Greetings. Welcome to Marcus & Millichap third-quarter 2019 earnings conference call. [Operator instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Evelyn Infurna of ICR. Ms. Infurna, you may begin.
Thank you. Good afternoon, and welcome to Marcus & Millichap’s third-quarter 2019 earnings conference call. With us today are President and Chief Executive Officer Hessam Nadji and Chief Financial Officer Martin Louie.
Before I turn the call over to management, please remember that our prepared remarks and the responses to questions may contain forward-looking statements. Words such as may, will, expect, believe, estimate, anticipate, goal and variations of these words and similar expressions are intended to identify forward-looking statements.
Actual results could differ materially from those implied by such forward-looking statements due to a variety of factors, including, but not limited to, general economic conditions and commercial real estate market conditions, the company’s ability to retain and attract transactional professionals; the company’s ability to retain its business philosophy and partnership culture amid competitive pressures; the company’s ability to integrate new agents and sustain its growth and other factors are discussed in the company’s filings, including its annual report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2019.
Although the company believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, it can make no assurance that its expectations will be attained. The company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.
In addition, certain financial information presented on this call represents non-GAAP financial measures.
The company’s earnings release, which was issued this afternoon is available on the company’s website, presents reconciliations to the appropriate GAAP measures and explanations of why the company believes such non-GAAP measures are useful to investors. Finally, this conference call is being webcast.
The webcast link is available on the Investor Relations section of our website, www.marcusmillichap.com, along with the slide presentation you may reference during the prepared remarks. With that, it is my pleasure to turn the call over to Hessam Nadji..
Thank you, Evelyn. On behalf of the entire Marcus Millichap team, good afternoon, everyone. Thank you for joining our third-quarter earnings call. MMI faced some headwinds during the third quarter, culminating in revenue and net income declines of 5.9% and 7.5% year over year.
Investor sentiment became increasingly clouded by headlines on recession and trade fears while many investors opted to postpone transactions in anticipation of lower interest rates. This is a sharp contrast to the urgency in the marketplace we saw last year, given the fed’s four consecutive rate hikes and aggressive forward messaging.
Internally, we experienced more variability in transaction closing and overall execution time line, as well as a persistent bid-ask spread. A transaction mix during the quarter also contributed to the revenue decline despite the company’s total number of transactions and volume actually being essentially flat with last year.
Given the natural variability of the real estate transaction market, we have continually balanced optimizing results in the short term while reinvesting in the company for the long term. In this spirit, a five-year look back at MMI reflects revenue growth of 46%, pre-tax income growth of 39% and sales force growth of nearly 40%.
This is based on trailing 12-month results through the third quarter of this year versus the same period five years ago. These numbers were achieved in light of flat to declining market sales in three out of the past five years. Now looking forward, let me highlight a number of factors that we’re encouraged about.
First, despite a choppy sales environment, real estate fundamentals remain healthy across virtually all property types. The historical tendencies to overbuild and over leverage during an expansion have not occurred in this cycle. The economy continues to generate solid job growth, fueling consistent real estate demand and rent growth.
Secondly, interest rates are now down 130 basis points from a year ago, and most importantly, appear to have bottomed, which should result in trading volume growth over the next few quarters.
We continue to observe record amounts of capital on the sideline, ample availability of debt capital and multiple offers for assets that are appropriately priced. Our expanded marketing efforts and intensified client outreach are generating more connectivity with buyers, sellers and borrowers than ever before.
As just one example, after several weeks of negative headlines, we held a special market overview webcast on September 12, which was viewed over 6,000 investors. The goal of the session was to share facts and grounded data points that balanced elevated economic concerns with solid fundamentals.
As another highlight, our expanded presence at industry conferences, private-label investor symposiums and webcasts have pivoted and now integrate market education with inventory exposure to a larger buyer pool. As a result of all these efforts, we are seeing modest but steady growth in our pipeline.
However, in the current environment, it simply takes more time to educate, underwrite and bring buyers, sellers and lenders together. Our brokers are also spending more time keeping deals moving forward. Taking a more detailed look at the quarter, our brokerage transactions declined 3% and volume increased by almost 3%.
Real Capital Analytics, or RCA, reported market sales volume decline of 6% for the third quarter. But further breakdown of RCA’s data shows market sales declining 11.5% excluding industrial sales, which were up 31% year over year. Industrial was an important growth sector and diversification opportunity for MMI.
And we registered a year-over-year brokerage transaction gain of nearly 37% in the sector. However, it currently represents a small revenue base for us. Excluding industrial, the RCA numbers suggest a larger margin of share gains for MMI in that core property type.
