Marcus & Millichap, Inc.

Thank you for standing by. This is the conference operator. Welcome to Marcus and Millichap's third quarter 2020 earnings conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press the 1 followed by the 4 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and zero. I would now like to turn the conference over to Evelyn Inferna. Please go ahead.

Thank you. Good afternoon and welcome to Marcus and Millichap's third quarter 2020 earnings conference call. With us today are President and Chief Executive Officer Hessam Nadji and Chief Financial Officer Steve DeGennaro. 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 variation of these words and similar expressions are intended to identify forward-looking statements. Actual results can differ materially from those implied by such forward-looking statements due to a variety of factors, including but not limited to the COVID-19 pandemic, 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 discussed in the company's public filings, including its annual report on Form 10-K filed with the Securities and Exchange Commission on March 1, 2020. 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 statement, 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 and is available on the company's website, represents reconciliation to the appropriate gap measures and explains why the company believes such non-gap measures are useful to investors. Finally, this conference is being webcast. The webcast link is available on the investor relations section of our website at 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 and thank you for joining our third quarter 2020 earnings call. We'd like to extend our well wishes for health and safety to everyone on the call. I'm pleased to report significant progress in overcoming the COVID-19 market disruption. During the third quarter, MMI registered sequential increase of 35% in total revenue and transactions, or 552 more deals over the second quarter. The company's earnings advanced with pre-tax income of nearly $8 million and positive cash flow from operations of $24 million after essentially working hard to break even amid the initial shock of the pandemic. We executed over 2,100 transactions and $9.1 billion in volume, including 442 financing transactions closed with 182 separate lenders in the third quarter. As a key illustration of our ability to connect buyers and sellers, even in a disrupted market, 44% of our brokerage transactions were ultimately acquired by an out-of-state buyer. This is a testament to our vast buyer relationships and expansive market coverage. Above all, these numbers reflect our team's unwavering client commitment, problem solving, and execution skills, especially in a difficult market environment. Internally, several factors supported the quarter's improved momentum, starting with the resurrection of many deals and listings that had been delayed or canceled. Our investor education webcasts intensified direct marketing and business development campaigns. We're also instrumental in connecting our sales force with as many investors as possible. In all, we have conducted 25 market overview webcasts, attracting nearly 90,000 investors, that's 90,000 investors, and generated 121 research publications and video segments since the onset of the pandemic. The market environment became moderately more constructive during the quarter as many lenders reentered the market and expanded financing options for investors. The broad availability of debt at record low rates is clearly a big factor in the marketplace. Let me reiterate that financing is still very much sector-driven with tight underwriting and conservative assumptions, and many deals require creativity and compromise in bringing buyers and sellers together. The uptick in market sales during the quarter is also indicative of investors cautiously emerging from the initial shock of the pandemic and deploying capital into the best-performing sectors. This includes apartments, fast food and drugstore single-tenant assets, industrial, and to a lesser extent, office and self-storage properties. Apartments have benefited from better-than-expected rent collections, with the exception of newer, high-end properties in urban areas, which have been hit much harder than the suburbs. Trading of hospitality, seniors' housing, and lower-tier shopping centers, already affected by e-commerce prior to the pandemic, remain hampered. Market sales were still down by an estimated 40%, as reported by third-party sources today. as price expectation gaps and economic uncertainty keep buyers and sellers apart. By contrast, MMI's brokerage transactions were down by 13% in the third quarter on a year-over-year basis. We believe this points to share gains for MMI. Our potential for additional growth in virtually every segment as well as recent improvements in our internal metrics Such as the ratio of died transactions and reduced marketing timelines bode well for the near-term outlook. Let me reiterate the challenging operating environment that still limits personal interaction with clients as well as in-person training and management of our sales force. A full return to normal operations is clearly dependent on medical solutions to the pandemic and their wide acceptance by the public. Accordingly, we have been and remain prepared for the long haul. We are further expanding our virtual business execution while leveraging our management talent beyond geographic boundaries to train and support our Salesforce. Nevertheless, rebuilding our pipeline and inventory levels to recapture year-over-year growth and achieve new financial milestones will take time. As we have demonstrated since the onset of the pandemic, Thank you for joining us. and consultative due diligence services as well as debt and equity placement across all property types. Their loan sale and consulting clients include commercial and investment banks, hedge funds, special servicers, government agencies, and private equity firms. Their debt and equity team specializes in structured finance and equity advisory for institutions, developers, and private real estate investors. Mission Capital's expertise and client base are very complementary to MMCC's core mortgage brokerage business. Their ability to help expand our business with lenders while generating distressed property sales leads will add value to our clients and our current sales and financing teams. In August, we introduced a major upgrade to the Marcus Millichap website with a special focus on making it easier for investors to search our inventory, connect with our professionals, and access our expansive content. This came on the heels of rolling out brokerage tools in virtual execution of our brokerage model and a major upgrade to our internal pipeline tracking system earlier this year. In short, we are leveraging the market disruption to strategically execute offensive measures that improve the firm for the long term. Now, taking a closer look at the quarter's results, we saw sequential gains in all market segments, particularly our private client business in apartments and single tenant net lease. Middle market and larger transactions also experience healthy movement. However, the higher price points remain somewhat more volatile than usual in contrast to the easier to finance private client assets. Financing revenue rose by 23% sequentially and declined just 2.5% from the same period in 2019. While refinancing continued to be a meaningful contributor, we did see an improvement in purchase finance volume. The strength of MMCC last quarter points to the successful integration of our acquisitions and the increasing productivity of our financing teams. MMCC remains a key component of our growth plan. On the recruiting front, we grew our brokerage sales force by 74 professionals over the past year, while our financing team declined by 20 as we shift toward more experienced financing professionals. The overall decline sequentially was expected and reflects a significantly more challenging market environment for newer professionals. As we have messaged before, this is very similar to past downturns. However, regardless of the headwinds against breaking into the business, we're supporting our newer sales professionals through intensified education, business planning, and management guidance. While the company's headcount trends will remain challenging for some time, History tells us that many of today's newer professionals who persevere through this period will be future market leaders. Looking forward, we are steadfast in executing the plan set forth at the beginning of the pandemic. This includes careful scrutiny of capital and resource deployment given the level of uncertainty in the marketplace, focus on assuring smooth operations, extensive internal support and communication, to make sure our team is as productive as possible. Maintaining high-frequency quality client outreach, especially as investors formulate strategies going into 2021. Strategically investing in technology and brokerage tools that advance our services and productivity. And last but certainly not least, leveraging the market disruption to scale our acquisitions. Since the launch of our acquisition initiative in mid-2018, MMI has completed the acquisition of seven companies. These have added valued members to our team who are contributing to our results. These numbers do not include the hiring of experienced agents. We believe the market disruption enhances our ability to add accomplished individuals, teams, and companies who come to know MMI's benefits. As such, acquisitions and platform investments remain our top capital deployment strategies. From a market perspective, plenty of lingering risks and uncertainties lie ahead, and investor sentiment is still fragile. We could face more economic constraints due to virus outbreaks and strained healthcare systems and or further delays in the next round of stimulus, which is badly needed. These factors directly impact tenants' ability to pay rent. At the same time, we cannot underestimate Positive factors and vast growth opportunities for MMI, including the following. First, Federal Reserve has declared its commitment to low interest rates and economic support for an extended period. This comes after the unprecedented liquidity injection from which the markets are already benefiting. Second, over half of the jobs that were lost in the first few months of the pandemic have been recovered. It may take time for many industries to stage a comeback and some jobs may never come back. However, the economy is already showing a shift toward innovation and resilience. Third, the release of pent-up demand upon a widely deployed medical solution to the virus should not be underestimated. As uncertain as the timing may be, we expect a sizable jump in consumer and business activity likely to occur sometime in the next 12 to 18 months as we truly recover from COVID-19. Fourth, record capital on the sideline is still looking to be deployed. In a global marketplace, commercial real estate provides the full gamut of risk-reward investment opportunities, which we believe will attract more private, client, and institutional capital to our business. And last and certainly, again, not least, although the full ramification of the election outcome on the economy will take time to assess, the general trend should be favorable for our business. Additional stimulus and focus on a medical solution are very much likely to be top priorities. All of these dynamics spell countless opportunities and some pain ahead for real estate investors. MMI is well-positioned and prepared to be the ideal trusted advisor in crafting and executing the best solution one client at a time. Our theme since the onset of the pandemic has been control the controllable. To this end, we remain agile, dedicated to supporting our team, and committed to our clients, especially as the market improves. Most importantly, we have substantial financial strength and a dominant brand Powering our offensive stance. Let me now welcome our new CFO, Steve DeGennaro, to his first earnings call. Steve?

