CBRE Group Inc - Class A (CBRE) — Q4 2022 Earnings Call Transcript

Good morning everyone and welcome to CBRE’s fourth quarter 2022 earnings conference call. Earlier today, we posted a presentation deck on our website that you can use to follow along with our prepared remarks, and an Excel file that contains additional supplemental materials. Before we kick off today’s call, I’ll remind you that today’s presentation contains forward-looking statements, including without limitation statements concerning our earnings outlook. Forward-looking statements are predictions, projections, or other statements about future events. These statements involve risks and uncertainties that may cause actual results and trends to differ materially from those projected. For a full discussion of the risks and other factors that may impact these forward-looking statements, please refer to this morning’s earnings release and our SEC filings. We have provided reconciliations of the non-GAAP financial measures discussed on our call to the most directly comparable GAAP measures, together with explanations of these measures in our presentation deck appendix. I’m joined on today’s call by Bob Sulentic, our President and CEO, and Emma Giamartino, our Chief Financial Officer. Now please turn to Slide 5 as I turn the call over to Bob.

Thank you Brad, and good morning everyone. As you’ve seen, we reported core EPS of $1.33 for the fourth quarter. While down significantly from a year ago, core earnings were slightly above the estimate we provided at the end of the third quarter. This outcome was driven by several of the more cyclically resilient elements of our business, like outsourcing and others that are secularly favored, like project management and the logistics asset class. These businesses, which together comprise about 45% of our core EBITDA, grew revenue more than we expected, offset by a slightly larger than expected decline in transactional revenue. Full year core EPS grew 7% to $5.69. This is a solid growth rate considering the more than doubling of long term interest rates, sharp equity market decline, and the credit crunch that constrained investment activity for most of the second half. Notably, we ended 2022 with virtually no leverage despite making share repurchases, infill M&A, and strategic investments that together totaled approximately $2.1 billion during the year. Looking at the macro environment, cap rates are up 100 to 150 basis points, perhaps a bit more for office, and we expect them to expand another 25 basis points or so before peaking, likely in Q2. While capital largely remains on the sidelines, we are beginning to see signs of asset re-pricing helped along by the narrowing of spreads. Among property types, multi-family and industrial fundamentals should remain strong, albeit with occupancy declining slightly from peak levels and rent growth continuing at a more modest clip than the double-digit pace set in 2022. Office will remain the most challenged property type as we do not expect occupancy to come close to pre-pandemic levels in the short term. Globally, we expect significant sales and leasing weakness in the first half before adverse conditions begin to ease later in 2023. Relative to 2022, we expect both Europe and Asia Pacific to outperform the Americas this year. For 2023, we expect core EPS to decline by low to mid double digits but still to be the third highest in CBRE’s history. As we’ve pointed out before, this would be a meaningfully better performance than in prior recessions, such as the global financial crisis when core EPS decreased more than 60%. In all, 2023 will be a transition year and we feel good about where we’ll be when we get to the other side of the downturn. While the macro environment can certainly change, we expect core EPS to grow strongly in 2024, exceeding the 2022 peak and reaching a record level in just the first year after a recession. With that, I’ll hand the call to Emma, who will discuss our quarter and our outlook in greater detail. Emma?

Thank you Bob. Before turning to our 2023 outlook, I’ll first discuss fourth quarter results for each of our segments, starting with advisory on Slide 6. Advisory net revenue and SOPs declined by 21% and 33% respectively, driven by a slightly more pronounced decline in our higher margin transactional businesses than originally expected which was partially offset by healthy growth from our property management business. For capital markets, sales and mortgage origination combined revenue declined by 46%, in line with our expectations. Capital markets revenue growth was robust in last year’s Q4, increasing by 53%, which accentuated the extent of this year’s decline. Leasing revenue was down 7% both globally and in the Americas, a slightly bigger decline than we expected with a notable slowdown in office activity in New York, Boston, San Francisco, and Seattle. In total, global office leasing revenue was 14% below prior year after increasing by nearly 50% year to date through the third quarter, albeit against relatively easy prior year comparisons. Outside the U.S., leasing revenue was down 6% wholly due to FX translation headwinds. In local currency, lease revenue increased in both EMEA and Asia Pacific. The 19% decline in loan servicing was attributable to fewer prepayments amid rising mortgage rates versus record prepayments in Q4 2021. Excluding prepayments, loan servicing revenue increased by 2%. Overall costs in advisory declined by 18%, but this was not enough to offset the 21% decrease in total new revenue. Turning to Slide 7, GWS net revenue grew by 13% with half of that increase coming from organic revenue growth. In local currency, net revenue excluding Turner & Townsend increased by 12% with facilities management up 9% and project management up 21%. GWS SOP increased by 30% with margin improvement driven partly by business mix. Turner & Townsend continued to grow impressively. In the first full year since acquiring a 60% interest, Turner & Townsend has exceeded our original underwriting. 2022 represented our highest ever year for client contracts coming up for renewal, totaling over $4 billion. GWS renewed 94% of this total, often with increased scope of our client relationships. Looking forward, we expect 2023 renewals to be just over half the level of 2022. The GWS revenue pipeline ended the year up 11% over year-end 2021, reflecting continued demand from first generation and outsourcing clients as well as expansion mandates from our existing client base. Turning to Slide 8, REI SOP declined to just $17 million in Q4 against an unusually strong prior year comparison. Our global development business posted a $6 million SOP loss primarily due to a $43 million loss in our Telford, U.K. development business. Lower SOP in U.S. development reflects the timing of asset dispositions, which were heavily weighted to this year’s first half, consistent with our expectations going into the year. Following an in-depth review of the Telford business, we wrote down a handful of projects where we expect costs to exceed our initial underwriting, and we also increased our fire safety reserve. We now believe Telford financial performance will improve going forward. Investment management AUM grew $5 billion sequentially, driven by net capital inflows of $4 billion and positive FX movements which offset $5 billion of mark-to-market declines. Investment management SOPs declined due in part to co-investment losses versus a gain in the prior year quarter. Excluding co-investment gains and losses, investment management SOP was nearly flat with the prior year quarter. Turning to Slide 9, our 2023 outlook is underpinned by the following macroeconomic assumptions. The U.S. will experience a short, moderate recession in 2023, unemployment will increase to near 5%, inflation will end the year above the Fed’s 2% target but clearly trending down, and 10-year U.S. treasury yields will end the year under 3.5%. Should the economic outlook change from this base case, our business outlook would also change. In our advisory segment, we expect a mid single digit revenue decline. This will be driven by growth in more resilient lines of business offset by a mid to high single digit decline in leasing and mid-teens decline in property sales. We expect SOP to decline by high single digits to low double digits as cost savings initiatives partially offset both relatively better growth in lower margin businesses and general cost inflation. In our property sales business, we expect the number of transactions will be subdued in the first half of the year and accelerate in the back half of the year. We expect our leasing business to continue to benefit from an elevated level of lease expirations. While the return to office has been slow in the U.S., EMEA and APAC have seen occupancy return at a faster pace. As a result, we expect these regions to be less pressed than the Americas in 2023.

Tony, first of all, even if the work you do for a client in a specific portion of their portfolio is shrinking, it likely would result in project management work, potentially transaction management work, and portfolio management work. So even if you have some shrinkage within an account, there are opportunities for revenue. But secondly, there is the addition of new accounts which has been very significant for us for the past year, actually record levels, and we’re expecting that going forward, where people are giving us more property to manage because they want to save costs, so the combination of those factors has allowed us to grow that business consistently over the years during downturns, and we expect it’s going to be a double-digit grower in 2023 for the same reasons.

Thank you and good morning. My first question relates to GWS and the outsourcing business, and I was wondering if you can take us inside that business a bit more and help us understand how in an environment where office usage is down and footprints are shrinking, that that business can continue to grow. Just would like to better understand what additional services clients are taking on to maybe offset smaller footprints.

Yes, and you’re asking with regard to property sales?

And leasing, just the more transactional stuff.

Yes, okay. Well, where we’re seeing activity in sales is for good assets, even in some cases office assets if they’re Class A buildings, fully leased, but for sure industrial and multi-family. If you went back to last year, even the end of last year, you would get a couple bidders that would test the waters, but now for some of the better quality assets, we’re getting several bidders and they’re bidding aggressively, and there are anecdotes on multi-family and industrial in particular where we’re seeing that happen. It’s quite a bit different from last year. There is a lot of capital that’s been on the sidelines wanting to acquire assets. There are a lot of asset owners that have wanted to sell assets, and we’re starting to see spreads come in a little bit now and the buyers get a little more aggressive in various cases, so that’s what you’re seeing there. With leasing, we continue to see very strong fundamentals in industrial. There is low vacancy, there are a lot of companies out there that still need space for a variety of reasons, and so we are seeing momentum there, and then you have, as we said before, considerable amount of renewal activity around office buildings and retail in particular.

Hi, good morning. Thank you for taking my questions. Bob, you talked about 2024 EPS recovering to 2022 levels at least. What gives you confidence on such a recovery, just given the macro environment and the uncertain outlook that we all have at the moment for the rest of the year? Are you seeing any signs on the ground of improvement, anything that gives you that confidence to go out and talk about 2024 right now?