During the quarter, private client revenue declined by 3.8%, while we saw a larger decline at mid-market and larger revenue due to higher variability in these segments and their outsized gains last year.
We’re also seeing more of a bid/ask spread at higher price points, and several large transactions were delayed or postponed late in the third quarter. Some of these transactions may come to fruition beyond the fourth quarter.
Looking beyond the short term, the company is poised to further penetrate larger transactions as we expect more of our private investors to seek larger, higher quality investments. At the same time, many of our institutional clients are acquiring more assets at lower price points and in secondary markets.
We are ideally positioned to facilitate this capital migration. In terms of trends by property type, our multifamily revenue has been challenged as the market has slowed in the aftermath of last year’s record pricing and trading volume.
We view this as a normal post-record cooling, especially since multifamily occupancies and rent growth remain very healthy. Overbuilding concerns are still limited to a handful of metros and demand for Class B and C assets remains strong, given the risk-adjusted return. There is simply a wider bid/ask spread that the market is working its way through.
Concerns regarding rent control measures were also impacting multifamily sales in some markets. For example, California and New York recently passed rent control legislation, which is exacerbating the slowdown in sales in the short term.
We expect these markets to recalibrate over time as they have low vacancies and high supply barriers, which are elected to get even worse due to rent control measures. These markets also have strong long-term attributes that drive job creation and the favorable demographics, which are attractive to many long-term investors.
It’s also important to remember that the overall multifamily segment is a massive and vibrant market. We are seeing continued buyer interest and capital migration to markets such as Florida, Texas, Arizona, Nevada, Washington and many others.
MMI’s comprehensive and growing North America coverage in virtually every primary and secondary metro and our consistency of execution are major advantage. From a brokerage point of view, private client multifamily sales are highly fragmented, which offers them additional share growth opportunity over the long term.
We are leveraging and building upon our leadership position in this important space. On the financing front, we are strengthening and growing MMCC through tailored technology and marketing enhancements, as well as the expansion of our lender relationships.
The third quarter’s modest revenue growth is largely attributed to transaction mix as the number of financing transactions actually grew 13%, but financing volume declined due to the higher number of smaller deals. Year to date, our financing revenue was up 15.2%, and transactions have increased 14.4%. Now turning to our sales force metric.
We added 75 professionals over the past 12 months or a growth of 4%. Our emphasis on hiring more experienced professionals has yielded great addition and remains a core part of our growth strategy going forward. We are taking additional steps through our recruiting team and regional managers to further build on this success.
Despite a competitive labor market, we are adding new talent attracted to our local management, mentorship programs and comprehensive training. Our seasonal performance assessment has led to increased terminations based on the company’s performance standards.
This is in line with our programmatic sales force development and management practices particularly in light of the maturing cycle. With respect to our acquisitions, we continue to see progress in the integration and contribution among the companies and groups that we’ve acquired over the last 18 months.
I’m happy to report numerous examples of client referrals and business opportunities spurred by our recent addition. These synergies add value to our network, brand and platform and provide incremental growth opportunities for MMI that complement our traditional organic growth model. Let me now turn to outlook and priority.
Our top priority is to expand inventory, pipeline levels and resume revenue growth. This will be achieved through the continuation of intensified client outreach and marketing initiatives, as well as the ongoing expansion of our sales force.
It takes time for this advisory-based client service to translate into revenue growth in a changing market, but this has been the foundation of our nearly 50-year history of achieving long-term growth. Ongoing improvements to the Marcus & Millichap platform and brokerage support systems remain major priority.
These investments are essential for the development productivity and long-term retention of our sales force, and we’re excited about a number of new tools and applications under development.
We are executing on our strategic growth initiatives, including expanding our financing capabilities and team, as well as the expansion of our larger transaction and further penetration through the IPA division.
MMI is well-positioned to scale future acquisitions as we optimize our targeting and infrastructure and continue to see more reasonable valuation expectations. We are currently evaluating additional acquisition opportunities that provide expanded market coverage and/or growth in key property types, as well as financing.
Based on what we’re seeing in the market, executing additional acquisitions remains our top capital deployment priority at this time. Let me reiterate our sensitivity to synergy, accretive valuation and long-term growth prospects as key parameters of our underwriting.
Given the importance of our growth-oriented focuses, both internally and externally, we are assigning a key executive in charge of corporate initiatives. The goal is to streamline communication and execution throughout the enterprise, and helps us plan and implement projects more effectively.
