Walker & Dunlop, Inc. (WD) Earnings Call Transcript & Summary

Yes. So we did -- you're right, we did go through a lot of change. The firm was accustomed to change by the time I came along because of those handoffs. There were the original 3 founders. Ben was active for the longest of those original named founders. And then you had Mike and Rob and Brian. And so by the time I came along and my partner, James Iker, and a number of others and the ownership of the company, by the time we came along, JBG had gone through management succession before. So it wasn't a first time. There were, however, other new dynamics unfolding when we went public. And if you rewind the tape at the time, 2017, we were going from being private to being public. We were going from being a partnership to being a more hierarchical public company structure with a CEO. We've never had a CEO. I had never been a CEO. I have never worked at a public company, let alone run one. I was at Goldman Sachs before they went public. So we were merging with another company. The Vornado/Charles E. Smith portfolio was almost quadrupling the size of assets that we were overseeing. And merging -- doing all the merging accounting systems, payroll systems, having to figure out who is going to run the engineering group, who is going to do this, who is going to do that? Hiring a lot of new people to implement the public company infrastructure. I would say when you kind of fast forward back to today, what are the things that we've gained from that? I do think our processes and our systems and other things. We were doing a great job I really do believe, as a private company, but there really is no comparison. In how many things are managed and overseen and done in the public company context, it's more rigorous. It just is, in part because it has to be because of internal audit functions that private companies aren't required to have and other things. I think in terms of the thing that we have worked hardest to try to maintain is our entrepreneurial agility. And that's difficult as you get bigger. It just is. You can't quite give people as much autonomy as you might have done in the past because you're more accountable. And everybody needs to be. And so you need to have a little more process and more systems. And I think we have done a good job of navigating that transition without losing our entrepreneurial edge, but also still satisfying all the requirements of this new format. You may have seen we were ranked in the top 3 of the Washington Post's Best Workplaces last year, which we take a lot of pride in. And I think that's a reflection of the fact that our team is really engaged. We do still distribute authority and responsibility. We give people a lot of rope and a lot of room to run. And that's something that Mike and Ben and Rob and Brian and the other founders of the firm really taught me and the rest of us is that if you want good people to stay, you have to give them a really meaningful work. And meaningful work comes from having enough ownership over what you're doing and not feeling like you're ever micro managed and that you have runway to perform and prove yourself. And we really worked very hard to try to maintain that in the public context.

You underscored the fact that you've never been a CEO before you became CEO. And you mentioned 2017, you won the Washington Business Journal CEO of the Year Award in 2017.

Right.

So I -- that may be a record, Matt, of being placed in your first CEO role and winning CEO of the year in your first year as CEO. In one of the videos that the Washington Business Journal put out around that, John Wilkinson says in it, you like to break the status quo. How have you broken the status quo? Because what I sense and have watched is you've taken this incredible firm and allowed it to continue to grow. You've been a very participatory member of the senior leadership team. And then at the appropriate time, you stepped forward and now have taken JBG to all new heights. But I've never sort of viewed you as a status quo breaker. How should I -- what am I missing about the Matt Kelly story that says they're a status quo breaker?

It's a good question. I don't know if I would say that's my thing that I'm a status quo breaker per se. I think maybe what John meant -- and I love John. He's one of my closest friends and a really successful entrepreneur in his own right. I think what he may have meant was that I tend not to just take things at face value without really questioning why. And when someone says, "Well, we need to do it this way because that's the way it's always been done." That, to me, isn't a sufficient answer. It's not a good enough reason to keep doing something the same way it's always been done. You may, in fact, keep doing it that way. But I'd like to understand why things are done and to really assess does it make sense to continue to do them that way? And we take that approach to chasing new deals to pursuing new prospects. When we were pursuing the Amazon HQ2 transaction, there was a process that was put in place that we were expected to follow, and we did. But we did everything in our power that we could to stand tall and to really try to distinguish ourselves from our competitors in the eyes of the folks that we were trying to woo to the area and invested money in marketing resources and in supplementing and supporting what the Commonwealth of Virginia, what Arlington County were doing in ways that I'm not sure others were doing because we said this is a pull-out-all-the-stops effort. And I don't care what the guidelines say about how we're supposed to pursue this. Let's do it our way because we have a sense that this is likely to prevail. And so I think when it gets at really is more just not necessarily accepting something as, okay, I understand that's why others do this, but why are we doing it? And should we be doing it that way? Or should we maybe take a different approach?

