Cushman & Wakefield Limited (CWK) Earnings Call Transcript & Summary

[Audio Gap] Obviously, it's very topical, been topical for a while, but even more so amid COVID. Very excited to have 2 participants. One, I know, has participated on our prior conferences. But Prologis has been there in different shape and form in our other conferences as well. Both bring unique perspectives. So very excited to have Dan Letter from Prologis. I'll introduce him in a quick bit. And Ben Conwell from Cushman & Wakefield. Before I get into the webcast, let me quickly read some disclosures. So please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. The webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please use the Morgan Stanley research website. And if you have any questions, please reach out to your Morgan Stanley sales representative. With that, thank you, Dan and Ben for joining and participating. A quick background. Dan is the President of the Central Region at Prologis. He's responsible for all activities, including development acquisitions and operations. The central region comprises over 150 million square feet across 10 markets, including Chicago, Dallas, Houston, Indianapolis, Nashville and Austin. Ben is a Senior Managing Director and Practice Leader at Cushman & Wakefield's e-commerce and electronic fulfillment practice. Ben's been in the space for a long, long time. He provides advice on strategy, site selection, design, execution on the retail side for logistics, occupiers and investors. Prior to joining Cushman in 2015, Ben was the Director of North America's logistics real estate practice for Amazon Fulfillment services. So obviously, a wealth of experience there as well. Very excited to have both of you, and thank you both for doing this. Maybe just to start off, and actually, before I start off, let me remind the investors, if there are any questions that you do have, feel free to post them on the website, on the webcast. And if, for some reason, you can't, you can e-mail them to me, my [ first name dot last [email protected] ].

Maybe just a big picture question. Obviously, e-commerce has been a big driver, pre-COVID, during COVID and likely post the pandemic as well. Can you give us a sense of what are you hearing anecdotally from your tenants on their individual e-commerce businesses? And if you can weave in some of the segments that you think going forward will have some of the highest e-commerce growth? Maybe Dan, we'll start with you.

Sure. And Vikram, thanks for having me. What I would say, I think about this as a silver lining, actually, which is hard to find those these days being at home now, working for 90 days, right? I look at it from a logistics real estate perspective, we have this tremendous, significant opportunity around the accelerated adoption of e-commerce, right? It has obviously been a tailwind for us through this entire last cycle. But given the new behaviors that everybody has had to learn and get better at, we're expecting to see tremendous growth. If you look at a couple of the top line numbers. E-commerce penetration at the end of 2019 was about 16%. And at the end of April, we saw it about 27%. And if you look at certain segments, grocery, for instance. Grocery, very underpenetrated at 2% to 3%, has grown 3 to 4x over the last few months through COVID, which just shows a tremendous growth opportunity. Anecdotally from our customers, of course, we see a ton from Ben's former employer from Amazon. They're our biggest customer. They're the biggest single user-absorbing space in logistics real estate today. We've got, I don't know, a dozen or so deals going with them at any given time right now, it feels like. And then I see them show up weekly. We've communicated with them more than weekly on opportunities and vacancies or -- and they're a big driver of our build-to-suit business. And this is global. This is not just in the U.S. We're seeing them certainly in Europe as well. But that being said, it's not just Amazon. We're seeing other big brands as well. Target, Walmart and Best Buy, the Home Depot, FedEx, UPS. Home Depot was quoted as saying that the traffic to their website in the last quarter has matched Black Friday traffic almost daily. I mean, that's just -- that's unbelievable. And then UPS has seen 12% international e-commerce growth, 19% domestically. And then you're seeing Walmart even come out talking about the fact that they are build -- they have a multiyear plan in place to build their e-fulfillment capacity. This all bodes very well for Prologis, I'd say. If you think about 9 years ago, actually, 9 years ago this week, Prologis and AMB merged. And we've spent the last 9 years curating the best portfolio in the best locations in the business. And of course, we've been building the best balance sheet in the business to ensure we are prepared for a crisis like this. Little we know, we'd have this tremendous tailwind to take us out of it as well.

That makes sense. Ben, could you add to that?

