Q4 2023 Marcus & Millichap Inc Earnings Call

Participants

Jacques Cornet Cornet; IR; ICR, LLC

Hessam Nadji; President & CEO; Marcus & Millichap, Inc.

Steven DeGennaro; EVP & CFO; Marcus & Millichap, Inc.

Jason Belcher; Analyst; Well Fargo Securities. LLC.

Presentation

Operator

Greetings, and welcome to Marcus & Millichap's Fourth Quarter and Year End 2023 earnings conference call. As a reminder, this call is being recorded. I would now like to turn the conference over to your host, John Cornet. Thank you. You may begin.

Jacques Cornet Cornet

operator. Good morning and welcome to Marcus & Millichap's Fourth Quarter and Year End 2023 earnings conference call. With us today are President and Chief Executive Officer, Sam Knology, Chief Financial Officer, Steve De Janeiro. For 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 transaction 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 in its annual report on Form 10 K filed with the Securities and Exchange Commission from February 28th, 2023. 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. Company's earnings release, which was issued this morning and is available on the company's website represents a reconciliation to the appropriate GAAP measures. It explains why the company believes such non-GAAP measures are useful to investors. This conference call is being webcast. The webcast link is available on the Investor Relations section of the Company's website at w. w. w. dot Marcus Millichap.com, along with the slide presentation, you may reference during the remarks.
With that, it's my pleasure to turn the call over to CEO. Hessam Nadji.

