Marcus & Millichap, Inc.

Marcus and Millichap's Third Quarter 2021 Earnings Conference Call. As a reminder, this call is being recorded. I would now like to turn the conference over to your host, Tom Scherer. Thank you. You may begin.

Thank you. Good morning and welcome to Marcus and Millichap's Third Quarter 2021 Earnings Conference Call. With us today are President and Chief Executive Officer, Assam Najee, and Chief Financial Officer, Steve DeGennaro. Before I turn the call over to management, Please remember that our prepared remarks and 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 can 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 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, 2021. 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 can 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 morning and is available on the company's website, represents reconciliation to the appropriate GAAP measures and explains why the company believes such non-GAAP measures are useful to investors. This conference is being webcast. The webcast link is available on the investor relations section of our website, at www.marcusmillichap.com along with a slide presentation you may reference during the prepared remarks.

With that, it is my pleasure to turn the call over to Assam Najee. Thank you, Tom.

On behalf of the entire Marcus Millichap team, good morning and welcome to our third quarter 2021 earnings call. We're very pleased to report another record quarter of revenue and earnings coming on the heels of a record first half. For the third quarter, we delivered revenue of $332 million, adjusted EBITDA of $51 million, and net income of nearly $34 million. Compared to the third quarter of 2020, revenue more than doubled and adjusted EBITDA increased more than fourfold. This is largely a testament to our pivot from helping clients solve problems and navigate last year's market disruption to leveraging and improving market environment throughout 2021. Historically low interest rates, record liquidity, and to some extent, higher motivation to transact ahead of tax law changes have bolstered the transaction market. Beyond the market recovery, we believe many of our actions and strategies over the past several years, particularly at the onset of the pandemic, also drove MMI's results. To put our performance into perspective on a pre-pandemic basis, we had outperformed our 2019 third quarter revenue and adjusted EBITDA by 68% and 83% respectively. While the market has improved dramatically, our brokerage transactions year-to-date exceeded the same period in 2019 by 28%, which is a clear outperformance compared to an estimated 9% improvement in overall market sales as reported by Real Capital Analytics. During the third quarter, we closed over 3,300 transactions representing total sales volume of 20.8 billion. This is similar to the record volume experienced during the second quarter of 2021 and over 36% higher than the third quarter of 2019. Year-to-date, total sales volume was $50.2 billion, reflecting close to 9,000 transactions, or just under 30% ahead of the same period in 2019. The primary driver of these record numbers is the impressive productivity gains of our brokers and originators and the power of the MMI platform, built on long-term client relationships, exceptional market knowledge, and of course, deal execution. Investments in technology, expanded client outreach, the addition of experienced producers, and the integration of recently acquired companies are contributing directly to our performance. Robust earnings growth also reflects a deliberate effort to balance ongoing investments in growth initiatives with expense management to achieve leverage. Steve will dive deeper into that. Let me now provide more color on various business segments. The foundation of our business, the vast and fragmented private client segment, is stronger than ever. Third quarter private client revenue grew 87% year over year and 51% over the same period in 2019. Our core private client apartment and single tenant and lease businesses have performed exceptionally well since the onset of the pandemic and continue to attract record capital given their strong fundamentals. We've also seen strength in self-storage, manufactured housing, hospitality, and shopping center sales. Our team is helping our clients act on opportunistic investments, shift capital across markets and product types, and reposition portfolios rapidly. Year to date, our private client revenue was up approximately 58% year over year and 29% over the same period in 2019. Many private clients transacted ahead of tax reform this year, but our recent survey, which included over 3,000 investors, points to personal and specific asset-related strategies, strong buyer demand, and record liquidity as the primary factors behind the decision to sell. We believe concerns over a higher capital gains tax rate and potential changes to the 1031 exchange deferred tax provision have contributed to trading volumes this year but are not the main catalyst. According to our survey, the majority of investors executed strategies driven by product type, market performance, and the economic cycle. Most importantly, the opportunity to lock in low interest rates ahead of a strong expansion cycle was noted. Third quarter revenue in our middle market and larger transaction segments together increased nearly threefold over last year. As a result, the average transaction size for the quarter increased 47% year-over-year and 23% for the first nine months of the year. Strength in our IPA division, particularly in the multifamily segment, was noteworthy as many institutional investors increased their allocations coming off of the