So JBG owns and manages over 20 million square feet of office, multifamily and retail assets all in the D.C. area. Before we dive into sort of asset classes in office and retail, hospitality -- not hospitality, multifamily, JBG's focus has been just on the greater Washington area since the firm was founded, actually as a law firm, way back when in 1960. And I know for a fact that you all have been asked numerous times by all sorts of different people to broaden your impact and go outside of D.C. and put a flag in New York and put a flag in San Francisco. And you all have remained focused on just the greater Washington area. Talk about that focus, Matt, and how that's been able to drive value for your investors beyond what you think you could do if you were to broaden the reach of JBG?

Yes. It's a good question, and we do get that question a lot. We often compete for deals and for tenants and others with players who are in other markets. And we see the way in which our local position and local scale really give us an edge. And that comes through in broker relationships and tenant relationships. There is no great substitute for having that local presence. Now lots of companies have a local presence in many markets, and that strategy works for them. And never say never as to where we may go one day. But for the time being and for our history, we have always had considerable opportunity in our home market. And the opportunities in that market have always stood out as the ones that we're best equipped to monetize and create value from. And if you just look at what you laid out, we have almost a 15 million square foot development pipeline. And there's no one better positioned in our market to harvest value from that than we are. Over half of the company is in the shadow of HQ2 right now, which is just in the first couple of years of what is likely to be a multi-decade run of incredible growth. I mean, Amazon alone is going to increase the daytime population of the National Landing submarket by almost 70% in the next decade. And there's nowhere else in the country we could invest and find similar tailwinds from a growth perspective. And most of our company is concentrated in that opportunity set. And so while we have at times evaluated that question of, are there better opportunities elsewhere and should we look at those, inevitably, when we do it, something else in our home market pops up that's very rich and appealing and attractive as an opportunity set. And we turn our attention back to that and say, "You know what? Let's not pay, as we call it, the out-of-town tax going into somebody else's market where there's a local JBG who may eat our lunch. Let's keep doing that here in this market, where we have deep expertise and relationships."

I'm wildly jealous of the fact that you don't have to travel to any of your offices on an airplane because I get the job of traveling to 38 offices across the country and spend much more time on airplanes than you do. But I'm curious as it relates to diversification and whether you hear from investors that say, it is the federal city. When you have a government in place like we do right now that seems to be bringing up spending bills as quickly as they possibly can, my assumption would be that investors say, "Well, that's great. That means more government contracts. That means more lobbyists. That means more lawyers, and that means positive for JBG." There have also been administrations that peel back on government spending. And all of a sudden, everyone's like, "Can we ever get another lease from a law firm or from a lobbying firm?" Does -- has -- have you -- I'm assuming that the view is that you have diversified enough in both asset classes as well as submarkets to the greater D.C./Maryland/Virginia area that you're not directly tied to just sort of government spending. And therefore, you've been able to sort of disassociate and diversify by saying, "Look, the submarket of Fairfax, Virginia really doesn't have a whole lot to do with the federal government spending. We have found real value in Fairfax. And therefore, that's why we're building a multifamily property there." Am I right on that?

Yes. I think it's a bit of both, right? I think what you said is right that we are much, much more -- we're not just an office company. We're certainly not just a government office company. Office today is about 70% of what we do, but we're on record saying that our intention in the next couple of years is to migrate the company to be majority multifamily. And we will get there by selling some of the noncore office that we picked up in the Vornado merger, which, for tax reasons, we couldn't really start selling until last year, and by building and acquiring new multifamily assets in our development pipeline. The federal government is our largest tenant. And so government, government contractors are a meaningful part of our office business. When you look at the future, the biggest part of our story is the Amazon growth story. And fast forward to a day in the future when we have completed the portfolio recycling and other things that I talked about, we will be office in National Landing primarily, as to our office portfolio. And then majority of the company will be multifamily in National Landing and elsewhere. And that's an economic growth picture that is very different from the D.C. office market writ large. It's very different from what government spending might mean for those types of office buildings. Much of the office that we control in that context is -- it's National Landing. It's really the Amazon tech growth story and one that we think is likely to play out much like it did in South Lake Union, Seattle, where Amazon grew in almost the same fashion from about 5,000 people to over 50,000 people in the course of a decade. And other users filled in north of 4 million square feet in addition to what Amazon did. And we think that's very likely to unfold in National Landing. And so does that mean the government and what it does won't be important? No. That will still be important. It will still be a critical anchor. Many of the tech tenants that we see looking at the Washington market come there because it has a rich talent pool, and they -- that's their primary input is talent. The other factors that are increasingly important are proximity to regulators, wanting to have an open dialogue with Washington, with lawmakers, with regulators, those who are setting policy because it's becoming increasingly important to the tech sector in general. And then on top of that, they're looking for cities that are not as constrained from a growth perspective as, say, New York or San Francisco. And while Washington does have a need for a lot more housing, while it does have its own traffic, transportation congestion, it's nothing like those other cities. And so when you line it up against the labor pool, it measures very favorably from a tech employer perspective. And we think by controlling that concentration of office in that submarket, National Landing, we'll be right in the center of the bull's-eye of where a lot of those folks want to be for all those different reasons.

So I want to loop back to the growth in the Amazon HQ2 development and all that in a second. But before we move off that, in Q2, you all had either deferred, reserved for or abate about $2.5 million of rent. Was that predominantly in your office portfolio matter? Or was that both in office and multi as it relates to that? And on top of that, what's your view right now as it relates to back to work? Because obviously, you've got this extensive office portfolio, tenants who run the full gamut, from the federal government all the way across to much, much smaller employers. What's your view given where we stand today on back to work?

Yes. Great question. When you look at COVID and its impact on our business, the tenant group that has been most impacted are retailers. And so a lot of our reserves are around amenity retail uses like restaurants and bars, not surprisingly. Parking has also taken a hit because people aren't driving into those office buildings. Those numbers have been ticking up slowly, but it's still a fraction of what it was pre-COVID. We do have one hotel that suffered a hit as well, and that's a small part of it. The biggest question, I think, on everybody's mind is how do people use their office space when all this is over. And I feel right now like I'm living the second of 2 summers, right, where the first summer was felt like a post-COVID summer. And now I feel like I'm back into this déjà vu, the COVID hunted house, you never know what's around the next corner. And we're seeing more office users push their plans to return to the office back. Some are pushing them back a month to October. You may have seen Amazon announce they're pushing theirs back to January. And I think the truth is no one really knows how we will engage with office space as companies, as employers in the future because the future is not here yet. We were really hoping it was going to be here September 7. I think a lot of people were. And I think a lot of companies are likely going to adjust their plans, hopefully only for the short term. What we're hearing from most employers is that they feel they must offer some level of hybrid work as a workplace amenity because people demand it, and they don't want to find themselves with a labor shortage. It's a tough hiring market already. And if you try to have everyone come back to the office 5 days a week, you are not going to like the result with what your employees do in voting with their feet. And many of them are gravitating to a Tuesday, Wednesday, Thursday plan. Maybe it's 4 days on the aggressive end. I don't know of anyone who's doing 5 days. We're hearing from architects that there is a lot of rethinking around how space will be utilized and how common area spaces will be utilized, what kind of IT will be needed. The focus is much more heavily on collaborative space because the view is if people are in the office fewer days a week, we want to make sure more of that time that they are in the office is spent collaborating. The thing that is tough to solve for is the fact that the vast majority of employees don't want to live in a clean desk, hot desk format. They want their own dedicated space when they're there. And that may, in fact, foreclose or forestall the ability of companies to really shrink their footprint much at all. So I'm not sure -- and we don't hear much of it, about companies looking at this as a cost-saving opportunity. We hear much more focus on how do I manage this next phase in a way where I just don't screw it up, I don't sound tone-deaf to my employees, and I create a space that's welcoming and inviting where they actually want to come back to the office. Because I think people are starting to see a bit of a degradation of the -- of engagement, of collaboration, of just people feeling like they're part of the team. And you can maintain course and speed with inertia for a while, which we did through the pandemic. It's really hard to do U-turns and to really get creative and disrupt what you're doing in ways that are productive if you're doing it all virtually. It -- versions of it can be done, but we hear consistently that folks really want to get their people back to the office some days a week.

