Marcus & Millichap, Inc. (NYSE:MMI) Q1 2024 Earnings Conference Call May 8, 2024 10:30 AM ET
Corporate Participants
Jacques Cornet – Investor Relations, ICR
Hessam Nadji – President and Chief Executive Officer
Steve DeGennaro – Chief Financial Officer
Conference Call Participants
Young Ku – Wells Fargo
Operator
Greetings, and welcome to Marcus & Millichap’s First Quarter 2024 Earnings Conference Call. As a reminder, this call is being recorded.
I would now like to turn the conference over to your host, Jacques Cornet. Thank you. You may begin.
Jacques Cornet
Thank you, operator. Good morning, and welcome to Marcus & Millichap’s first quarter 2024 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 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, 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 February 28, 2024.
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 morning and is available on the company’s website, includes a reconciliation to the appropriate GAAP measures and 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 www.marcusmillichap.com, along with the slide presentation you may reference during the prepared 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 entire Marcus & Millichap team, good morning and welcome to our first quarter earnings call. The highly anticipated start to the interest rate easing cycle by the Federal Reserve messaged in early 2024, reversed course during the first quarter. The shift toward higher-for-longer has prolonged interest rate volatility, which remains disruptive to real estate valuations, marketing of listings and transaction closings.
After dropping 51% in the first quarter of 2023 from the previous year, overall market sales volume dropped another 19% in the first quarter of 2024 based on preliminary estimates by RCA. Given this difficult backdrop, revenue for the quarter was $129 million, with an adjusted EBITDA loss of $10 million. These results reflect the productivity drag on our sales force as listings take longer to market and many deals continue to fall out of contract due to financing issues or repricing. This is time-consuming for our sales force, as you can imagine and limits their bandwidth to engage in new business development in the current environment.
Our financial results were also impacted by expenses related to investments made over the past several years in talent retention and acquisition, technology development and implementation, and expanded brokerage support. The expected revenue levels, which would typically follow these investments in a stable market, remain hampered temporarily as we work through this market disruption.
We remain steadfast in our strategy to stay on offense and position the company to lead in the eventual recovery. This includes ongoing investments in business development efforts, client outreach, branding and ensuring that MMI remains prominently in the center stage at key industry events.
As an example, client demands for market analysis, updated valuations and general advisory services remain at an all-time high as investors navigate uncertainty. To remain fully capable of providing this level of granular client support, we have proactively maintained our service level and resources. As we know from past cycles, staying close to investors and developing new advisory-based relationships during tough times leads to future revenue growth.
Our strategy is also unwavering when it comes to pursuing strategic acquisitions, attracting additional experienced individuals and teams, and returning capital to shareholders. During the quarter, we added several brokerage and financing professionals in key segments where we lacked coverage and began dialogue with a number of new targets and investment opportunities. Our underwriting is highly sensitive to balancing near-term downside with future upside and strategic enterprise value when it comes to valuations and deal structure.
Looking back at M&A opportunities, we decided to pass on over the past 18 months. There is no doubt that results would have been below expectations had we accepted terms required by the sellers. Having said that, the bid-ask spread in the market is not keeping us from pursuing targets given the importance of external growth.
Internally, we continue to focus on providing our team with the best-in-class tools, training, communication and support. The company’s expanded research content is instrumental in keeping investors informed and connecting our sales force to clients and prospects.
Additional resources have been added to our recruiting team to help our managers increase outreach to high-quality sales professionals to regain momentum in our traditional organic growth. While these efforts are making a difference, the turnover rates for newer individuals remain elevated due to the challenging market environment.
We continue to proactively transition lower probability individuals out of the firm if they are not able to meet key development and production metrics. In time, we believe our organic growth will fuel net contributions to headcount as we build on our recent success in attracting experienced professionals.
Notwithstanding the current challenges, MMI closed over 1300 transactions in the quarter, including 234 financings with 121 separate lenders in this tough environment. These numbers reflect our ability to solve problems for clients, facilitate opportunities for investors and get deals done. MMI remains the top investment brokerage firm by number of transactions, which, in turn enables us to execute on behalf of our clients due to our market reach and unique investor access.
From a market perspective, we continue to see hamper transaction activity across all business segments and price points given the macro nature of the interest rate shock still working its way through the industry. However, a number of very important positive signs are emerging that I’d like to point out.
First, even without the shift in Fed policy toward lowering interest rates, the passage of time is driving price adjustments. Positive momentum on buyer tours and offers is building on realistically priced assets across all property types and markets. This is indicative of the record capital on the sideline, awaiting more clarity on interest rates and well-priced acquisition opportunities. As prices reset, we are seeing an uptick in our inventory with assets coming to market at more realistic values, which should have a higher conversion rate in the quarters ahead.
Many sellers who were hoping for a Fed miracle are coming to terms with having to sell due to maturing loans that cannot be extended or refinanced without fresh equity or personal circumstances, which we typically rely on as a driver of transactions. Situational distress is also increasing for assets that were underwritten too aggressively with short-term financing that is terming out and those with operational issues.
We are also seeing growing demand for our auction services, which is a complementary offering we added ahead of the market downturn, while these positive factors will take time to manifest in better financial results, we believe they are the building blocks to an eventual recovery. Most importantly, when the market becomes more favorable, we believe the production capacity of the talent that has been added and retained for the firm, coupled with numerous technological advances we’ve made over the past few years will play a major part in accelerating our growth into the next cycle.
In the meantime, we continue to guard our strong balance sheet with diligence while pursuing internal and external growth opportunities and keeping the Marcus & Millichap brand as strong as ever.
With that, I will turn the call over to Steve for additional insights into our financial results. Steve?
Steve DeGennaro
Thank you, Hessam.
As Hessam mentioned, revenue for the first quarter was $129 million compared to $155 million in the prior year quarter. Breaking down revenue by segments, real estate brokerage commission for the first quarter was $109 million and accounted for 85% of total revenue compared to $135 million last year, a decrease of 19% year-over-year.
Brokerage volume for the quarter was $5.7 billion, over 1102 transactions, down 21% and 14%, respectively compared to last year. Average transaction size was approximately $5.1 million, down from $5.6 million a year ago, partially driven by a lower mix of deals with institutional buyers as well as lower property values across asset types.
Within brokerage, our core private client business accounted for 67% of revenue, or $73 million. This compares to 67% and $91 million last year. Private client transactions were down 20% in dollar volume and 17% in number of transactions. This is largely due to restrictive financing by banks and credit unions, which are the primary funding sources for smaller transactions.
Our middle market and larger transaction segments together accounted for 29% of brokerage revenue, or $32 million compared to 29% and $40 million last year. Middle market and larger transactions combined were down 21% in dollar volume and 14% in number of transactions.
Revenue in our financing business, which includes MMCC, was $14 million in the first quarter compared to $16 million last year. Fees from refinancing accounted for 51% of loan originations this year compared to 46% last year. During the quarter, we closed 234 financing transactions totaling $1.7 billion in volume, compared to 279 transactions for the same $1.7 billion in volume in the prior year. Other revenue was $5 million in the first quarter compared to $4 million last year.
Total operating expenses for the quarter were $149 million, 13% lower than a year ago, primarily due to lower variable expenses directly attributable to revenue and cost containment efforts. Cost of services was $77 million for the quarter, or 59.5% of total revenue, a decrease of 210 basis points over the same period last year, consistent with the lower revenue.
SG&A during the quarter was $69 million, a decrease of 5% year-over-year primarily due to lower agent marketing support tied to last year’s revenue and continued proactive balancing of key investments with expense reductions.
For the first quarter, we reported a net loss of $10 million, or $0.26 per share, compared with a net loss of $5.8 million, or $0.15 per share in the prior year.
For the quarter, adjusted EBITDA was negative $10.1 million compared to negative $7.4 million in the prior year. The effective tax rate for the quarter was 32%, which takes into account the level of expenses that are non-deductible for tax purposes in relation to estimated pre-tax income for the full year. The future tax rate may fluctuate as the relationship between these 2 components change given prolonged market uncertainty.
Moving over to the balance sheet, we continue to be well capitalized with no debt and $346 million in cash, cash equivalents, and marketable securities, which was down from the prior quarter’s balance of $407 million. The decrease during the quarter was expected and reflects seasonal outlays for current and deferred agent commissions, performance-based management bonuses, which were significantly lower as a reflection of 2023 financial results, as well as investments in talent acquisition and retention.
As a reminder, our deferred earnings program has a 3-year vesting period. Therefore, the deferred commission payout was larger than usual given the record revenue performance in 2021. During the quarter, we declared a semi-annual dividend of $0.25 per share representing a total of $10.1 million. That dividend was paid during the first week of April. Over the past 2 years, we have returned more than $160 million to shareholders and have roughly $71 million remaining on the current share repurchase authorization.
We remain committed to a balanced long-term capital allocation strategy. This includes a combination of investing in technology, recruiting and retaining the best-in-class producers, strategic acquisitions, and returning capital to shareholders through dividends and opportunistic share repurchases.
Investors entered this year with expectations of lower inflation and the start of Fed rate cuts by Q2, which would stimulate transactions and pave the way for a capital markets recovery. Recent inflation data, however, has tempered prospects for near-term rate cuts and fueled further uncertainty around the number of cuts expected in 2024. Given this backdrop, the market recovery seems likely to be pushed out at least to the second half of 2024.
Cost of services as a percentage of revenue for the second quarter should follow the usual pattern and be sequentially higher than the first quarter. SG&A is expected to be largely in line with the first quarter, reflecting the benefit of cost actions previously taken.
As mentioned earlier, our tax rate is highly dependent on the level of non-deductible expenses and more importantly, the variability of pre-tax income for the full year. As a result, the rate could fluctuate significantly from quarter-to-quarter.
Our primary focus continues to be proactive engagement with clients, leadership at industry events, ensuring the MMI brand remains top of mind and technological enhancements, all in support of our sales and financing professionals. The investments we have made in systems, talent, and market coverage will position us to capture growth as market conditions improve.
With that operator, we can now open up the call for Q&A.
Question-and-Answer Session
Operator
(Operator Instructions) And our first question comes from the line of Young Ku with Wells Fargo. Please proceed with your question.
Young Ku
Just stepping up for Blaine here. Just wanted to go back to your comment on the current environment. Clearly, the transaction market is depressed but of the transactions that are happening today, could you provide some color on what percent is driven by some distress and then versus those that are occurring naturally?
Hessam Nadji
Good morning. Happy to answer that. Hessam here. We are seeing more and more situations where the sellers are having issues with operations, or maturing loans that require fresh equity in order to get refinanced or recapitalized. And that’s really the definition of distress that we’re seeing more than the typical wholesale large portfolio dispositions by lenders that you would typically categorize as distressed, a very little of that is really affecting the market and much more so of the situational examples are driving the market.
Overall, distress is becoming a bigger factor, but really not the driving force in the current real-time transaction activity. The bulk of the market is simply driven by both the personal circumstances of the private investor, bringing product to market, or some middle market and institutional investors deciding to punt on certain assets that they don’t believe will perform to their expectations going forward and just have the typical seller motivation that is bringing product to market.
A year ago at this time, there was so much more uncertainty related to the timing of this down cycle and what the Fed would or wouldn’t do, and that pushed a lot of people to the sideline. With the passage of time, we are seeing the natural kind of realization that this cycle is not going to go away overnight. And therefore, if there is a reason to sell a property, might as well bring that product to market and redeploy the equity, or get out of a situation that is very likely to underperform, looking ahead.
What we’re also seeing is that financing is generally available. There’s liquidity in the market. The underwriting standards and the essential loan to values that we’re seeing today is much more restrictive than in a normal market environment. That has become more of an obstacle to getting more transactions done than anything else. Although as I mentioned in my formal remarks, we’re able to essentially find a willing lender that is available in the marketplace as long as the realistic terms are met by the borrowers. I hope that gives you some color.
Young Ku
No. That’s helpful. Could you talk about what product types could see the most distressed? We’re hearing multifamily potentially. And then office, obviously, but we’re just interested in kind of your thoughts there.
Hessam Nadji
What we’re seeing on the product type comparison is that retail continues to have favor, if anything at all there is to be said about retail is the 15 previous years of recalibrating, shortage of new construction, conversion of retail to other uses, and reduction of essentially supply has repositioned shopping centers in particular much better today than any time we’ve seen in the last 20 years.
At the same time, tenant demand appears to be at the highest level we’ve seen in that same time period. And the combination is really driving a lot of interest in shopping centers. That’s an outlier in terms of positive momentum for transaction activity, plus, retail and certain other property types like hospitality or even office didn’t have the tight spread between cap rates and interest rates before the Fed tightening.
Therefore, there was more of a margin of absorbing the negative leverage that has significantly impacted multifamily and industrial, which were the 2 property types with the lowest cap rates prior to this tightening cycle. That’s where we’ve seen the biggest valuation disruption and uncertainty on pricing.
On the multifamily side, we are seeing a rebound in tenant demand in occupancies after a soft period in 2023 and part of 2022, which is a very positive sign. But you’re right in that we’re seeing more examples of maturing loan problems, especially because the last 3 years were driven by very aggressive financing by a lot of debt funds that are terming out, as I mentioned in my comments. And those situations need some kind of a solution, whether it’s raising equity, recapping, or a sale. And we’re actively working with our clients across the country on numerous examples of those kinds of transactions.
The fundamentals of multifamily are still solid. There’s a housing shortage. The home affordability index is showing the widest gap between renting versus owning. So the fundamentals are there. And the pockets of overbuilding that we’re seeing throughout the country in multifamily are really limited to about 8 to 10 metros. Therefore, the industry is still doing well.
I think it’s going to take some time for the repricing of multifamily to really set in. This is where part of our results has been hampered more than usual because the private client multi-family, the private client single-tenant retail is more affected in this cycle because of the interest rate shock. In that normally, we have the Fed coming into the market as sort of a rescue when there is a recession or a credit market problem in this cycle is, of course, the reverse, where the Fed has caused the disruption in valuations.
We are actually successful in many, many office sales. The key factor in office is that the book is being judged by its cover. In that distressed office is really limited to older urban product. Suburban product is much better off than urban product, and we’ve sold both distressed and well-performing office assets in the quarter throughout the country.
And industrial is holding up okay. Sales in the market for industrial were down 20% in the first quarter. And we’re viewing industrial as an ongoing growth opportunity for the company. So we’re actually adding coverage and penetrating more of the industrial market because we believe that long-term it’s here to stay. But it is showing signs of a pullback. Hotels were down 23% in the market. And for us, that’s another growth opportunity. We continue to do well there. And the self-storage business, which we’re a top player in, has also seen a major drop-off in transaction activity. But again, as market leader there, we are very well positioned to take advantage of that segment.
Young Ku
Great. Thank you for the color. And then you talked about experiencing higher turnover given the current environment. So how should we think about your brokerage count as we progress through the year?
Hessam Nadji
Well, first, a little bit more details on what is happening in that. We’ve gone from the pandemic to a post-pandemic, major market reversal to the upside, and then a very dramatic market shift downward because of the interest rate shock. So the last 3-year to 4-year period has provided nothing resembling a typical market environment in which we train people, we mentor people, they learn the fundamentals of brokerage underwriting, client contacts, and they basically start to develop their production and their brokerage career.
This disruption, both on the way down, on the way up and on the way back down, is the primary reason that skill sets aren’t developing in the way that we’re used to saying through our excellent training and market-leading ways of mentoring new people into the business. That’s what’s causing the disruption in that. A lot of the people that you would typically bring in after, let’s say, 2 years of this initial training and mentorship would become productive or would become standalone new additions to our sales force.
And we’re still attracting at the top of the funnel a phenomenal volume of both interns, fellows, and new agent candidates. What is causing the challenge is the higher turnover rate of the people that have been through the training but are not able to function because the market challenges and headwinds and the lower transaction velocity is just making it very hard to break into the business. So that’s a little bit more color on the mechanics of what where the challenge is.
We do expect this to be an obstacle we will overcome. We’re taking a variety of different initiatives, both on the top of the funnel, to bring in more candidates. We’ve implemented a new version of a screening test and a screening process for our management team. We’ve added recruiters that are helping them with the bandwidth and available time in order to reach in, reach out to more candidates. And so, all of that, we’re confident will make a major difference. But I think the biggest difference will come from the market, essentially settling and being able to provide a somewhat of a normal operating environment for new trainees.
Meanwhile, I really want to emphasize the importance of the success in bringing in experienced individuals and teams. It’s more than offsetting the disruption and the creation of new producers through our organic channel and the fact that we strongly believe in a multi-channel strategy going forward, getting back to our organic contribution to the sales force when the market really normalizes, and at the same time, continuing to build on our success of bringing in experienced people. We make a point to only bring in experienced individuals and teams that don’t overlap with our existing sales force, in order to make sure that we’re expanding the market coverage and the segment coverage and not cannibalizing our existing sales force.
Young Ku
Okay. That’s helpful. And lastly, can you provide some thoughts on external growth opportunities that you may be pursuing, maybe in terms of what stage of negotiations that you may be in right now, and then maybe also compare those opportunities versus repurchasing shares?
Hessam Nadji
Yes. I’ll let Steve comment as well. But in general, we are always in the market with a proactive strategy in various verticals that we believe are complementary to our core business, as well as an ongoing pipeline of core business acquisitions or individual and team recruiting. It never stops. So we have explored different opportunities in appraisal and advisory services. We’ve explored a number of boutique brokerage acquisition opportunities and boutique finance acquisition opportunities in the last 12 months to 18 months, as well as considerations around the investment management vertical where we’re looking at some opportunities there.
But the most important aspect of our growth strategy is the balance that we’re trying to maintain between the near-term risk in underwriting and valuation, as I mentioned in my remarks. It’s a very tough environment in assessing that near-term risk and the timing of the market recovery versus the bid-ask spread that appears to be in the marketplace. It is narrowing. I will say, our current conversations are much more realistic that are ongoing right now than they were even 6 months to 9 months ago.
But nonetheless, for us the important thing is to be in the market through our platform, developing relationships, knowing the targets that would work for us from a cultural perspective, and having more of a ground-up strategy than just trying to buy share, if you will. Steve, do you want to add some comments to that?
Steve DeGennaro
Yes. I think more broadly around capital allocation, which I think is what you were getting at, Young. It’s important to acknowledge that we are wanting to invest for long-term growth. That means investments in technology, recruiting and retention, as Hessam has talked about, as well as M&A and returning capital to shareholders. And in different environments, our priorities and our focuses can move around, can shift depending on circumstances as we evaluate the best use for deploying our capital.
As it relates specifically to repurchases, which I think you mentioned, we’ve always said our repurchase program will be opportunistic. And to that end, we’ve repurchased roughly $70 million of shares over the last 18 months or so. That is a program that we can dial up or down depending on a balancing of the various opportunities and other relative uses of our capital.
So, yes, we were a little bit on the lighter side this last quarter partly, I guess you could say, a function of the fact that the business is not necessarily generating as much of the free cash flow as we do in normal time. So that’s just an example of how we balance our various priorities.
End Q&A
Operator
Thank you. And we have reached the end of the question-and-answer session. I’ll now turn the call over to President and Chief Executive Officer, Hessam Nadji for closing remarks.
Hessam Nadji
Thank you, operator, and thank you for joining our first quarter call. We appreciate your participation and look forward to seeing many of you on the road and look forward to our next earning call. The call is adjourned.
Operator
And this concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.