Pleased to. And thank you, Vikram, for the opportunity to participate again. But I won't thank you for teaming me up with Dan because I learn so much every time Dan and his colleagues speak in a forum like this or one-on-one. So certainly concur with many of Dan's observations. We only need to look at our own shopping activity, our own shopping patterns here over these recent months to understand why there has been, yes, a blessing and a curse in the logistics real estate space in the face of what has admittedly been a horrible thing for so many, a horrible time for so many. We see from clients a number of common trends. And I would include among those many, many clients because of the disruption in supply chain, because of the all but frozen retail outlet capacity in so many brands. We're seeing many, many clients say, I need what I call triage space. I need immediately available, hopefully, short term, very short-term space. But I've got inventory in the wrong places. I have inventory on hand, and I don't have a bottom of the funnel, if you will, to draw that inventory into physical stores. So that immediate demand, we certainly see as being an unusual bounce in the industry. Two, I certainly concur around the grocery space. Work that we do at Cushman & Wakefield, working with grocers, with 3PLs, with freezer and cooler, developers and investors, we've seen a significant demand -- uptick in demand for that kind of space. Again, we're seeing the growth of online grocery. We're seeing prepared meal kits. And how much of that will continue remains to be seen. But where we "stabilize" in terms of demand for online logistics space, whether it be ambient, whether it be cold storage and from the service providers who support that industry, where we really normalize remains to be seen. Yes, we're seeing those growth rates at 2 plus x where we were pre-COVID. We know we're not going to normalize or stabilize back to penetrations that are in the mid-teens and growth rates for online in the mid-teens. But somewhere between those mid-teens and that surge spike of the high 20% growth rates, it will be fascinating for all of us in the space to see where that shakes out. So those are just a couple of our [indiscernible]. Vikram, just one more -- oh, I'm sorry.

We just have a -- We just had a question which came in related to what both of you talked about, so I'll just throw that in there, which is, in addition to grocery, if you were to highlight a few opportunities you think would sort of drive the next wave of demand. I know last conference, we talked a little bit about health care. But are there any opportunities in your mind that are kind of early and would be the next big growth driver from here on from an e-commerce perspective?

Well, Dan, I think he's looking at you.

Yes. Well, I would say, yes, we're going to see this more broadly than grocery. I use grocery, honestly, because it has seen the largest growth based on our numbers in the last 90 days. And we actually expect to see somewhere between 140 million and 185 million square feet of net new demand through a various -- through half a dozen, maybe more segments. So maybe there's incremental growth in many of them. But think about paper and packaging, consumer goods. Just think about the parcel delivery. This is really big. If Amazon -- if UPS has seen 12% international e-commerce growth, that's significant growth for one customer in that parcel space.

Yes. I -- when I look at the parcel space, UPS, FedEx, DHL and AMZL or Amazon Logistics, we're in the continuing period of what I call the arms race of significant investment in capacity, in technology from those service providers. And there will be, in my opinion, plenty of brown box parcels in the years ahead to keep all of those providers sufficiently busy and continuing to grow their capacity. I would say, in terms of other verticals or other spaces, the home improvement space. What we've seen with Home Depot and Lowes and other regional players, that has continued to be a very, very significant driver. And as online adoption and penetration continues to broaden, we're going to see continued growth in that space. And then another one to call out has been the remarkable continued growth in home furnishings and furniture. Heavy, bulky is very, very difficult to fulfill. It's very difficult to deliver and it's very expensive to deliver. But it's been clear, we've seen -- we've seen so many folks as they've been trapped at home, ordering not just hand sanitizer and masks, but ordering furniture from a number of those leading national brands.

And Ben on top of that furniture would be electronics, right?

Agreed.

Electronics retailers typically carry a very thin inventory, and they're going to -- that's going to have to increase in a big way.

Agreed. Agreed. And you mentioned, Dan, the growth of retailers like Best Buy and others like that. We certainly see that across the country, the growth of that electronics space. It's not as difficult to deliver unless you're delivering, fulfilling for big screen TVs. And historically, that category has been one where early on, it got a lot of traction in terms of online. We'll certainly see that continue.