And it's got to be a totally different thing as it relates to the outlook for lease renewals right now in your portfolio to the degree that a year ago, a lot of people were sort of like, "No idea when we're back in the office. And now we got a big lease coming up, I may not sign it." My assumption, Matt, would be that today, if you've got a big lease renewal coming up, people are negotiating that lease renewal because they know they're going to go back to the office. It's just a matter of sort of, is it October, February of next year, with that question mark of, do I need the office space, is off the table. Is that fair? Or are you seeing people still say, "Don't know if I actually need the space?"

I think that's fair. We've actually been pleasantly surprised that most of our -- the vast majority of our renewal activity has been medium and long term. We've seen a lot of 5-, 7-, 10-year deals coming out of COVID. There are, I think, a number of employers that -- if they're very small, like we've seen in the district in D.C. proper, and we've sold most of our D.C. proper assets, but we see this through some of the third-party assets we manage that a number of small operations, small businesses have let their leases expire and have said, "We've got 10 people. We're all working from home. We're just going to let it lapse. And when it's safe to get back in the water again, we'll just go out, and we'll lease space somewhere because the market's not that tight. And I'm not worried about not finding space." And so we're starting to see some of that come through in the numbers of new tenants in the market. We're seeing a lot of new tenants that are larger, restarting processes that were on hold during COVID, during the heights of the pandemic. Renewals are in line with where they were pre-pandemic, only there are more of them. And because folks are generally not initiating searches for new and different space, they're staying where they are. But they're not pushing for short-term deals the way you might have expected that they would just to see how this plays out. I think most employers are comfortable making a call that says, "I know I'm going to continue using office space. Not exactly sure how, not exactly sure how many days a week, but we're not going to all virtual." That doesn't work, and how they come back and how that then translates down the road into space utilization is still an open question. And it's one that may involve individual neighborhoods, clusters in certain submarkets needing potentially more coworking space, more flex space, more meeting spaces that are amenity-driven and amenity-like to the underlying base of office tenants who are there in days of the week that are necessarily not that easy to predict right now.

So as you focus on kind of transitioning/transforming JBG from having a portfolio that was more weighted on office to more weighted on multi, you have one multi project under development right now. I think it's an 800-unit project that's under construction right now, a bunch in the pipeline. As you look at the market today, does your -- do your numbers and thoughts right now say, "Let's put more shovels in the ground, even though the cost of construction is going up, getting labor is tough and all the other things?" Or are you a buyer at these sort of ridiculously low cap rates on the multifamily side? What's the -- as you sit around with your team and trying to grow the multi portfolio, is it a build or is it a buy scenario today?