Hessam Nadji

Thank you, Jacques. On behalf of the markets in which our team, good morning and welcome to our fourth quarter and year end earnings call. Wondering, 23 ended up as one of the most challenging periods for the commercial real estate industry. The residual effect of soaring interest rates and volatility caused to break down in valuations and pushed buyers and sellers alike to the sidelines. The impact of widening bid-ask spreads and severely restricted financing was illustrated by the lack of the usual fourth quarter investor urgency to close deals before year end. For the year, transaction and financing volumes declined by an estimated 55% market wide based on third party sources annualized revenue for the fourth quarter was $166 million, up modestly from the third quarter, and adjusted EBITDA loss came in at $4.5 million for the year revenue was just short of $650 million, a decrease of 50% from the prior year with an adjusted EBITDA loss of $20 million. While these results are extremely frustrating for our team. It is important to note that despite this challenging environment, and then I still closed roughly 7,500 transactions last year. Once again, more than any other firm. Our unique marketing system and culture of collaboration resulted in 44% of our closings going to out-of-state buyers, which highlights our ability to generate buyer interest locally and nationally, even in a disrupted market. Our ability to solve problems and uncover opportunities for our clients resulted in the movement of $12.6 billion across markets and product types. The Company's financing experts that MMTC. and IPA. Capital Markets closed nearly 1,100 financing transactions with 350 separate lenders, leveraging this vast network of lender relationships and real-time information exchange among our originators are major advantages for our clients in this market. These numbers and the company's financial results would be significantly stronger, if not for three key challenges that we believe are temporary. The first is the market's impact on our productivity lift. Things have been difficult to price appropriately and are taking longer to market and put under contract and elevated portion of our deals have fallen out of contract with many going in another contract more than once. This is due to lender and or buyer issue and essentially having to remarket the same deal multiple times to reach an actual closing the net impact of getting the job done for our clients in a difficult environment reduced time for new business developed.
Second challenge is higher expenses related to investments made over the past few years for top-tier talent at a time when their revenue production is well below long-term averages entirely due to market headwinds. We're confident that the strategy behind acquiring and retaining top level producers, all of which were made with sound underwriting, will drive long-term growth as the market recovers.
Lastly, the broad nature of the market disruption has not only impacted larger institutional transactions, but has also impeded private client transactions more than past cycles. Although the percentage decline in private client deals is still far less than larger transactions. Pricing uncertainty and widened bid-ask spreads across all property types have lowered private client trading pullback by banks and credit unions that usually provide the majority of financing for our private client deals.
Is it contributing factor to this particular challenge?
The good news is that the passage of time and the market's realization that interest rates are unlikely to return to record lows, starting to spur the valuation reset necessary to bring buyers and sellers back into alignment. We anticipate that ASSETS previously withheld from the market in the hopes of better pricing will be brought to market at more realistic prices in the quarters ahead. This shift is being prompted by maturing debt as well as operational issues, particularly in deals that were underwritten aggressively over the past few years. Our IPA division is seeing an uptick in inventory coming to market by institutional owners as well as cautious interest on the buy-side. In the meantime, our strategy to remain on offense while being diligent on investment underwriting and cost management continues into 2024. Some examples include our leading presence at key industry events and conferences such as National Multi Housing Council, NMHC, ICSC, NAB and other organizations covering every major property types. Our client webcast, which to over 40,000 investors last year, expanded research content through 33 hundred publications and various client outreach programs, help our sales force stay connected and enhance their client relationships, service expansions, including option and loan sales, continued to provide alternative ways to add value to our clients. We continue to have success in attracting top local teams and groups and remain highly focused on sourcing acquisition opportunities. Recent negotiations with firms within our core business as well as complementary service lines, reinforced the external growth opportunities and interest in MMI. However, they have been hampered by ongoing gaps between pricing and terms expectations. Given the degree of short to midterm market uncertainty, we're confident that over time there will be more realism by sellers as we pursue additional opportunities to accelerate growth. Notwithstanding our cost containment measures, we're investing more in M&A related resources as this area remains a high priority. Another key priority is expanding recruiting resources and programs. Our experienced professional targeting and acquisitions continued to show success. In the last year, we brought onboard numerous experienced individuals and teams across the country and product types Recent examples include a major institutional apartment team that joined IPA in our Washington, D.C. office and major capital markets team that joined in New York as well as highly experienced market leaders added in Dallas, Nashville, Los Angeles and Toronto, just to name a few. Our net hiring of newer professionals continues to be a challenge as the market disruption is keeping the fallout ratio of newer agents elevated in the fourth quarter, we initiated a proactive push to terminate those who are unlikely to become productive. The flow of new candidates is actually increasing which is very encouraging. And we're expanding our internship, mentorship and training programs as part of our commitment to return to positive net hiring of new associates.
Looking forward, we believe that the Fed's eventual lowering of interest rates and investors' growing confidence in the economic soft landing will be the key catalyst in rising trading activity. Persistently strong job numbers and January is higher than expected inflation data have taken the pressure off the Fed to start easing further fueling the higher for longer trends we pointed out on our last call. However, with the real estate pricing reset underway and some degree of interest rate easing by the Fed expected by midyear. We're cautiously optimistic for an improving market environment in the second half of this year. In the meantime, our theme of control, the controllable drive management's focus has applied to internal tools, education and best practices sharing as well as providing best in class brokerage services to our team. At the same time, we continue to pursue external growth opportunities through our acquisition strategy. Our playbook from past down cycles in 52 years of being in business continues to improve each time with the benefit of technology, a strong and growing brand and laser focus on revenue growth throughout the recent market and economic shifts, we've had effectively balanced strategic investments with returning capital to shareholders. And MI. has a long history of producing high-quality earnings that have generated strong cash flows through multiple economic cycles. The combination of share repurchases and dividends reflect our commitment to maximizing shareholder value. The strength of our balance sheet, combined with our leading market position and brand form an exceptionally strong foundation for our long-term success.
And with that, I will turn the call over to Steve for additional insight on our financial results state.

Steven DeGennaro

Thank you, Hessam. As previously mentioned, revenue for the fourth quarter was $166 million compared to last year's $262 million. For the full year, total revenue was $646 million compared to last year's record high of $1.3 billion. Revenue from real estate brokerage commissions for the fourth quarter was $145 million or 87% of total revenue compared to $236 million last year, a decrease of 39% year over year. For the quarter, total sales volume was $8.7 billion across 1,413 transactions, down 33% and 31% respectively. For the full year 2023, revenue from real estate brokerage commissions was $560 million and accounted for nearly 87% of total revenue compared to $1.2 billion last year, a decrease of 52% year over year full year. Sales volume was $30.8 billion across 5,475 transactions, down 55% and 40%, respectively. Average transaction size during the fourth quarter was approximately $6.2 million compared to $6.4 million a year ago. For the full year, average transaction size was $5.6 million compared to $7.5 million in the prior year. Year-over-year decrease in average transaction size reflects a decline in property values as well as a lower mix of revenue coming from middle market and larger transactions due to the disproportionate impact of the market disruption on institutional business within brokerage for the quarter, our core private client business contributed 66% of brokerage revenue or $95 million versus 62% last year. For the full year, the private client business contributed 67% of brokerage revenue for $373 million versus 58% last year. Middle market and larger transactions, which experienced strong growth over the past couple of years together accounted for 31% of brokerage revenue for $44 million during the fourth quarter compared to 36% last year. For the full year, middle market, larger transactions represented 30% of brokerage revenue or $166 million compared to 40% last year. For the quarter, private client business declined 35%, while middle market and larger transactions declined 49% and 47%, respectively. For the full year, the trend away from larger deals was more pronounced with private client declining 45% and middle market and large transactions declining 61% and 66%, respectively. Revenue in our financing business, including MMCC, was $16 million in the fourth quarter compared to $22 million last year. During the quarter, we closed 237 financing transactions totaling $1.5 billion in volume compared to 408 transactions or $2.4 billion in volume in the prior year. Financing revenue for the full year was $67 million compared to $113 million last year. This was achieved across 1,076 transactions totaling $6.7 billion in volume compared to 2,143 transactions and $12.8 billion in volume last year. Other revenue comprised primarily of consulting and advisory fees along with referral fees was $6 million in the fourth quarter compared to $5 million last year. For the full year, other revenue was $19 million this year compared to $18 million last year.
Turning to expenses, total operating expense for the fourth quarter was $183 million, 29% lower than last year.
In the full year.
Total operating expense was $705 million, 39% lower compared to the prior year. Lower expenses were primarily due to a reduction in variable expenses related to lower revenue cost of services was $105 million or 63.4% of total revenue for the quarter, a decrease of 550 basis points compared to prior year. For the full year, cost of services was $407 million or 63% of total revenue, a reduction of 240 basis points compared to last year. The lower cost of services as a percentage of revenue reflects lower commission rates as fewer agents surpassed revenue thresholds. Sg&a in the fourth quarter was $75 million, an increase of 2.9% over the prior year, primarily due to increased stock compensation and consolidation of office space in certain markets.
For the full year.
Sg&a was $285 million, a decrease of 5% compared to last year. Full year decrease was attributable to lower variable compensation tied to business performance impacted by market conditions, along with ongoing cost reductions. The decreases were partially offset by expenses related to talent, acquisition and retention, as well as new business development and marketing support. Despite the market disruption and its near-term impact on our earnings. We remain committed to investing in our operating platform, sales force growth, technology and infrastructure based on our experience through multiple cycles. These enhancements during a downturn have proven to drive long-term value. We are working diligently to balance near-term profitability with these strategic investments.
During the fourth quarter, we reported a net loss of $10.2 million or $0.27 loss per share, compared with net income of $7.9 million or $0.2 per share in the prior year. For the full year net loss totaled $34 million or $0.88 loss per share compared to net income of $104.2 million or $2.59 per share last year. For the quarter, adjusted EBITDA was negative $4.5 million compared to positive $14.1 million in the prior year. For the full year, adjusted EBITDA was negative $19.6 million compared to positive $165.5 million in the prior year. The effective tax rate for the quarter was 12% and for the full year was 16%.
Moving on to the balance sheet, we remain well-capitalized with no debt and $407 million in cash, cash equivalents and marketable securities down only modestly from the prior quarter's $411 million. During the quarter, we returned a total of $14.6 million of capital to shareholders through dividends and share repurchases at an average price of $27.92 per share. For the full year, we returned $59 million of capital to shareholders, including $39 million in share repurchases and $20 million in dividends despite the challenging market environment. This is a testament to the strength of our balance sheet and the conviction in the long-term outlook for the business since inception of our capital return programs, roughly two years ago, we have returned more than $150 million to shareholders and still have nearly $72 million remaining on the current share repurchase authorization.
Finally, last week, we announced that our Board declared a semiannual dividend of $0.25 per share for approximately $10 million payable on April fifth, 2024 to shareholders of record on March 12th, 2024. Looking ahead to 2024, the headwinds facing the market are likely to remain a challenge through the first half of the year. In addition, our deal pipeline coming into the year did not have the same momentum it did going into 2023. However, we are cautiously optimistic that the end of the Fed's aggressive rate hikes will lead to improving conditions in the latter half of the year. We expect first quarter revenue to follow the usual seasonal pattern and be down sequentially from Q4. Cost of services for the first quarter should follow the seasonal reset and be in the range of 59% to 61% of revenue. This is slightly lower than the first quarter of last year. Given current market dynamics, SG&A for the first quarter should decrease year over year in absolute dollars consistent with lower revenue and lower agent support costs tied to 2023 revenue. We remain committed to helping clients navigate external market conditions. While internally we continue to drive operational efficiency through best practices across the organization. We know that the investments we continue to make in the platform today positioned us to capture growth when market conditions normalize and transactional activity resumes.
With that, operator, we can now open up the call for Q&A.