This includes helping us scale the evaluation, vetting and underwriting of potential acquisitions and coordinating post-acquisition integration. I am excited to announce that Marty Louie will be transitioning from his current post as CFO into this vital role.
He is well qualified to help us move forward with more efficiency and speed given his skills, tenure and relationships throughout the firm. Marty will remain in his current post as CFO until his replacement is selected, and we will be initiating the search shortly.
In closing, our brand, growing platform and balance sheet remain strategic points of strength as we pursue our growth plan and create shareholder value over the long term. At this point, I’d like to turn the call over to Marty to discuss further financial results in more detail.
Marty?.
Thanks, Hessam. Before diving into our financial results, I want to thank Hessam and the board for allowing me to focus my attention toward the company’s growth initiatives. I’m very excited for this new opportunity to help our team take the company to the next level. And now for our financial results.
In the third quarter, MMI executed 2,435 transactions for the total sales volume of $12 billion, which was slightly higher than the year-ago period. Our average commissions per transactions came in lower due to transaction mix during the quarter.
Total revenue was $198 million, which reflected a 5.9% decline over last year’s third quarter, which has increased approximately 15% year over year. Real estate brokerage commissions, which account for 91% of our revenue, decreased 6% to $180 million while financing revenues grew a modest 40 basis points to $16 million.
We experienced a 3.7% decline in private client revenue for the quarter, which came in at $121 million as a result of a slower sales environment as many investors opted to hold on to assets in the immediate term and/or refinance.
Revenue in the Middle Market and Larger Transaction businesses declined nearly 17% and 7%, respectively, as activity levels in Larger Transactions continue to slow this year after a robust increase in 2018. As we have noted, larger deals, particularly executed by private clients tend to be more variable over time.
Additionally, we were boosted last year as interest rates were rising, and the fed was aggressively messaging further increases into the future. As a comparison, combined revenues from our Middle Market and Larger Transaction businesses were up nearly 27% in the third quarter of 2018.
As Hessam noted, we have seen less urgency to transact in the market this year in anticipation of declining interest rates. Year to date brokerage revenue was down 4%, while transaction count and volume were slightly down by 3% and 1%, respectively.
In light of the market shift and changes this year and a slower sales environment, we believe we will continue to gain market share and make the Marcus & Millichap platform more competitive. Financing revenue of $16 million for the quarter was largely supported by a rise in refinancing transaction.
This is consistent with other periods of lower sales during, which more investors have refinancing options for liquidity. The decrease in financing volume was due to the decline in average transaction size for the quarter. However, on a year-to-date basis, our financing revenue is actually up 15%.
Our financing business remains a major focus of our growth plan. Other revenue which is comprised primarily of consulting and advisory fees along with referral fees from other real estate brokers came in at $2 million for the quarter. Lastly, we finished the quarter with 1,945 professionals for a net addition of 75 over the last 12 months.
We continue to add more experience and best of sales professionals to our team, increasing our head count by 81 professionals or 4.6% over the last 12 months to 1,846. We remain confident in achieving our long-term target of growing our sales force by an average of 100 professionals per year.
During the quarter, total operating expenses decreased 4.9% to $174 million. The decline in operating expenses for the third quarter was due to lower cost of services and lower SG&A. Cost of services fell 6.6% year over year to $124 million due to lower commission expenses, driven by the decrease in revenue.
As a percent of total revenues, cost of services fell by 50 basis points to 62.6% due to transaction size, mix and brokerage compensation. As a reminder, cost of services is primarily comprised of the commissions we’ve paid to our investment sales professionals in compensation for our financing team.
SG&A decreased year over year to $48 million as we remain vigilant in cost management while making investments to support our sales force, revenue growth and platform improvements. This includes lower back office and compensation-related costs, offset by increases in marketing support and business development initiatives.
This also includes planned facility expansion necessary for future growth in key markets. Our SG&A also includes acquisition-related expenses. Diluted earnings per share for the quarter was $0.49, compared to $0.53 per diluted share last year, representing a decrease of 7.5% year over year.
Our tax rate for the quarter was 26.7%, which was on the lower end of our guidance from the previous quarter. Due to the elimination of certain operating expense deductions and states conforming to changes related to the 2017 tax law, we expect our effective tax rate for the full year to be in the 28% to 28.5% range.
Adjusted EBITDA decreased to $27.9 million during the quarter while our adjusted EBITDA margin was 14.1%. While we were able to manage some of our operating expenses this quarter, we continue to invest in key initiatives to improve our technology and broker systems, as well as resources to scale our acquisitions and other growth initiatives.