That makes sense. The -- you touched a little bit about Amazon and Amazon really driving parts of their business and the demand or leading from the front. Amazon also started a -- maybe a trend, I should say, in terms of faster delivery, same day, 1-day delivery. Can you talk about how that need, desire, a push from other retailers may evolve post-COVID? And what types of real estate lend itself now to that growth? And I know, Dan, you've done a lot of work on Last Touch. So maybe we'll start with you.

Yes, sure. A couple of thoughts there. And let's talk about Last Touch because it's coincidental that Ben and I are on the same panel here. But I remember when we first started our Last Touch business at Prologis, sitting over lunch in Seattle talking about it with Ben on sharing notes. And it was as you were transitioning from Amazon to Cushman. And Ben gave me a fair amount of encouragement that we were thinking about it the right way. And what we were thinking about with Last Touch, it's pretty simple. Get buildings closer to the people, right? And understand that the customer who has been so focused on ensuring they have all the bells and whistles in their building for so long are going to be willing to forego those bells and whistles for that product, even if it's older, obsolete product, as long as it's closer to the customer. And so we have put a lot of focus in our Last Touch business over the last 5 or 6 years. And think about Last Touch as properties, industrial properties that can get to the end consumer within a couple of hours, not days, a couple of hours. And then the next segment of logistics real estate being city distribution, which has really calibrated for 1- to 2-day delivery. So we had started this business, really -- Prologis was built with an infill strategy. Last Touch was just taking us deeper into the urban core, getting in further infill. And we knew we needed to try to stay at least next to our customers as they figured it out. And they've been trying to figure it out. And so we were dabbling in it as well. We started in Seattle. We started in San Francisco. We've talked a lot about our multistory building in Seattle there. And what we were doing was really building these things one at a time. And we are either building or buying one at a time, just trying to understand that business a little bit better. It's really hard. The information is very fragmented. Most of the ownership in the close end markets for these Last Touch areas are ma-and-pa-type companies that buildings have been passed down for generations, and very little CapEx, a lot of deferred maintenance in these properties. So you really need to have a boots on the ground strategy in order to execute something like this. And we started doing half a dozen or so deals a year. And then we codified a strategy globally about 18 months ago, and we've done 45 deals in the last 18 months. And is that a lot for a company of our size? It is a couple of billion dollars. And they are a well-defined class of real estate within Prologis and within the logistics real estate sector now because when you go to a Last Touch building with Prologis, you know what you're getting. So -- and with that -- and Ben, do you recall that lunch that we had talking about this? Maybe you feel pretty good about having a few things in the [indiscernible]

I do [indiscernible] you following my advice. Yes, I'm so glad you followed my advice.

Yes. As we work with...

Ben, maybe we can expand on that. Like, on the Last Touch segment but as you work with a wider variety of clients, can you give us a sense of how they're thinking about kind of this need for speed?

Yes. And we can't generalize across all different kinds of product types. The way I like to describe it with clients is your Last Touch strategy, just like every point of differentiation in your supply chain and in your delivery, it's got to fit with your value proposition. And not every single retailer out there needs to match Amazon hour per hour, or service for service. It's true that Amazon has trained us and that is to expect free and fast and frictionless customer service. And that informs for many, many retailers what their Last Touch, their final handoff strategy wants to be. But the tendency to want to blanket, say, that everybody has to offer next day. Everybody has to offer same day. It will be the death mill for many, many brands to try and emulate that when only a select number have the scale and the capacity to pull it off most successfully. We, as an industry, will continue to gravitate towards ever faster. We will often work with clients and say, look, you don't have to match that value. You don't have to match that offering exactly. In fact, it could be a serious mistake. I couldn't agree more with Dan in that the world of final touch is all about, yes, getting the right inventory as close to significant population density at the right time. So that you can execute that immediate, that fast delivery, whether fast is same day or next day. In that space, as we look at development opportunities and where that demand for final mile is trending. Since that first conversation that Dan and I had, we've continued to see what I call a sort of a two-pronged development or leasing strategy. For many seeking to occupy this kind of space, when they identify the perfect location, the ideal location to deliver -- no pun intended, but to deliver their value proposition, it may not be a fully functional, high-utility building. It may not have the ideal number of doors, the ideal amount of parking or circulation. But what it has is A1 plus location. And for some occupiers, they will adapt and they will choose location over perhaps ideal utility. The other -- the alternative, of course, is where a golden location and occupier in tandem with a developer like Dan's team to redevelop that ideal location with a highly functional, latest technology sort of building. Not everybody can wait. Not everybody can wait for that full development cycle. And I think that -- those dual paths, we'll continue to see.