Question and Answer Session

Operator

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we poll for questions.
Our first question is from Jason Belcher with Wells Fargo. Please proceed with your question.

Jason Belcher

Thank you and good morning out there. So I'm just wondering if you can talk a little more about the different transaction size buckets for commission revenue, particularly as it relates to any potential recovery on, are you expecting any particular deal size bucket to lead that recovery? Can you just comment on that.

Hessam Nadji

Good morning, Jason. Good to have you on the call. Clearly, most of the recoveries, the private client is the first to recover because of the entrepreneurial nature because they can afford to acquire smaller assets with all cash and then put financing on it at times when financing is constrained and do creative things on the sell side, like a seller carry and basically worked through a lot of market headwinds that we've seen in past cycles in this cycle because of the broad nature of the dislocation and because of the credit constraints that we're seeing among banks and credit unions, as I mentioned in my formal remarks, which are the primary source of smaller transactions, mid-cap small-cap transactions are really hindering that private client recovery. Having said that, of course, the the magnitude of the transaction decline in the smaller price points, it's far less than the institutional segment or the 20 million-plus segment as far as predicting where it's going to come in. First, I would still expect the private client segment to start showing an uptick because of the fact that the prices are readjusting expectations are readjusting more inventories come into market. And those factors usually the entrepreneurial nature of the sub $10 million, 15 million marketplace. What's interesting is that in the last just in the last 30 days, really since the beginning of the year, we're seeing a lot more institutional interest, especially in markets that have been impacted by some pockets of overbuilding or a big reversal from rent spikes in the last three years to rent declines in the last six months or so. And have it's encouraging to see the pencils down attitude of institutions start to shift away to showing interest in getting back into the market. So I don't think the institutional market is going to be far behind, but I still expect the private client to lead the recovery.

Jason Belcher

Thanks.
That's helpful.
And just to follow up there, you referenced some uptick in certain markets that had been depressed, but can you just share a few of those markets where you're where you're seeing some encouraging green shoots there?