It's a great question. So we have a pretty unique hand when you look at our pipeline of new development because we have plus or minus 5,000 units. We've got, as you said, almost 1,000 units, 808 units under construction right now, 1900 Crystal Drive, 2 300-foot tall towers overlooking Reagan Airport, the District, the river. It will be the best new product in all of Northern Virginia when it's completed in a couple of years. We have, in Amazon, as I mentioned earlier, this unbelievable demand driver. Amazon is over 1,600 people today, growing to just under 40,000 in the next decade. That'll be 10x their current size just within the next 5 years. And when you fast forward to the day when they're even halfway through their hiring trajectory, their people alone will generate enough demand to support almost the entirety of our pipeline, if we could build it all right this second, which, by the way, we can't because we still have to get some of it entitled, some of it designed and ready to go. So when we look at our opportunity set, Amazon is a dramatic accelerant. And we will not be able to keep up with the demand, even going as fast as we can and doing as much as we can. We control over 3/4 of the unencumbered new supply in that submarket. So we really are the provider of housing to everybody but, in particular, to a lot of those new Amazonians. And we know from the experience of South Lake Union in Seattle, roughly 20%, 25% of their team like to walk and bike to work. And so you do the math on that, at 40,000, that's roughly 8,000 potential residents. And we don't have that much housing in our pipeline. So the math is incredibly favorable. So we look at long-term growth trajectory in rents as one metric that attracts us to a new investment opportunity. So we're builders in National Landing, for sure. But we also look at upfront price point. And to your comment, cap rates on housing right now are incredibly low. Some of those cap rates, you have to really parse what's a pre-COVID or post-COVID number in terms of rents. Rents in the D.C. area are -- in our portfolio are back almost to exactly where they were pre-COVID. So we've recovered a lot of what was lost in the depths, but it's very difficult to find real value. And so we're focusing when we're trading out of office buildings that are noncore, and we want to redeploy the capital right away, but we don't necessarily have a development opportunity teed up. We're looking at probably 20 deals for every 1 that we make, and it's usually a deal that has some funky dynamic with ownership or the sales process or -- is coming online in a submarket where we see a lot of exciting growth in the future. And that's places like Union Market, like the ballpark, like other neighborhoods where we know a lot of the office tenants, especially tech tenants, want to go. And so that's where we're focusing our efforts. The other question, Mark, is construction costs. What happens there? We see lumber prices are coming down now, but they spiked to crazy levels. 1900 Crystal Drive, we could have started in March of 2020. And we checked our swing because we thought, we gambled and thankfully paid off, that contractors would tighten their pricing coming into COVID -- into the COVID winter of 2020, which they did. And we ended up saving about $30 million to $40 million on that deal. And so that experience showed us that what you read in the papers about housing costs, and the cost of construction in that market aren't necessarily applicable to what's happening in commercial, we are seeing some trades spike their pricing. But in many ways, we're still not back to pricing that we saw pre-COVID. So that's a volatile market, and it's one that we pay a lot of attention to because that's -- building a building is -- you're just buying it slowly over time, and your basis obviously matters.

So you and Amazon are building not only an incredible community for their HQ2, but you want to make it the most technologically advanced infrastructure in the country. And you signed a partnership with AT&T at National Landing to create an advanced 5G network. I actually read a press release that you all put out that you just got -- the Arlington County Board just gave you rights to use, I got to get this right, the excess dark fiber and conduit access in National Landing. So first of all, parse that for me. Are you going into the dark web, Matt? I like read that and I was like, he's going to the dark web. I'm not sure what's down there, but he's going in there. But what is it that you and -- you are doing as it relates to creating this 5G network? And quite honestly, we've all talked about a future -- a city of the future, and Google spent a ton of time and money trying to create the city of the future up in Toronto and completely backed off of all of that. It seems like you have the size and the scale and the focus with a partner like Amazon to really show us what the, at least, community, maybe not city, but community of the future is going to look like. So what does this partnership and what does getting access to the Arlington County dark fiber mean?

So great question. We -- a couple of years ago, right after winning HQ2, we went to Seattle, and we sat down with the major tenant brokers in that market and a lot of the big tech companies that are there. And we asked them, we said, "Okay. You followed Amazon here or so it would appear. Why did you do that?" And the #1 answer was talent. We can hire people here. We like -- they like to hire Amazon employees because they're well vetted, well trained, well screened. But they also like the talent pool in that market generally. We have that. Okay, check. They said, "We value robust, redundant, ubiquitous connectivity." And we sort of thought, "Well, isn't -- doesn't every major gateway city have that? Aren't we awash in fiber and everything else?" And the short answer is no. It's not consistent. We don't have it everywhere, and we certainly don't have the latest WiFi 6 and 5G and all the other things that are coming along next. We spent some time with Virginia Tech and their team, their real leaders in wireless communications. And as you know, we're helping them develop and develop around their new innovation campus in Alexandria. And they said, "You guys are in a great position as a dominant real estate owner to be a real facilitator of 5G connectivity." And I will tell you, we knew very little about this a couple of years ago. But we invested some resources in building out our team and bringing on advisers to help us get smart. And what they said was essentially, if you own enough of the physical environment, you can facilitate 5G connectivity because you have to hang these antennas in a lot of different places. You don't have to negotiate with 50 different landlords to get it done. You can essentially offer the service on a ubiquitous basis in your neighborhood by controlling building facades. And if you already control them, you probably have one of the more complicated elements of the mosaic that you need to do this. But there's more to it than just that. You should ideally have access to or control of wireless spectrum. You should have control of redundant fiber connectivity. That's where Arlington County comes in. Arlington had laid a lot of this but had not partnered with service providers yet. And we were already in discussions with a lot of service providers to help activate the 5G network that we plan to roll out and to be a part of deploying the spectrum that we acquired from the FCC last summer. So the deal we put in place with AT&T is one that will allow us through them as a service provider, and others who will come along here after, to provide the 5G connectivity service that our customers want and to do it on a robust, redundant fiber backbone. That has now been supplemented by what Arlington County had already invested in and to do it in a way that will allow us to deliver that service inside the buildings and outside the buildings and to use our spectrum that we acquired, the CBRS spectrum, to offer private cellular networks, again, through service providers so that tenants who want to innovate and tenants who have autonomous robots or vehicles or anything in what you would think of as the Internet of Things that needs to communicate rapidly over high speeds, get to edge data centers, do it in an urban environment where there's lots of interference but where it can still function, we want them to want to come here because we will have, no kidding 5G, no kidding ubiquitous fiber, indoor and outdoor 5G, edge data computing where you don't have to go all the way out to Ashburn data centers to process your data and allow your device to function. And we can do all of that in part because we own a lot of the physical real estate, and we now have deals with fiber to supplement that with the county. But we can also do it because we're not in it for the data. We're not like some of these examples you laid out, where the objective was to get people's data. We don't care about that. We want our customers to want to come here because they can do things here they can't do anywhere else. And so we just wanted to have enough control of these assets so that we could identify the right partners, have them commit to do it quickly and have partners who were aligned with us in providing good service for their customers, not using it as a backdoor way of trying to get access to customers' data. And so -- and that's the partnership we have with Arlington County, with AT&T. We're all very well aligned on that score. And by the way, that's what our customers want to hear, too. And so we think it's a real win-win of a partnership and one that you're going to hear a lot more about in the coming years as we continue to put together deals with other service providers to really roll this out. And you'll see 5G operability actually accessible by 2022 in this submarket with everything that we're doing and the partners that we have in place, which will make us, I think, one of the first big urban concentrations in the country to be able to do that.

Just real quick on that because we're about to run out of time. Is there anything from an autonomous vehicles standpoint that would allow you to provide transportation inside this community that is distinct from other places in the country?

Yes. I mean, I think what you'll see, autonomous vehicles have to process tremendous amounts of data in order to function properly. And they have, in other cities, built these little purpose-built ecosystems for them. And where they start is low levels of interference. They just want to get the concept right. Autonomous vehicles need to be able to work in an interference-laden urban environment with lots of moving people and other cars and airplanes flying overhead and helicopters and other things. And by having 5G operability and by having the high-speed, redundant fiber connectivity and by having edge data computing nodes, which is the next phase of what we're working on, we'll be able to provide operators of those kinds of devices with the infrastructure they need to enable their product to function. So it will make our submarket a perfect test bed for somebody who wants to innovate and develop and not do it in a cornfield somewhere but actually do it in a real city. And then, by the way, maybe bring some lawmakers over across the river to see what they're doing and to see this is innovation at work, and this is what the future could look like. And I think that's a really powerful combination.

It's super powerful. It's really exciting. And it's by far the most technologically advanced in the built world of anything that's going on out there right now. In other words, I don't know another developer who is at this cutting edge because of the partner you have, because of the scale you've been able to amass and the ability to, if you will, change the dynamic between the technology providers, the cellular providers, the county and what you're building. And it's super exciting, and I can't wait to see as you take your team and as you continue to build there what that ends up producing. As you can imagine, Matt, I could keep going, but I told you it'd be just an hour. And I'm going to let you go and thank you for spending the last hour with me. It's -- I love doing these, particularly when I'm talking to a friend and someone I've known for a long period of time. JBG and W&D have a long, long, long history. As you well know, we actually provided JBG with its first loan ever that my dad did for Donald Brown back in the 1960s. And as you also know, Don Brown and Mike Glosserman and the rest of your partners have all been dear friends of mine over a very, very long period of time. So I'm extremely appreciative of you spending the time today, sharing your insights on the markets. Congrats on all you've done at JBG, and I look forward to seeing you when I'm back in D.C.

Appreciate you having me, and I look forward to that as well. I'm honored to be asked to do this and really enjoyed it.

Thanks, Matt. I hope everyone has a great day. We'll see you again next week on another Walker Webcast. Take care.

Thanks.