market disruption in 2020 and became more aggressive in acquiring assets ahead of a robust rent growth cycle. Our positive results in larger transactions also highlight two aspects of our long-term strategy. First, it illustrates our unique ability to expose institutional assets not only to the best-of-class institutional buyers, but to private capital sourced through 50 years of cultivated relationships. The power of our expanded buyer reach is clearer than ever in the current market. Secondly, our results highlight the effectiveness of our strategy to diversify into larger transactions and utilize the hybrid private client institutional brokerage model to attract and retain exceptional professionals. We added several top-level IPA teams in various property types over the past three years that have acclimated to our culture and system very well. Our financing division, MMCC, also continued to grow with third quarter revenue rising 88% over last year. Year to date, MMCC's revenue was up 73% and 59% over 2019. This is a reflection of various investments to better support our financing professionals, a number of whom are achieving career milestones this year. We're also seeing positive results from expanded lender relationships, and acquisitions made over the past few years, and new leadership. Consistent with our capital markets growth plan, we recently announced an investment in a strategic alliance with M&T Realty Capital Corporation. This partnership is unique in the industry in that it combines our market-leading multifamily brokerage and origination capacity with M&T's access to Fannie, Freddie, HUD, and FHA financing. By investing in resources and infrastructure dedicated to supporting our platform, M&T brings a highly efficient process to our team, which in turn provides clients with competitive agency debt, streamlined and rapid view quotes, and execution at no added cost. MMI's upfront capital investment in the partnership provides the foundation for us to generate incremental revenue growth by significantly raising the financing capture rate of our own $10 million-plus apartment sales. Year-to-date, we closed $16 billion of these sales, which points to a great opportunity to also provide the financing on these transactions. As importantly, the partnership improves our ability to better integrate financing into our sales and advisory services for the same client base and expand our relationships and repeat business. Shifting to our Salesforce, the management team remains laser focused on retention and recruitment. As we have previously messaged, turnover among newer brokers remains elevated given the impact of the pandemic last year and still hampered in-person interactions. Our virtual recruiting, virtual training efforts are unwavering. However, the current environment still presents a challenge for the development of inexperienced individuals. Several new initiatives are being prepared for execution in 2022, which we expect will shore up our recruiting and new talent development results. On the other hand, we're seeing high levels of productivity from recently hired experienced professionals and have a healthy pipeline of candidates we are actively pursuing. Now, looking forward, we continue to see a favorable macro environment and a positive market backdrop with continued job growth, historically low interest rates, and ample liquidity fueling real estate transaction volumes. Our internal metrics, including our pipeline, inventory, and narrowing price expectation gaps point to continued strength in the near to mid-term. Fundamentals are healthy or improving, which further supports strong buyer demand. As examples, Following record rent growth in the second quarter, apartments once again registered record rent growth in the third quarter, and we're seeing improvement in space demand across most property types. Investors appear most cautious about office and seniors housing investments, while confidence has increased since last quarter for hospitality and shopping centers. While concerns over inflation and rising interest rates have increased over the past few months, lack of overbuilding and commercial real estate's hedge against inflation bode well for strong buyer demand. As for MMI and our strategy, our balance sheet remains formidable and positions us well for continued growth. Building on our acquisitions over the past three years, scaling our capacity to add companies and groups, remains a major focus and our top capital allocation priority. Valuation expectations have shifted rapidly this year compared to last year. Nevertheless, we're encouraged by opportunities in synergistic areas that could expand the MMI platform and are in dialogue with potential new teams and firms. We're also excited about the next phase of platform investments designed to further elevate our M&A infrastructure training programs, marketing, and our suite of proprietary technologies. We expect to announce the addition of a highly experienced and innovative Chief Marketing Officer and a new Chief Human Resources Officer as key additions to the leadership team. These pivotal roles will help us advance our client services and Salesforce productivity. Before I turn the call over to Steve, let me express our gratitude to our clients who put their trust in us and are the reason behind our 50 years of success and back-to-back record quarters. I would also like to recognize the efforts of our entire team who show incredible dedication to our clients and the firm and are the backbone of our closing nearly 9,000 transactions or nearly 40 per business day so far this year.

I will now turn the call over to Steve for a more detailed breakdown of our results. Steve? Thank you, Hassam.