Hessam Nadji

Absolutely. I'll give you two examples. One is a supply-constrained market that for many years has been a preferred market with a lot of buyer demand and the other is more of a high beta market.
The first one that's interesting to point out is the San Francisco Bay Area and because it lags into job recovery lag in their rent recovery despite being a very supply constrained by region, you didn't see the kind of benefit from investor demand that we saw in other markets in 21, 22 and yet on an apples to apples basis, market like that is now a diamond in the rough in many ways. And we're seeing a lot more investor interest and that market than many others. The other example is Phoenix, of course, or even in markets like Atlanta, where you see a lot of construction and the absorption of those units has been strong. And then the plumbing market was on fire with a pullback of some of the some of the momentum on jobs and some overbuilding we've seen a reversal there and therefore, the price correction has been more pronounced and the kind of volatility from peak due to a drop has been more dramatic. Nonetheless, again, interest is picking up even in a market like Phoenix, that's been through a lot of ups and downs because over the long term, if you're looking at a replacement cost and really look at the price per unit trend that we're seeing. This is a great window of acquisitions. And I'm on for long-term investors that believe in growth markets like Phoenix, they're seeing that benefit. Now conversely, in a market like the Bay Area or even Southern California, because there's so supply-constrained, they're seeing that benefit again with price adjustments that makes it very competitive now on a replacement cost basis to be a buyer in this market again.

Jason Belcher

Really helpful. Thank you. And just one more follow up there, but if I may on on these markets where you're starting to see increase interest. Could you just comment on any particular property sectors that might be leading the way there?

Hessam Nadji

We continue to see retail as a comeback asset and in some ways, a preferred asset that the consumer remains very strong. Retail is way ahead of the curve and having reinvented itself because of e-commerce over the last 10 or 15 years. There has been a major pullback in new construction for well over 10 years now in retail and the power of destination, retail, entertainment and experiential retail are out in the marketplace in full force. We're seeing more retailers expand that perhaps in the last 15 to 20 years. And there is a pricing power on behalf of the owners. I'm very involved with ICSC as a trustee. And it's fascinating to see the confidence level of major retailers looking to expand into brick and mortar and brick and mortar has been rediscovered as an essential part of retail. And so it's really interesting to see that evolution go full circle with brick and mortar retail. So lots of interest there. Prices have adjusted in a way that you're starting to see that kind of alignment between buyers and sellers because again, they're further ahead of the curve and the cap rate spread to interest rates wasn't as dramatic as the apartments and industrial. So in the multifamily marketplace, which is usually the most stable, we're seeing more of a dislocation and a drop in trading activity because of that tight cap rate band and to interest rate, both for the tightening cycle began that delivered a very significant valuation disruption for multifamily. And so the market is sifting through it at the same time, you have a lot of maturing loans from debt funds and short term financing options that are terming out. And so that's creating some pressure. And of course, you have pockets of overbuilding, but I really think all of this is temporary and multifamily would be a phenomenal investment on a long-term basis.
And then lastly, of course, industrials continues to be very much a favor, but there's definitely pockets of overbuilding on the industrial warehouse side of the equation. We're becoming more and more active the product product that today is still very much distressed is office in general, but specific office investments are really getting judged incorrectly in that. If you look at urban office, vacancies are well north of about 22%, 23%. If you look at the newer suburban product that's been built in the last 10 to 15 years, those vacancies are around 11%. So there's a really a tale of two markets within office, but the sector is just being judged with too much generalization. I would say that's probably the product type where we have the most difficult bid-ask spread situation, other product that's hospitality doing well. So storage is doing well. Velocity is way down, but from a fundamentals perspective and investor demand for those products are doing well there is some overbuilding happening with storage as well on a local market basis. But as a whole, it still is garnering a lot of attention. So I hope that gives you the idea of different product types.

Jason Belcher

Great color. Thank you so much for that. Switching gears a little bit, I think you mentioned the investment in technology initiatives in the quarter. Can you talk a little bit more about what so what that was related to and what kind of benefit you get from that?