That makes sense. I want to just quickly weave in 2 questions that just came on the webcast related to what we've just talked about over the last few minutes. So one, in thinking about Last Touch quick delivery. Do you envision retail spaces or malls that may be challenged fitting in at any point? And then a separate question that just came in. I just want to throw it out there. On the grocery growth that both of you alluded to, specific Dan for Prologis. I would imagine there is a temperature control aspect that's needed to the facilities. So how does Prologis plan to take advantage of this growth in grocery?

Sure. I'll start since there's a Prologis aspect to 1 of those 2 questions. But first, on the mall front, we have talked about publicly and we've been asked this question a number of times over the last several years as e-commerce has been increasing. And I would say, you'd think about it in 3 buckets, really, or 3 major issues around it. One, zoning, right? Cities still are expecting to see retail and the sales tax that comes from that. Owners around the country that have malls and retail boxes, own them at a very high basis. So for them to capitulate, it's a significant write-down, a significant loss on their side. And then just really the assets themselves. They're not necessarily -- the trouble retail has not been very well located. Okay. So now in those 3 buckets right now, okay? So are cities now going to be more amenable to it because they're going to find more stores have been impacted in their respective cities? Maybe. We'll see, okay? This just started. Are owners really in the financial situation for most of their real estate or some of their real estate... [Audio Gap] Logistics. I don't know. It's hard to say you look at some of the big mall operators and other retail owners, you'd see that they've been highly impacted, and they're really having a hard time collecting rent for sure. And then location wise, locations are locations. The one thing I would say, over the last 3 months or so, I've talked to a lot of various retail developers or landlords. And what I'm finding is just more of those same issues. One example is -- I'll just give you a round number. I've looked at over a couple of hundred properties, probably 250 properties. And I've found 6 that are worthwhile spending time on, even spending time on. One may be very well located and there's going to be a dark store there for a long time. But you're sharing space with a thriving big box retailer in that same park lot. How is that cohabitation going to exist? It's early. So do I believe there will be more opportunities than there was before? I think we did the first one on the West Coast last year when we bought a former electronics store in Anaheim. It's actually the only one I'm really familiar with in the country. I mean, there might be one in the East Coast, some place. But that said, I just don't see the opportunity as being broad. Unfortunately, there are some malls and retail boxes in some pretty phenomenal locations that would work pretty well for Last Touch. It's just got a long way to go based on those few issues. And then on the grocery front, we're not interested in going and building a bunch of cooler boxes by any means. But think about a grocery store. Grocery store is not just freezer cooler, right? So will we do a box in a box? For sure. Absolutely. But what percentage of a grocery store, a big box grocery store is freezer cooler versus just ambient storage? I mean, there's tremendous growth. I don't know the numbers off the top of my head. But this is not a situation we're interested in going and building a bunch of very highly customized, highly bespoke freezer cooler-type buildings. But we do own a pretty decent land bank, very well-located land bank. There's ground these situations. There's other ways to monetize that opportunity.

Makes sense. Maybe just -- so moving on, before I get into kind of meshing e-commerce with what everyone's talking about, which is changing of supply chains and maybe more inventory. Maybe I'll get a question out of the way because we've got a lot of them that have come through. Can you -- both of you, from your perspectives over the last few months, but maybe even more recently, talk about two aspects of value. One, what have you seen or heard about rental rates? Markets that are maybe more challenged versus markets that are holding up? And how do you see this evolving? And then can you talk about capital values or cap rates? Ben, maybe we'll start with you.

Sure. Sure. First, on the rental rate front. Again, pre-COVID, we were seeing still very, very tight vacancies nationally and historically tight vacancies in many, many markets. Significant coastal markets have continued to lead in terms of absorption. And even in the face of significant deliveries of new product, we still were not calling for any kind of significant bump in vacancies. Right? When you're talking about 4% and 5% vacancies or in the case of New Jersey, even less than that. Yes, additional deliveries will have some effect, but we're not really -- we weren't expecting to move the needle in 2020 and 2021 very significantly. Then here comes COVID. And it has poured gas. It is has poured an accelerant on demand. If not immediately today, in many markets, we see some pause. But we think with high conviction, because of the increase in demand that Prologis and Cushman & Wakefield and others are expecting, we think there will continue in many, many significant markets to be that upward pressure on rents, strong absorption in the face of deliveries, upward pressure on rents. In the secondary and other markets, they're all different, and it's difficult to generalize. But not to the same degree perhaps, but still, many of those secular drivers that are creating so much demand will be present in what we used to call secondary markets. So I think that trend in '20, in '21 and perhaps even beyond, we're feeling with a pretty good degree of confidence.

Yes. I completely agree with you, Ben. If -- sorry, a little bit of feedback there. If you look at the safety stock that we've been talking about, 285 million to 570 million square feet of additional demand on top of the retooling demand that we just talked about. That's tremendous. That's on top of a more normalized absorption once we come out of this. So yes, we had a tremendous first quarter, and we were en route to a great 2020, it seemed like it. And of course, we flattened everything out with all of this. So we see it very flat. And so -- but I would say it's really in the same pockets that we saw pre-COVID. Yes. Houston is in my region. We've had an issue in Houston. We've rebuilt the team. We went and hired the best guy in the business. And we've got now the best team down there focused. And we've gotten -- we've ensured that we've gotten our outside share of the deal flow as soon as COVID came into play because there's the trifecta going on down there. With oil and gas, there was an oversupply. And then on top of it, this pandemic. So the team has done a great job. I feel actually pretty good about our numbers in Houston for the year. But don't get me wrong, rent growth is going to likely be negative. And we were making sure that we were going to win those outside share of the deals that were available. But activity continues to slog along in virtually all these markets. And so I feel really good about it. And then think about some of these secondary markets. Ben, to your point, you can't generalize because normally, you could look at, and maybe this is a bias comment being a head of the Central Region. But I have Cincinnati in our region here. Well, Cincinnati is building the Amazon Prime Air hub, right? You got UPS in Louisville, right? And then there's a major hub for FedEx in Indianapolis. So you can access 70%, 80% of the world's population in 48 hours. You talk about faster delivery, getting products around. The demand that is -- these tailwinds and just think about the parcels delivery that you just talked about a few minutes ago, Ben. It's hard to generalize any of these secondary markets. And I think we're going to see a net benefit, really, across the board.

That makes sense. And just to...

[indiscernible] to the cap question.

Yes, go ahead.

Briefly to your capitalization and value question. Our capital markets team, in general, we saw a very brief pause on a number of multi-tenant transactions. Single-tenant with good credit, we really saw no COVID effect in terms of pricing, in terms of cap rates. In terms -- in many regards, coverage on new assets brought to market. If anything, we see an increase in appetite, in motivation to own industrial assets of different types and in different kinds of markets across the country. To the extent that there had been some slowdown in some cause, the demand for deals has been backing up behind that blockage, if you will, that dam. We're seeing very, very strong demand for well located -- especially single tenant, but in many markets, multi-tenant product. So we're not seeing a COVID discount at any kind of scale. Select anecdotal examples, but not at all kind of the secular level.

