a little bit about the balance sheet. You're targeting 0 to 2 turns of leverage. I think you're in the midpoint there. What govern the decision to hit that range? And what governs where you fall within that range at any given time?

Yes. So what governs the range is that we are highly committed to remaining investment grade. So it's really important for us that we can stay within that range or have a -- if we do lever up to 2 turns that we have almost immediate path to delevering. And what you can expect to see from us is borrowing M&A will remain pretty much where we are in the leverage-neutral range, half a turn or less. For M&A, we'll probably approach to turn, but it's very unlikely that we're going to exceed a turn or go near 2 turns of leverage in the near and medium term.

You mentioned investment grade there. Obviously, that's important for your cost of capital. What other advantages do you see in terms of dealing with your client base?

Yes. It is really important to clients and it's a big part of the conversation when we're working with these large global occupiers. They do care what their service providers are credit rating in, our ability to continue to provide those services. So it's a part of the conversation. Investment grade is obviously not a part of our conversation now it has become more and more upgrade conversation. So it's not just important to our cost of capital, but it's important to our relationship with our clients.

You also mentioned the M&A opportunities. I think some of these that you're looking at are north of $1 billion. Maybe you can talk a little bit about what you're trying to expand into what types of markets or either potentially new products.

Yes. So it's difficult to provide details by nature of the confidentiality of M&A. But we're very focused on building a pipeline of potential targets and cultivating those targets takes a long period of time to do that. That can build out capabilities across our company. So all 3 segments primarily focused on the more resilient lines of business, which, again, is a large portion of our EBITDA. So there's a huge opportunity there. But what's important to emphasize is that it's all within our core. We are not looking to expand outside of real estate services. There is -- we see a big opportunity to increase our capabilities even within what we already provide. There isn't a need to go acquire a software company, for example. So we had a lot of feedback to talk about strategic M&A, transformational M&A, and that raised concerns that we were trying to go out of what we know. There is a massive opportunity within what we already do to increase those capabilities.

While we look at your geographic exposure, I think you're north of 100 countries. Do you feel that you have fully penetrated all of -- any of those markets? Or are there still a lot more room to grow in each one of those?

There's pockets everywhere. So within -- we are in over 100 countries, some were -- don't have a tremendous amount of presence and some we may only have presence in one product or just we have capital markets and leasing services, but we may not have outsourcing or investment management. So there is absolutely opportunities to fill in those gaps geographically.

At the beginning of the conversation, you mentioned that rates were up 40 basis points or so since you reported earnings. Maybe you could talk a little bit about the impact that is having on your business.

And that just happened over the last 6 weeks since we announced earnings. So coming out of Q2 and moving into Q3 from a capital markets perspective, so investment sales and originations, we were expecting that revenue to increase sequentially from Q2 to Q3. We're now 6 weeks in, I think, and we now no longer expect that to increase sequentially. So the recovery has clearly been pushed back. That rise in rates really sold transaction activity in a way that I don't think the market was expecting. It's just been much more challenging to do -- to transact. And I think it's become much more challenging for all of us to determine when that inflection point will actually come and we'll see transaction activity rebound. We started this year talking about that happening in the second half of this year. It's clearly not happening in Q3. It's clearly happening in Q4. And in Q2, we started talking about that happening early next year. And now we believe that may get even pushed back into the second half of the year. But I want to make clear that it's very hard to predict. And the main thing we're focused on is being ready to pivot when we do see that inflection point coming. So in terms of what will happen -- we think is going to happen broadly in Q3 based on this slowdown in capital markets activity, which is also impacting our -- we, as a seller, our interest in monetizing some of our development assets is delaying that. We're expecting our EPS from Q3 and Q2 to decline in the high teens range.

Okay. I think if I've done the math right, you're guiding core EPS to be down 20% to 25% for 2023. Your outlook for 2024 suggests that it will be above your past peak. Maybe you could just walk through some of those considerations? And what gives you the confidence to get such a robust outlook?

Yes. And this is something that we get a lot of questions on, and I just want to reframe why we started talking about '24 earlier this year. And the reason we did that is because we want to give a framework around what the consistent earnings or recurring earnings of our business are and how the different components of our business behaves to make out of a downturn. It wasn't to provide explicit guidance around where 2024 will be. And I just talked about how you see the recovery continuing to be delayed or that gets delayed, but less likely you're going to see that record level of earnings in 2024. But what I do want to make clear is that once we have that inflection point, and we have 3 to 4 quarters of growth within our transactional lines of business within capital markets, we do see that recovery over that 4-quarter period. If it starts in the second half of 2024, between '24 and the first half of '25, we will hit that record level of earnings. If it gets pushed out into 2025, it will hit the record level of earnings in 2025. And I want to frame why the point around like how achievable our GWS business, will be over $1 billion of EBITDA this year. That business continues to grow at a double-digit rate on a consistent basis. If that grows at 10%, if our REI business grows at 10%, which would not get it anywhere near the peaks of 2022 or 2021. And if our advisory business grows at 10% to 15% in the recovering market is not a significant amount of growth in EBITDA. We'd be able to get to that record level of earnings.

So it's coming. We just...

It's coming. Yes, we just don't know when.

Great. I'll just open it up to the audience to see if there's any questions out there. Okay. Maybe just one more for me then. What do you think investors underappreciate about CBRE?

I think it's all about what our future growth coming out of this downturn is going to look like. So the power of our balance sheet, we are -- we talked about, we're leverage-neutral. We're going to put that to work, and the amount of growth of that will drive coming out of this downturn is very meaningful, and it's going to help separate us even farther from our peers. The growth in GWS in U.S. that we're constantly asking what is driving that business. That business will continue to grow at a double-digit rate for the foreseeable future. And I think the other piece is our leadership team, leadership team that Bob's in place over the past 5, 10 years, is ready to drive this growth forward and is able to manage the operations of this business in a way that we haven't been able to before.

Great. Well, Emma, thank you very much for doing this with us. We greatly appreciate it.

Absolutely. Thank you.