Hessam Nadji

I'm happy to Jason. There is an initiative for internal proprietary system development. We've done a great deal of it over the past three years. And all of that effort is around the productivity level of the back office that basically supports our sales force, whether it's the underwriting process, the proposal preparation process before an agent goes out to meet a prospect and them shifting from that back office internal productivity to them the marketing of our listings. We have done quite a bit of work on our website that's geared toward ease of finding our inventory. We introduce an application not too long ago called MIMI. that enables investors to register with us tell us what they're looking for, save their searches by property type price range, a geography and as our system basically does a real-time search to match that criteria if the buyers alerted and the listing agent is alerted and we make that kind of a linkage between potential investors and our listing of brokers much, much more efficient. That application now has well over 100,000 investors registered. And they also get notifications of our research content and upcoming industry and Marcus & Millichap. And that's so that's an example of an application we introduced and we continue to refine. And then our marketing center within our internal proprietary inventory system called M-Net is a fantastic automation example of making it really simple for our brokers to launch email campaigns of new listings and to be able to monitor the interest level that is coming in from our website from various screened out potential investors, potential buyers and being able to get in touch with them very easily knowing who's looking at what product type, what interest level. They have also to mix the targeting of our new listings to the right audience, a lot more efficient because our system is constantly tracking all of this a movement in activity and harnessing it by creating smart, basically distributions of new listings to the right target audience. These are just a couple of examples. We invested in equity multiple as we announced last quarter, which is really a phenomenal platform for a lot of our clients that need to raise capital as sponsors and their ability to very quickly reach out to the huge audience of crowdfunding type of investors to raise equity or equity shortfalls that our sponsor clients may have as a great value add. And we're just in the early stages of rolling that out and introducing it to our key brokers. And also in we've made an investment in Archer, which is a really interesting startup around the whole notion of streamlining multiple data sources into a modeled synthetic NOI. estimate right now, predominantly multifamily, where it's a very accurate, highly accurate synthetic and why that makes the initial stages of doing a BOP broker opinion to value or preparing to sit down with the client much more efficient that our brokers know what's happening in every sub market, what's happening in every Metro, they know what's on the market, what the price per units are, what the rent per units are, but to have this automated tool as a kind of a validation of their market assessment is very helpful. And we're looking to bolt that process onto our analytics on the back office. So that entire analysis, analysts can become a lot more efficient. So those are just a few internal and external examples of how we're leveraging technology used to make the business more efficient and more powerful.

Steven DeGennaro

And Jason, just to elaborate on the last two, those proptech investments. Those started out as commercial relationships. We liked what we saw as we evaluated the technology for the internal and synergistic reasons that has some elaborated on. We like that. We like the opportunity and at that point decided to make those investments in each of those firms.

Jason Belcher

Thank you both. Really, really appreciate all that detail. And then lastly of maybe one more for you, Steve, just switching gears to the income statement, I noticed your interest income and other line jumped a little higher this quarter. Just curious if that was mainly driven by higher interest rates on your short-term investments or if there was something else behind that?

Steven DeGennaro

Yes, that's exactly at higher rates. Obviously, we've got $400 million plus on the balance sheet between cash and our various investment vehicles. We did during the quarter elect to swap out some shorter term lower rate investments for some longer term vehicles still exist and well within our investment policy, but swapping out cash that was earning of 1% to 2% for a little bit longer time horizon earning above 5%. So we're active in that regard. Obviously, with the strength of our balance sheet, we're never pressured to sell anything even if it happens to be a below market and it gives us the opportunity to swap a lower-performing asset, a vehicle was four for higher performing.

Jason Belcher

That's helpful, thank you. And just on that the longer time horizon vehicles, what kind of duration are we looking there one year or two years in that in that range.

Steven DeGennaro

I think the max we go out is something like 30 months.

Jason Belcher

Okay.
All very helpful.
Thanks.
Thanks for taking my questions.
Guys.

Hessam Nadji

Thank you, Jason.

Operator

Yes, if there are no further questions at this time, I'd like to hand the floor back over to Hessam Nadji for any closing comments.

Hessam Nadji

Thank you, operator. And thank you to everyone who joined the call, and we look forward to seeing you on the road and having you back on our next earnings call.
Paul?
Thank you very much.

Operator

This concludes today's conference.
You may disconnect your lines at this time. Thank you for your participation.