Vikram, I started at this company on the development side of the business and have been on the investment side of the business since I -- basically since I started here. And I remember getting through the last downturn. And I was so thankful that Hamid had decided to keep a core group of investment officers on staff because I benefited from that. But being able to go poke around and look for deals. But we didn't have the financial position like we have today to get through it. And so going into this and seeing this opportunity -- in March, I mentioned earlier that we've been building this balance sheet to get ready for this type of opportunity. That's when a guy like me salivates. I'm thinking, wow, we're going to go here. Let's go after this. Okay, now we're going to go figure out what that COVID discount is, because I still have to figure out how to get any sort of deal through committee, which puts a rigorous process in place, or put a rigorous process in place for us. But that said, I'll tell you, of all the deals that I've looked at, and I have a pretty good view across the U.S. and a pretty good handle of what's going on in Europe, too. Happen to be in Chicago, my hometown here, where we happen to be in the right place, at the right time, deep into a very long contract with a seller that was over their skis. And we were able to capitalize on that for a piece of land, and we actually have a handshake for a user to go build a suit on that site already. But that was just -- and colleagues around the company were frustrated with us because they're worried that we are setting the bar for the market. And within Prologis I was, hey, we're going to get this 40% discount COVID, right? Because this all happened in March. And what we did was we put in a discount to the rent, and we discounted it further thinking, wow, what's happening? Nobody knew there's no price discovery going on. But now what we're realizing a few months later is it's one-of-one deal. And it happened to really truly be us just at the right place, the right time with the right seller, not very sophisticated, that just needed to get out of their situation. And so we're seeing a slight dip maybe for the second quarter. But I think that's largely due, really, to just a flattened rent growth rate that we just talked about. But coming out of this thing, we expect cap rates actually to be lower. The 10 years dropped 100 basis points. How can it not be, right? We think -- they're actually going to be lower than they would have been without the crisis because we think we'll have interest rates -- lower interest rates for longer, which will bode well for values.

That makes sense. I know we've almost run out of time. So maybe one big picture question to close for both of you. We've always talked about the broader supply chain and how the real estate component in there is a very small part of it, maybe 5% of the value. And so there's an ability to push rents. But if you will take, holistically, a look at the supply chain, what aspects of the supply chain you think could evolve more efficiently or more effectively over the next few years post-COVID? Dan, maybe we'll start with you.

I think it's going to be all around the labor side and automation. I think their needs -- labor is this #1 pain point for our customers. And so I think -- who knows what the new normal looks like, right? How comfortable are people going to be working close to each other in warehouses? So what sort of robotics do you need to add to supplement or augment your team with? We've spent a lot of time -- our Prologis ventures, our corporate venture capital arm, they wake up every day thinking about what sort of disruption could occur in our side of the business or our customer side of the business and innovation. And we, as a company, spend a lot of time thinking through that labor, ensuring that we're providing real estate solutions as close to that labor pool as we possibly can. Because until -- but without that labor, our customers are in trouble.

I would say -- well, I certainly agree with you, Dan, about the labor being such a key. And I know that Prologis has taken significant steps to being smarter, being more purposeful in facilitating labor for your tenants, especially in some large parks. Let me just comment then on a little bit further up the supply chain. The anticipated -- the talk and the anticipation of supply chain diversification, moving more and more sourcing if they're in one country, moving to hedge their bets a little bit. The phrase that I've heard from clients recently, China Plus One. Not necessarily pulling out of China, but hedging exposure to one particular country in Asia. A significant share of potential business, exploratory meetings we're hearing about, say, in Vietnam, a lot of that is driven by sort of this China Plus One strategy. I think we'll see more of that. How much of that really comes back to significant increases in manufacturing here in the states, on-shoring, near-shoring to Mexico, remains to be seen. But I think it's going to be a huge driver that we all need to be very cognizant of because it's going to have a direct impact on where, what kind of logistics assets get developed.

So that was great, fascinating comments and conversations, and I'm sure we could go on for another half power. But unfortunately, we've run out of time. Thank you both for doing this. I'm hoping the next time, we can meet in person and obviously, most important of all, everyone stay well and stay safe. And thank you all for the investors for listening in. I hope all of you have a great rest of the week. Thank you so much.

Thank you.

Thank you very much. Good to see you.