As discussed in the past, our adjusted EBITDA margin, just like our overall performance, should be viewed on the long-term basis as there could be some variability from quarter to quarter. As a result, we expect our adjusted EBITDA margin to remain under pressure for the remainder of the year as we continue to work to further grow our pipeline.
Moving to the balance sheet. We finished the quarter with strong liquidity levels with approximately $376 million of cash and cash equivalents and core cash investments.
As Hessam mentioned earlier, our capital position continues to be a major advantage in the event of an unexpected market downturn, investments in our platform, improving our organic model, as well as additional strategic acquisitions. This is particularly important as we aim to scale our acquisition capacity.
In addition to the acquisition of Form Real Estate Advisors, which we closed during the fourth quarter, we are currently working on a variety of opportunities that are at different stages of discussions. We look forward to updating you on definitive milestones in the coming months.
Before closing, I’d like to point out a number of key factors, which may have an impact on our results for the remainder of the year. First, Q4 of 2018 revenues increased nearly 14%, with brokerage revenue up 19.1%.
During that quarter, our private client revenue grew 15.5% while the Middle and Large Transaction business grew 14.4% and 41.3%, respectively. Last year’s comparison is especially challenging given the slower transaction market this year. Second, we continue to make incremental progress in growing our inventory and pipeline.
However, transaction time lines remain extended due to price expectation gaps. A number of delayed closings and postponed transactions that impacted the third quarter may take more time to come to fruition beyond the fourth quarter.
Third, the slowdown in apartment sales in the near term continues to be a challenge especially in markets impacted by recent rent control legislation.
While we expect the apartment market to recalibrate with support from strong fundamentals, healthy overall rent growth and lower interest rates, growth in sales velocity may remain hampered in the short term. Lastly, our cost of services and SG&A tend to be at higher levels in the fourth quarter. I would like to now open up the call for Q&A.
Operator?.
[Operator instructions] Our first question is from Stephen Sheldon, William Blair. Please proceed with your question..
Hi, guys. Thanks for taking my questions. And congrats on the new role, Marty. You talked a little about the opportunity in the industrial sector and the boost it probably had to overall industry volumes. I think you break out some vertical exposure, but I don’t think you do an industrial lease that I’ve seen.
How big is that vertical for you right now? And how do you think about going out for that opportunity? Is it a major focus in the near term? Or are you talking more longer term?.
Stephen, thanks for your question. Right now, industrial is one of our smaller product segments. And we have a very aggressive plan to expand it. We’ve had some success in a number of metros in the last 18 months since we really put the plan together. And that has shown us that there is a very good opportunity for us to penetrate the market.
It’s a little bit more complicated in that there’s a lot of owner user billings, and our value proposition is a little bit different. And therefore, we’ve had to kind of tailor our approach to the client base. There’s a lot of sale-leaseback opportunities. These are a lot of small businesses that have a lot of capital tied up in their real estate.
And so there is a pretty significant educational part that we bring to these small businesses. They have to be private investors, so from that standpoint, it’s very much right down the fairway of the kind of a customer base we’re used to servicing.
And it’s shown very good success, and we’re looking for different ways to scale it in a variety of metros. But today, it’s a relatively small revenue base for us.
And that’s why when we compared our performance to what’s happened in the market, we had to dig a little deeper to understand why the normal pattern of how we outperform the market from a transaction perspective, penetration perspective, a market share perspective didn’t look right if you look at the headline numbers.
And it turns out, if you exclude industrial, which again, is a small base for us, the market contracted by 11.5% when we were essentially flat on a year-over-year basis. So that’s why it was important to point it out..
Got it. Makes sense.
On the elongated deal time line, is there any way to frame how much they may have expanded? And then any potential quantification of the degree of impact from the transaction pushout that you noted?.
We don’t really quantify it. We certainly track it internally. But from a disclosure perspective, that’s not information that we normally publish. However, I can tell you that transaction time lines have expanded somewhere between 7% to 10% over the last year or so.
And it’s just a natural byproduct of the fact that it’s taken more time to bring a buyer and seller together, certainly because of the bid/ask spread in the marketplace, the negative headlines and some of the uncertainty that I spoke to during my formal remarks, but also to get the loan secured and this new element of timing, given the expectations of falling interest rates.
That has been a factor this year more so than we’ve seen before. And it’s a combination of all those things that we are working our way through..