Yes Chandni, I’ll comment and then I’ll give it to Emma. First of all, we actually expect 2024 to not go back to ’22 levels but actually exceed ’22. A big part of that is the large portion of our business that’s either secularly benefited or cyclically advantaged, all of that outsourcing business which in aggregate is now quite large. Anything we’re doing for the industrial or multi-family asset classes, we expect to be strong by then. Project management will be strong, we expect the debt business to come back, so all of those circumstances are driving it. Now, the thing that would cause it to not happen is if we were wrong about the recession, if the recession was worse or lasted longer or started later, but those parts of our business are what we expect to drive that outcome.

Yes, to put a little context around what those numbers look like, Chandni, if you think about our resilient lines of businesses, we’ve talked about that being 40% contributor to our SOP. In 2022, it was 45% of our SOP; in 2023, it’s going to be closer to 50% to 55% of our SOP, and those are our lines of business that we expect to continue to grow through a recession, so that’s becoming a larger and larger part of our business. Then our transactional business lines, we expect them to rebound starting a little bit the end of 2023 into 2024, and what’s important to know about that is the growth that’s embedded in that outlook to get back to above 2022 levels means that our advisory lines of business, our transactional lines of business would need to grow less than they did in 2021. Putting that all together, it’s very achievable. Then on top of that, what’s not embedded in the 2024 guidance or our outlook is any sort of material capital allocation or M&A, which would put us far above 2022 levels.

That’s very helpful, and that’s exactly what I wanted to discuss for my next question, but with a focus on 2023. Regarding buybacks and general capital allocation, you mentioned a modest use of capital in 2023, which indicates that the buyback is not included in the EPS guidance provided today. How would you prioritize buybacks versus M&A in 2023, and do you expect buybacks to resemble those of 2022?

Sure. When we consider capital allocation, we assess buybacks and mergers and acquisitions, evaluating which option will provide a better long-term return. In 2022, there weren't many M&A opportunities, but we are developing our pipeline and seeing conversations pick up in a way that we did not see last year. Since there wasn't significant M&A activity, we repurchased nearly $2 billion of shares when our stock was at an appealing valuation, and we plan to keep that option open. We are continuously assessing whether to repurchase shares or pursue a major transformational acquisition, and we will keep you informed as we progress. However, we did not include specific expectations for these actions in our outlook, as we are uncertain about how things will evolve moving forward.

Hey, good morning. I was wondering if you could speak to how you’re thinking about free cash flow conversion as a percentage of your core net income in 2023.

We anticipate our free cash flow conversion to be similar to 2022, around 75%. It's important to recognize that since we are in a declining market, there can be inconsistencies in the timing of bonus accruals and cash payouts. If we adjust for those timing factors in 2023, our free cash flow conversion is more aligned with the mid-80s, which is our long-term target. Therefore, we expect that by 2024, we will experience a more stable growth environment, achieving a mid-80% free cash flow conversion.

Yes, thanks. Good morning. Bob, just circling back on the sales activity, I’m just curious, in your mind, is the potential pick-up in activity more a function of the overall level of interest rates or more of a stabilization of rates and spreads, where people can actually know what their cost of capital is before they start to underwrite transactions? I’m just trying to figure out which one’s the bigger lever, the actual rate or the stabilization of rates.

I think probably right now, it’s the stabilization of rates. The other thing, Steve, that I think is going on is people are recognizing that with all the concerns about the economy, and obviously there are considerable concerns, the fundamentals in industrial and multi-family are really strong - really low vacancy rates, every reason in the world to believe that rental rates will go up at least somewhat, and that’s in what’s going to be a tough year and then longer term, it’s going to be better. Then you have this just very human thing about sellers being ready to sell and buyers being ready to buy with capital and sitting on the sidelines for a long time. As soon as two or three circumstances start to line up favorably - fundamentals, stabilization of rents or rates, rates coming down a little bit, some talk in the market that maybe the recession won’t be as bad as we thought. When you get that confluence of circumstances, things start to shake loose a little bit, and as soon as one or two buyers go into the market, others start to get into the market because they’re afraid they’ll be left behind.

Yes, absolutely. I do want to step back, and there are two major things going on that are different. The first is the U.K. put in a fire safety act which is still under review, related to a very terrible fire that happened in 2017, so through that act, they’re requiring all home builders who have built a building over a certain size over the past 30 years to bring those buildings up to the current fire safety standard, so as a result, we and all other homebuilders in the U.K. are having to go through this process of determining what the cost will be across all of our buildings that we’ve built over the next five, 10 years, as long as it takes us to remediate those issues, and that’s where you see the non-cash, about $140 million reserve that we took in Q4. What’s important to know about that is that is our best estimate of what we think the cost will be to remediate those, but the actual cash outflow to remediate those issues across those buildings will be over a very long period of time, so we view that as an isolated, anomalous issue that’s occurring across all homebuilders in the U.K. The second piece is how the operations of our business are being impacted, and that’s primarily related to the external environment, record cost inflation, we had a number of COVID slowdowns that we’ve talked about over the past numbers of years within Telford specifically, so what we did in Q4 is we evaluated all of our projects, you saw that we impaired a number of assets and we took a $43 million loss in Q4 - for the full year, it was just shy of $50 million, and we believe that that’s contained, that that’s a very good estimate of the value of those assets going forward and that we’re at an inflection point going forward, and we expect under new leadership and with the tailwinds behind U.K. build-to-rent that that business will continue to grow going forward.

Okay, thanks. I’d just wonder, are you seeing any green shoots at all in the U.K. housing market from a demand perspective, or has that not yet started to pick up?

A little bit, Steve. You know, we still have the economic circumstance that we have with high interest rates, with concerns about the economy that’s causing people to not spend the way they would spend normally, so that’s a little bit of downward pressure on the business, but we’re encouraged by what we see in terms of the longer-term trend.

Great, thanks. Maybe we can go back to leasing for a second. I’m just curious how your strategy around that might be changing, just given the longer term implications that remote and hybrid work could have on performance and impacting the space. I think, Bob, you’ve talked about expanding in industrial, so maybe just how thoughts around that changed, and if you can remind us what percentage of the leasing revenue comes from the office sector, that’d be helpful.

Okay, Emma, do you have the percentage of our leasing that comes from office?

It's a little over 50%, which has decreased from about 70% in 2019, showing a steady decline.

Our current assumption is that the downward pressure on office leasing will continue for the time being. There hasn't been much change in the return to office over the last few months. We have developed a plan for the next several years that expects this trend to persist. We anticipate a gradual shift from lower quality to higher quality assets, leading to increased rental rates, which will positively impact the business. However, we expect a larger portion of our income from leasing to come from industrial properties rather than office spaces compared to the longer-term past, and we do not foresee that changing. Emma's comments about our growth plan for the next several years fully reflect this perspective.

Thanks, that’s helpful. Then just one on geographic performance, it seems like your commentary and expectations around EMEA and APAC are maybe a bit incrementally more positive relative to the Americas. I’m just curious if there’s anything driving those underlying assumptions - is it thoughts about economic growth or potential for a shallower recession there, but anything you can expand on, on performance of those other geographic segments, that’d be helpful.

We are currently not anticipating a recession in Europe, and we expect Europe to perform better than the U.S. regarding return to the office. In Asia, we predict a return to office conditions that resemble historical trends, and we have very strong businesses in Korea, Japan, and China compared to our historical performance and relative to our competition. Our business in Japan has grown significantly, and we expect it to continue expanding. The economic conditions are positively skewed, and the return to office situation is also favorable as we transition from the U.S. to Europe and Asia. Additionally, our business position is particularly strong in Asia, and our operations in Europe and the U.K. have also improved significantly over the past few years, contributing to this positive outlook.

Thank you very much. First question would be if the move-in rates in the last couple of weeks have changed anything in terms of tone from major CBRE clients that you’re hearing.

I don’t think it’s had a major impact, Jade. Everyone seems to believe that uncertainty will persist for a while. Our outlook for the year remains largely unchanged. We continue to expect a relatively mild recession, anticipating that we will emerge from it toward the end of this year or early next year, with the capital markets recovering in the latter half of the year. We are already observing positive signs anecdotally. While we don’t want to draw too many conclusions from those signs, we believe we will see more of them in the latter half of the year.

Jade, I’ll walk through development first and then our investment management business. On the development side, any impairments, and we don’t think there should be significantly more this year, are embedded in our guidance for that segment, and as I noted in my remarks, we’ve already generated $100 million of SOPs in January alone in our development business, so we feel pretty confident in how the development business will pan out for this year. On the investment management side, what we’re expecting is slightly positive net flows for this year, so $5 billion primarily from our listed mandates and then also from infrastructure, and from our opportunistic funds to a lesser extent, and then we’re also embedding a slight decrease in the market value of that AUM which will offset some of those net inflows.

Thanks everyone for joining us, and we look forward to talking to you again when we report on our first quarter.