In the third quarter, we delivered all-time record revenue, adjusted EBITDA, net income, and earnings per share. While year-over-year comparisons are extremely favorable, we are more pleased with the significant growth in all areas of the business compared to the pre-pandemic third quarter of 2019. Total revenue in the third quarter was $332 million, which exceeded our previous record of $285 million in the second quarter of 2021 by 16.6%, and marks the second time a record quarter has occurred outside the fourth quarter. For the nine months ended 2021, total revenues were $801 million, up 71.7% year over year, and up 40.9% compared to the same period in 2019. Brokerage commissions for the third quarter accounted for approximately 90% of our total revenues, or $300 million, an increase of 113% over the third quarter of 2020, and 66% compared to the third quarter of 2019. On a year-to-date basis, brokerage commissions increased 72% year over year. Our core private client business remains a strength, accounting for 61% of brokerage revenue for the quarter or $183 million, which is an 87% increase compared to the third quarter of 2020. Revenue from the private client segment for the first nine months of 2021 was $447 million, an increase of 58% over the same period in the prior year. In spite of our leading market share in the private client segment, There is still plenty of white space in this highly fragmented sector, and the sheer size of this market provides further growth opportunity. This quarter, our middle market and larger transaction market segments together accounted for 36% of total brokerage revenue at $109.3 million, up nearly threefold year over year, as Hassam mentioned. Brokerage revenue from these combined segments for the first nine months of 2021 accounted for 35% of total brokerage revenue, or $248 million, and we're up more than double year over year. Of note is the recent growth in our larger transactions, which represented approximately 25% of total brokerage revenue for the third quarter, growing nearly fourfold year over year. Moving on to MMCC, revenues from financing fees reached $29 million in the third quarter, an increase of 88% year-over-year and 84% as compared to 2019. Financing fees for the first nine months of 2021 were $75 million, up approximately 73% year-over-year and 59% as compared to the same period in 2019. MMCC growth was driven by several acquisitions made during the past year, along with continued strong performance of our tenured financing professionals. Revenue from refinances accounted for 53% of loan origination fees for the quarter and for the first nine months of 2021. Other revenues comprised primarily of consulting and advisory fees along with referral fees were $3 million for the quarter, up 53% compared to the third quarter last year, and up 61% compared to the same period in 2019. Other revenues for the first nine months of 2021 increased 49% year over year. In the third quarter, we generated total sales volume of $20.8 billion across 3,325 transactions, representing year-on-year growth of 129% and 55% respectively. For the nine months ended 2021, we generated total sales volume of more than $50 billion across 8,942 transactions representing year-on-year growth of approximately 81% and 50% respectively. Brokerage transactions increased 61% year-over-year in the third quarter and 51% year-over-year for the first nine months of 2021. We continue to capitalize on the strong market environment and see our outperformance as a testament to the strength of our brand, our platform, and our value-added brokerage and financing capabilities. Record revenue, while remaining diligent about expense management and execution in the business, created significant operating leverage in the quarter. For the third quarter, total operating expenses were $287 million, an increase of 89% year over year, but far less than the 110% revenue growth during the same period. For the nine months of 2021, total operating expenses were $694 million, a 57% increase compared to the total revenue increase of 72%. For the third quarter, cost of services was $219 million, or 65.9% of total revenues, 300 basis points higher than the third quarter of 2020. For the first nine months of 2021, cost of services were $507 million, or 63.3% of revenue, up 180 basis points year over year. The increase was driven by senior sales and financing professionals reaching higher commission levels earlier than in prior years, given our record production levels. SG&A in the third quarter was up 30% year over year, primarily due to increases in performance-based compensation tied to record earnings and brokerage support costs, which correlate with higher business volumes. SG&A rose 20% year over year for the nine months ended in 2021 due to the same factors, as well as valuation adjustments related to acquisitions. These increases were partially offset by the reduction of in-person events industry conferences, and travel. For the quarter, we generated 84 cents earnings per diluted share compared to 15 cents in the third quarter of last year and 49 cents per share in the third quarter of 2019. For the first nine months, diluted earnings per share were $2 as compared to 48 cents and $1.42 for the same periods in 2020 and 2019, respectively. Our tax rate was 26% and 26.7% respectively for the three and nine months ended September 2021 compared to 24.1% and 29.1% for the same periods of last year. Adjusted EBITDA for the quarter jumped to a record $51 million or 15.3% of total revenues compared to 7.7% in the third quarter last year and 14.1% in the third quarter of 2019. Moving to the balance sheet, we finished the quarter in the strongest position in our history with $528 million of cash, cash equivalents, and marketable securities, which is an increase of $79 million year over year. Along with the investment and the strategic partnership with M&T, Assam also mentioned that we are actively working to build on our track record of acquisitions last year and are pursuing additional acquisition opportunities as well as investments in technology and platform improvements as our capital allocation priorities. Turning now to the near-term outlook, as favorable economic conditions persist, we expect the positive momentum to carry through to the end of the year and into 2022. Cost of services for the fourth quarter should follow the normal trend and increased sequentially to a range of 67 to 68% as more agents meet higher commission thresholds based on outperformance to date. SG&A for the fourth quarter will include continued investment in infrastructure and enhancements to the management team, as Hassam noted, and therefore should reflect modest sequential increase. We expect our full year tax rate to be in the 26.5% to 27.5% range. Overall, this was an excellent quarter and continues to build on the strong year the team has executed and delivered on thus far. With that, we can now open up the call for Q&A. Operator?

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the queue. You may press star 2 if you would like to remove your line from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Blaine Heck with Wells Fargo. Please proceed.

Great. Thanks. Good morning. Hasan, can you just provide your latest thoughts on potential risks from regulatory issues? And I think, you know, the main concern has been around the elimination of 1031 exchanges. Is it your opinion that changes to that program are effectively off the table? And are there any other regulatory issues we should be monitoring that could affect your business going forward?

Blaine, good morning. Thanks for being on the call and for your question. As it's been widely publicized, the current proposal for tax reform has improved significantly as related to various aspects that would affect commercial real estate, including the 1031 exchange tax deferred provision, compared to the original proposal. In fact, we just hosted an update on this very topic with our featured speaker, who is the CEO of Real Estate Roundtable, Jeff DeBoer, who is incredibly active on behalf of the industry with Capitol Hill, on really making sure that these proposals are grounded and well thought through. So that, as of this moment, which is a little bit of a moving target, we believe that the proposals have improved dramatically, and yes, from what we understand, the 1031 exchange provision has been removed from any significant change. Now, as Jeff reminded, all of our clients

the webcast there is still a process and still negotiations going on but the improvement is clear since the April May timeframe great that's helpful can you guys just talk about the M&T partnership in a little bit more detail if possible was there an initial cash outlay for that agreement I think the press release mentioned a preferred stock investment so any detail there would be helpful and then you know, when does or when did the agreement kind of go into effect, and how should we think about the effect of that partnership on financing revenues as we think about them going forward?

Sure. We definitely have improved the tools and the process we now have with M&T through the strategic alliance and our partnership with them that did involve a capital investment into M&T. By setting it up as we have, we have the benefit of dedicated personnel on the M&T side and processes workflow and execution improvements over any other agency lending-oriented correspondent relationship we've ever had before. The reason for that is because we're now a step above a normal standard correspondent relationship, and we've actually entered this partnership with M&T, which allows us to have more deal control as well as these synchronized processes for quick quotes, for deal submittal status, movement on pending transactions, and, of course, getting deals across the finish line in partnership with M&T and the agencies. So from that standpoint, the execution will be significantly better than anything we've had in place. This enables in turn our originators to have the benefits of these expanded tools and better execution and therefore be able to integrate better with our investment sales teams. As I mentioned in my formal remarks, we're a leading broker of major apartments valued at 10 million plus or any way that you analyze the multifamily market, we're the number one broker. in transactions. Therefore, having this expanded capability and access to agency lending through our originators enables our investment sales brokers now to bring more value to the same clients. So not only can we capture a higher percentage of our own transactions through agency financing, and by the way, other financing, our originators continue to clear the market on behalf of the borrower. Agency debt, of course, is not the only option. As everybody knows, this year, for example, the share of agency execution is down significantly from last year because of market changes. And therefore, I think the notion that we will integrate better, we will capture more repeat business from the same client base that does financing with us and does investment sales transactions with us are clear advantages. In addition to additional recruiting and really retention benefits, a value proposition brought to our team because of this enhanced partnership.

Great. That's helpful, Culler. I guess, can you give the dollar amount of that initial capital investment or no? We will not disclose that. Okay. Okay. Moving on. I guess, you know, on previous calls, you know, you guys have discussed, and on this call you did as well, but some challenges in hiring due to having to kind of conduct the recruiting virtually. And we noticed the number of professionals continued to decrease sequentially between the second and third quarters. You know, have you guys found that as cities opened during the quarter hiring became a little bit easier or are you still kind of, you know, swimming against the tide of professionals leaving because they've had such a rough year last year? And if that's the case, you know, when do you think that fallout starts to wane given that you're seeing such better velocity on the transaction side this year?

Sure. Let me separate my answer on the retention front from the recruiting front. On the recruiting front, we're having very steady success in attracting new talent and people coming in. Of course, it's a very competitive labor market, as everybody knows, but we are still getting a very strong flow of new candidates that are coming in through our virtual career nights and virtual recruiting and interviewing process, as well as, of course, the in-person part of all that has improved significantly from even six months ago. It's just not back to normal. The effect of the net numbers that you mentioned, Blaine, are more driven by the fallout from Last year, as you mentioned, and really even the first part of this year, the environment is much more challenging for a new person who's learning the business, who's being mentored and trained either by a mentor, sales or loan originator, or our regional managers because of the fact that the in-person physical component of that learning and development, whether it's team meetings and group training and activity reviews or client interactions, has been hampered and remains hampered quite a bit But the numbers really show what's happened over the past 18 months, not so much as an indication of what's going to happen over the next 18 months. To your point, we expect a dramatic improvement in all this as everyone can come back into the office and we can resume much more of our in-person part of the culture and training and touch points. We are fully prepared for a hybrid work model. Of course, the business with brokers being on the road so much and in front of clients so much is quasi-hybrid anyway, essentially as an industry. But even more so now with the technology that was implemented and what's been learned throughout the pandemic, a hybrid work model will be very effective for us. But that will always have a large physical component because that's an important part of the business that we're in.

Okay, great. That's helpful. Last one for me. can you just talk a little bit more about the opportunities that you guys see in front of you with respect to additional acquisitions maybe just some more color on you know the types of businesses you're looking at whether it be on the financing or transaction side and then you know any color on the size of deals would be helpful as well sure I'll take that and have Steve chime in as well we have been exploring

many companies that are complementary to the firm have had ongoing conversations with a few that we're very encouraged by within our core business and complementary to our market coverage and product type expertise on the brokerage side. And of course, on the financing side, as we have shared with you many times before, there is ample runway. Many of our metros still don't have fully developed finance professionals or teams on the ground. Many of our teams have the capacity to grow further and our ability to capture more of our internal financing opportunity and, of course, grow externally is significant on the financing side. So it's a parallel track of looking at targets both on the financing side as well as the investment brokerage side. But being very targeted and selective based on what's complementary is and not an overlap that would result in conflict. In terms of other business lines, we've looked at some other adjacent businesses. Our own governance around that is the first and most important question in our mind, and that is, will being in this business line add value to our core customer base to our future customer base that we're looking to grow with, i.e., institutional investors that we're growing with through our IPA strategy, which has been very effective, and lenders with whom we're looking to do more business, as reflected in our acquisition of Mission Capital last year. And the very important component of Mission Capital was their loan sale business. which put us now in a place to bring a whole other value proposition to the same lenders we've been doing standard mortgage brokerage with who often sell loans in pools or even individually that we weren't really qualified to capture. Those are just some examples between the IPA strategy and the loan sales strategy and ways we're looking to supplement the core business. But there's appraisal as a potential vertical. There's investment management as a potential vertical. For the private client segment, there are services such as cost segregation and other consultative advisory services that will be complementary. So within the context of how will we add value to our clients, and how we support our current sales force through a better value proposition, we look at other business lines to supplement our growth.

Yeah, and in terms of, Blaine, we've also made changes to our process internally. Historically, our M&A efforts have been either led by or initiated by boots on the ground or local sales management who have got relationships with other firms, boutiques in their territory. Those efforts will continue. However, we've also initiated a more centralized process where we've got executive sponsorships of deals and potential targets. We brought on additional resources on the legal and the financial side to be part of that process, enhanced our capabilities in that area.

Great. That's helpful, Collar. Thanks, guys. Thanks, Blaine.

We have reached the end of our question and answer session. I would like to turn the conference back over to management for closing comments.

Thank you, Operator. Once again, let me thank everyone for participating on our earnings call, and we look forward to seeing more of you on the road and through additional virtual connectivity. But most importantly, I really want to thank our clients, as I did in my formal remarks. Once again, without their trust in us, we would not be achieving the results that we are achieving and, of course, the tremendous hard work of our entire team.

Thank you for joining the call.

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.