Stephen, this is Marty. One of the things I’d like to add to that is that the good news, though, is that when you look at some of our other metrics like died deals that were under contract, as well as expired listings, all of those metrics are at historical low levels. So that’s the promising part about our pipeline right now..
Great, thank you..
[Operator instructions] Our next question is from Mitch Germain, JMP Securities. Please proceed with your question..
Thank you.
I know you’re doing some marketing and other client outreach, and you said – I’m curious, based on your comments, how long until you start to see results from those efforts?.
Mitch, normally, when we have intensified marketing campaigns and the kinds of additional activities that we have been implementing over the past six months, it takes one or two quarters to see additional listings that come out of that process and additional closings and maybe a little compression of time lines because we tend to reach bigger buyer pools through these activities.
In this environment, it’s taking longer for all the reasons that we’ve discussed earlier. So I can’t really quantify it, but I can tell you that the interest level of the clients is there, the attendance levels are definitely there, which really tells you that our clients are looking for direction.
Our clients are trying to decipher all the conflicting data points that are coming in and what does this mean to them.
And so from the standpoint of getting closer to more private investors, more institutions and everything in between that we’re targeting for relationships, this is really helping us get the brand out there and open dialogue with a lot more people, and – but it’s taken longer for all of that to translate into specific listings and closings..
Got you. I know you used to talk about the cross-regional sales activity. I’m curious where that percentage sits..
Well, to your point, Mitch, we have continued to engage in those, not only in the United States, but also internationally through our Global Capital Markets initiative, where we have brought a Marcus & Millichap’s lag representatives and our inventory to about half a dozen international symposiums around the world predominantly capturing private investors from different countries and regions around the world that are very interested in U.S.
real estate. But domestically, the connectivity between all of our various regional activities has become much more inventory-based. For example, we just had an event in Florida, we had an event in Southern California, we just had an event in the Bay Area.
All of these events are now pivoted toward featuring inventory and connecting local buyers, especially coastal buyers that are looking to move capital to a higher cap rate markets or rotate capital from one product type to another, and we’re getting a lot of traction. And so far, the results have been great from an attendance perspective.
And one of your questions last time, Mitch, was about the tracking of the metrics from all these events and some of the expenses that are related to it. And as a reminder, we track every attendance, both physical and online and follow-up with the clients and track how much business eventually comes from these activities..
I’m curious about the cadence of transactions in the quarter. It seems like – did you see a pickup as the quarter progressed? I know it’s not a metric you’ve shared in the past, but I’m just curious about momentum in the business..
Actually, sentiment and activity slowed down in the latter part of August and the first part of September. So a lot of the headwinds that I referenced in my formal remarks really intensified in the latter part of the quarter.
If you recall, in August, there was just a lot of negative headlines regarding the inverted yield curve, trade wars and recession fears, a lot of which has not subsided, thankfully. But there was lots of activity, incoming phone calls, a request for information from our clients as a reaction to all of that.
So it was a really later part of the quarter that showed the increased concerns..
Great. Last for me. Curious about the performance of the M&A that’s close. I guess, there’s been, if I’m not mistaken, four transactions, I believe, three of which have kind of been absorbed, and I believe one newer one. I could be off on that, but I apologize. But I’m just curious about how performance is tracking relative to your expectations..
Sure, Mitch. We have executed six transactions since June of 2018. And obviously, their maturation time with us is a key point as it takes some ramp-up for each of these companies to get listings, have a chance to market them, to say nothing about getting acclimated and integrate it into our system and so on. So they’re at various stages.
Some of our transactions closed in late 2018 and early 2019 with Form being the last one that closed in October. So they were at various stages. But what I can tell you is the amount of interconnectivity, common client opportunities is really encouraging.
It’s – we’ve seen it across the board, especially when you look at some of the Canadian opportunities where capital is looking to deploy various product types for United States, our expanded Canadian presence has already turned into a few referrals.
And the integration of financing and our brokerage in Cleveland throughout the Midwest has been very successful. And they were very encouraged. This is one of the key reasons we’re looking to scale our acquisitions, we’re looking to very carefully in a calculated fashion, dedicate more resources to it because I think we’re doing it right.
It’s all ground-up organic types of common cultures that drive the interest on both sides. And part of dedicating Marty’s experience and time and energy to it is tied into that strategy..
Well, I wish Marty the best..
We have reached the end of the question-and-answer session. And I will now turn the call over to Hessam Nadji for closing remarks..
I’d like to thank everyone for joining us for our third quarter call. We look forward to seeing some of you on the road and your attendance on our next quarterly call. Thank you very much..
This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation..