Why this formidable global business is still underestimated

CBRE (NYSE: CBRE) is the world’s largest commercial real estate services and investment firm. With a dominant market position in leasing and property sales, as well as in investment management, CBRE is a formidable business but one we think is still underestimated. Sir John Templeton famously said that the four most dangerous words in investing are ‘this time is different’, however we believe CBRE has emerged from recent downcycles as a higher growth and more resilient business. We also believe recent cyclical headwinds are abating and will likely turn to tailwinds, further boosting growth. In this piece we unpack how CBRE has evolved, what has been driving recent performance and why we believe this time really is different.

A high-quality business benefitting from three structural growth trends

The earliest form of the name CBRE was Coldwell Banker ('CB') in 1974, but the business’ origins date back even further to 1906 as a San Francisco real estate franchise. After merging with Richard Ellis International ('RE') in 1998, CBRE began to gain international scale through the early 2000s. It listed via IPO in 2004. Since then, the business has benefitted from three structural trends:

1. Outsourcing: Property owners and occupiers seeking to reduce costs, increase efficiencies and focus on core competencies are outsourcing commercial real estate services. In 2004, CBRE served ~60% of Fortune 500 companies. Today its customers include over 95% of the Fortune 500.
2. Consolidation: To obtain a more consistent level of service both locally and globally, these property owners and occupiers are also consolidating their property and facilities management service providers. Not only are more companies outsourcing, but they are outsourcing more services. CBRE disclosed that in 2022, 80% of their top 100 clients purchased 4+ services compared to less than 25% in 2012.
3. Institutional ownership of commercial real estate: Institutional investors are increasingly allocating to real estate as an asset class through various unlisted and listed vehicles. Not only does this require use of capital markets to acquire and finance purchases, but also service vendors to manage the portfolios.

What has changed?

Until quite recently commercial real estate (CRE) services firms including CBRE had largely derived revenues from transactional business lines such as capital markets and leasing. This led to cyclical earnings streams and large peak-to-trough variations in EPS. Consequently, following the global financial crisis, CBRE has strategically looked to reduce cyclicality by increasing the percentage of group revenues from less cyclical, more recurring sources.

This has largely been achieved by thoughtful capital allocation, including a series of acquisitions within new, higher growth and higher margin segments. Some recent examples include Turner & Townsend (2021, project management with mix of office and infrastructure, accretive to core EPS), J&J Worldwide Services (2024, services provider specialising in government-regulated industries) and Direct Line (2024, data centre infrastructure provider).  

 

CBRE’s total addressable market (‘TAM’) has significantly expanded as a result. At IPO in 2004, with exposure to just the US CRE industry, CBRE estimated their TAM at US$22bn. Today with international capabilities, the occupier outsourcing TAM is worth over US$350bn.

The majority of group revenues are now from ‘resilient’ sources

Consequently, CBRE today is fundamentally less cyclically exposed, with 68% of group revenues from higher quality, ‘resilient’ earnings (versus only 28% in 2000). CBRE defines ‘Resilient Businesses’ as those that grow across market cycles because they are inherently non-cyclical (e.g. facilities management and J&J) or benefit from secular tailwinds (e.g. Direct Line and Turner & Townsend).

Comparing recent cycles to the GFC, this has led to smaller peak-to-trough EPS drawdowns and faster recoveries. We believe this lower peak-to-trough variation in EPS shows that this time is, in fact, different.

 

A turn in the cycle?

Despite the dearth of office demand driven by pandemic lockdowns, various segments of CRE showed resilience from 2019 to 2021, which marked the last capital market cycle. From 2021, higher inflation, Central Bank rate hikes and widening credit spreads led to commercial real estate portfolio devaluations and a collapse in property transactions. The subsequent denominator effect for asset allocators and the ‘higher for longer’ narrative for rates led to further weakness in the sector.

Consequently, global CRE sales volumes are currently at near decade lows, and yet we see ‘green shoots’ appearing, and several factors which point to a continued and sustained recovery.

Some of these factors include:

1. Private capital liquidity: This is high by historical standards with estimates ranging from US$300-400bn. Deployment of this capital is expected to enter strategies that can effectively compete within the higher cost of capital environment with enhanced return and new credit strategies. This should spur transaction activity.
2. Easier lending standards: Whilst interest rates remain elevated, the Fed Senior Loan Officer Opinion Survey (SLOOS) is showing a lower share of banks tightening standards. Bidding activity also continues to improve suggesting a healthy adjustment to the new interest rate environment. Easier lending standards suggest a more accommodative environment for capital market transactions.
3. Stabilisation in office and retail fundamentals: During COVID, capital focus shifted to industrial (including data centres) and away from office and retail given structural shifts in demand. This resulted in a bifurcation of demand in office and retail, with poorly located and lower tier sites witnessing extremely low demand and absorption rates, and a tight environment for prime space. JLL Research shows 39% of office buildings have no vacant space and redeveloping 400 buildings with the highest vacancy in the US would reduce the national office vacancy rate, which sits at just over 20%, by ~370bps. Multiple indicators suggest a potential turn in the cycle, including reduced office inventory through both removals and lack of new starts, alongside a continued ‘return to office’ trend and plateauing employer intentions to decrease office utilization.

Whilst CBRE has reduced its relative exposure to cyclical revenues, it still maintains a market leading position in transaction sales and leasing volumes and is therefore well positioned to capture upside from a recovery in capital markets and the associated incremental margins.

An under-appreciated earnings cycle

CBRE has performed well in 2023 and 2024 and currently trades on a 21x blended forward price-to-earnings ratio, close to historical highs. However, we believe this is fully justified by a significant improvement in the quality and resilience of the business. Furthermore, we also believe the earnings outlook remains under-appreciated, with a substantially larger base of higher growth earnings from its so-called ‘resilient businesses’, further boosted by a potential cyclical recovery in transaction-related segments which benefit from high incremental margins. 

The outlook for CBRE’s earnings is, of course, not immune to the broader macroeconomic cycle; however, our confidence in the earnings outlook remains high even within a ‘higher for longer’ rate environment, while the improved quality of the business mitigates potential risks around a significantly adverse move in interest rates.