Thanks, Hessam. Before I review our results, I want to express my enthusiasm for having joined Marcus and Millichap as CFO. I have been on board now for 90 days, but this is my first opportunity to speak to you in this forum, so I thought it would be helpful to share some of my initial observations. At a high level, I've been impressed by the culture, the incredible attention to detail, and the focus on execution in the business. Of course, our balance sheet is extremely strong with cash and core cash investments of almost $9 per share, which is well above our peers, and no debt. That has helped us remain on the offensive. The company also has an expense management culture. There is certainly a willingness to make tough decisions and to act swiftly. There's also a growth and opportunity-driven culture that is constantly searching to fill geographic and product-type gaps in our portfolio. As we look at acquisitions, culture, fit, and economics are appropriately important factors in how we evaluate M&A deals. I also see opportunities for improvement in the business. Scaling for growth requires that we constantly reassess our processes and likely invest more in technology. We cut costs in the spring in response to the pandemic, but as the business comes back, we will invest differently from how we did previously with a heightened focus on innovation. Continuing on the theme of scale, we can scale our acquisition capabilities and turn the M&A process into a strategic advantage that allows us to leverage our strong balance sheet to be disruptive at a time when there is market displacement. The company's growth plan is very well aligned with my experience, and I'm very excited to contribute to MMI's future. Turning now to the results, we are pleased with what we accomplished in the third quarter, given the backdrop of the macro environment. In addition to the typical year-over-year comparison, I will also be sharing sequential quarter results. Since we are in a pandemic, year-over-year comparisons do not tell the complete story, Nor do they highlight the significant progress we have made over the last six months. Total revenues in the third quarter declined 20% year-over-year to $159 million, but improved 35% sequentially. This was driven by a rebound in transaction activity across all our business lines as shelter-in-place orders were lifted, financing markets improved, and investors needing to transact reengaged. Revenue from brokerage commissions contributed approximately 89% of our total revenues and were down 22% year over year, but improved 36% on a sequential quarter basis to $141 million. Our private client market segment, which accounted for nearly 70% of our real estate brokerage revenue for the quarter, was $98 million, declining 19% year over year, but increasing 38% from $71 million in the second quarter. Brokerage revenue from our middle market and larger transactions was down 29% year-over-year, but improved 31% on a sequential quarter basis. Multifamily, retail, and office were the largest contributors on a sequential quarter basis, followed by industrial and self-storage as our specialty brokerage teams continued to make gains. Moving on to MMCC. Financing fees were relatively comparable on a year-over-year basis, but up 23% to $16 million from the second quarter. Refinance transactions accounted for 60% of our financing fees in the third quarter compared to 66% in the second quarter as purchase financing improved. The corresponding increase in purchase financing from 34% in the second quarter to 40% in the third quarter Reflects an improvement in investment sales transactions and financing availability as many investors moved off the sidelines to put capital to work. Other revenues, comprised primarily of consulting and advisory fees along with referral fees from other real estate brokers, were $2 million for the quarter, comparable on a year-over-year basis and up 59% on a sequential quarter basis. During the third quarter, We executed 2,139 transactions with a total sales volume of $9.1 billion, down 12% and 25%, respectively, from the third quarter of 2019. Sequentially, the number of transactions and sales volume were up 35% and 31%, respectively, from the second quarter. We continue to focus on the headcount and productivity of our investment sales and financing professionals. Year over year, we grew the combined team by nearly 3% with 1,920 sales professionals and 79 financing professionals for a total headcount of 1,999. We are encouraged by recent progress in attracting experienced professionals, which remains a key strategy. Total operating expenses for the third quarter were $152 million, down 12.7% year over year primarily due to a decline in cost of services that accompanies lower brokerage revenues. On a sequential quarter basis, we saw a 27% increase in total operating expenses, primarily due to a 35% increase in cost of services driven by the recovery in transactions off the second quarter lows. Cost of services was $100 million for the quarter, or 62.9% of total revenues. An increase of 30 basis points over the third quarter of 2019 and 10 basis points over the second quarter of 2020. Cost of services tend to increase throughout the year as our professionals earn escalating commission splits based on cumulative annual production. The significant market disruption skewed the share of our transactions to senior professionals with higher commission rates in the second quarter. That trend moderated in the third quarter as a broader mix of our professionals closed the deals. SG&A in the third quarter increased 3.4% year over year and 14.3% on a sequential quarter basis, primarily due to accrual of performance-based incentive compensation, as well as marketing and other support-related costs for our existing sales force, as well as recent acquisitions. These factors are largely tied to our better than expected financial results in the third quarter and improved outlook for the overall year. These increases were partially offset by reductions in headcount, salaries and related benefits, and other controllable costs. We continue to scrutinize costs and deploy capital strategically given the degree of uncertainty in the market. For the quarter, we generated $0.15 earnings per diluted share as compared to $0.49 last year. Our tax rate for the quarter was 24.1% as compared to a 26.7% tax rate in the third quarter of last year due to a significant decline in income before taxes and a partial reversal of certain tax positions. Adjusted EBITDA decreased by 56% from last year to $12 million, with an adjusted EBITDA margin of 7.7%. On a sequential quarter basis, adjusted EBITDA nearly tripled and our adjusted EBITDA margin more than doubled. Moving on to the balance sheet, we finished the quarter in a strong liquidity position with approximately $343 million of cash and core cash investments We also saw positive cash flow provided by operating activities of $24 million for the quarter. Our cash position and solid balance sheet ensure the continued smooth execution of our day-to-day operations, which is our first priority. At the same time, the market dislocation has provided us with more opportunities to use the balance sheet for growth As you saw with our acquisition of Mission Capital in October. As for the near-term outlook, we are encouraged by the signs of recovery we are seeing in the market. Our deal pipeline continues to build off the lows we saw in Q2, so there is reason to be optimistic. However, the recovery is inconsistent and uneven across property types and geographies. Headwinds and uncertainties exist as we are still in the midst of a pandemic. All of this is causing us to continue to be prudent and take a cautious approach for the remainder of 2020 and into 2021. Based on the limited visibility we have today, we expect modest, sequential quarterly revenue growth for the fourth quarter. Consistent with historical seasonality, cost of services will likely trend higher in the fourth quarter as our professionals earn higher commission splits through the year based on cumulative performance. Accordingly, we expect cost of services in the fourth quarter to be in the range of 64% to 66%. We continue to manage our controllable expenses tightly. As such, we anticipate SG&A to be generally similar to the levels we saw in the third quarter. It should be noted, though, that the closing of Mission Capital will increase our operating expenses beginning in the fourth quarter, While revenue ramp up may take several months, which is typical of most acquisitions. Lastly, we expect our tax rate to be approximately 28 to 30% for the full fiscal year. With that, we can now open up the call for Q&A. Operator?

Thank you. If you would like to register a question, please put the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the one followed by the three. We now have a question from the line of Blaine Heck with Wells Fargo. Please go ahead.

Great, thanks. Good afternoon. Can you just talk about the opportunities that you guys see in front of you with respect to acquisitions? Clearly, you guys are getting a large one done this quarter. I think it's Probably the largest since I've been covering you guys. So should we expect a little bit of a pause as you integrate Mission Capital? Are you actively working on other deals? And if so, can you comment at all on the size of potential acquisitions? Will they be similar to Mission or smaller like the others that you guys have done over the last few years?

Hi, Blaine. Hessam here. I'll take that one. Thanks for asking the question. We are actively in discussions with a number of firms and really targeting firms based on service needs, market coverage needs, and compatibility of culture, and making sure that one plus one really equals three, both for the target firm and for us. It's not so much by size. So we have dialogue going on with some larger firms and some smaller boutique firms, both at the same time. And we are actively pursuing those discussions. The integration of mission is something we're excited about. It's well underway. We've been thinking about it for some time as our discussions with them became more serious and realistic. And so the advantage of having a management team that's ready to absorb a great addition like mission and integrate it fairly quickly doesn't take us away from being able to talk to new opportunities.

Okay, that makes sense. And kind of related to that, in the past few years, I think part of your growth plan has been to expand into additional property types in the brokerage business. How do you think the crisis will impact this? Do you think as the investment sales market recovers, you guys can kind of use that recovery to springboard into those sectors? Or is it maybe a case of where you stick to your core competencies throughout the recovery phase and put off the expansion into other sectors for when things are a little bit more normal or stable. Sure.

The good news is we have so much runway in every property type, including those that are considered our core segments. Apartments, retail offer plenty of additional growth opportunity for us. There are plenty of markets where we can add more capacity to even those long-term stable segments for us. as well as expansion into office, industrial especially. We're very excited about our industrial expansion plans and, of course, MMCC. That's the good news. We're not really hampered by limitation of market opportunity in any of the product types. So our discussions range in all the different property types as well as MMCC, of course. That's, as we've said many times, significant growth opportunity for us. And with a transaction like Mission, where we can actually add another service line, like loan sales, loan advisory capabilities, and their structured finance, debt, and equity, which is very complementary to our core mortgage business, makes it even more synergistic and more exciting. So we're looking at all of the above and making sure that it's, once again, about cultural compatibility, growth opportunity, and making sure that we're not Thank you very much.

Were there more investors on the sidelines, just kind of waiting for some clarity? Or do you think on the opposite side, do you think there was any deal flow that could have been attributable to investors trying to get out in front of the potential of regulatory changes, 1031 exchanges probably being the biggest of those?

We've been watching that very carefully for the past several months and looking for any trends. I would say that... Thank you very much. Thank you very much. Thank you, guys. Thank you.

Mr. Nadji, I'm sure there are no further questions at this time. I'll now turn the call back to you.

Great. Thank you, Operator. And thanks to all of you for joining our call. We look forward to having you on our year-end earnings call and seeing some of you on our virtual sessions coming up between now and then. Thank you very much.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines. Thank you and have a great day.