HFF, Inc. (NYSE:HF)
Q2 2016 Earnings Conference Call
July 26, 2016 08:30 AM ET
Myra Moren - Director, IR
Mark Gibson - CEO
Greg Conley - CFO
Jade Rahmani - KBW
Brad Burke - Goldman Sachs
Mitch Germain - JMP Securities
Good morning and welcome to HFF Inc.’s Second Quarter 2016 Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer and instructions will follow at that time. As a reminder, this conference call is being recorded.
I would like to introduce your call over to your host Ms. Myra Moren, HFF’s Director of Investor Relations. Ms. Moren, please go ahead.
Welcome to HFF, Inc.'s earnings conference call to review the company's operating performance and production results for the second quarter. Monday evening we issued a press release announcing financial results for the second quarter. This release is available on our Investor Relations website at hfflp.com.
This conference call is being webcast and is available on the IR section of our website along with a slide deck you may reference. This call is being recorded.
Please turn to the slide labeled disclaimer and the reference to forward-looking statements. This presentation contains statements that are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995 including statements regarding our future growth momentum, operations, financial performance and business outlook.
These statements should be considered as estimates only and actual results may ultimately differ from these estimates. Except to the extent required by applicable securities laws, we undertake no obligation to update or revise any of the forward-looking statements you may hear today.
For more detailed discussion of risks and other factors that could cause results to differ, refer to our second quarter 2016 earnings release filed on Form 8-K and our most recent Annual Report on Form 10-K, all of which are filed with the SEC. We may make certain statements during today's call which will refer to a non-GAAP financial measure. And we have provided a reconciliation of this measure to GAAP figures in the release.
With that in mind, I will introduce our senior management team. Conducting the call today will be Mark Gibson, HFF's Chief Executive Officer, and Greg Conley, HFF's Chief Financial Officer.
I'll now turn the call over to our CEO, Mr. Mark Gibson.
Thank you, Myra. Good morning everyone and welcome to HFF's second quarter 2016 earnings conference call. As outlined in our earnings release yesterday afternoon, revenues in the second quarter of 2016 declined approximately 5.9% to 117.7 million when compared to second quarter of 2015. We continue to invest heavily in our business evidenced in part by the 13.9% increase in total headcount over the past 12 months, which is consistent with our long term strategic plan.
Of note, this increase in headcount of a 105 net new associates represents HF’s larger overall hiring increase in a 12 month period in the firm’s history and that includes a substantial increase in our analyst ranks throughout the organization.
Additionally in the second quarter, HFF expanded its western US presence by opening an office in Phoenix, Arizona, with a focus on debt and equity placement as well as investment sales serving Arizona and the greater southwest region.
As we’ve mentioned on previous earning call, our headcount growth is a result of both our organic and its external recruiting efforts, the firm will balance these two approaches based on a strategic need and the operating environment. Given the current operating environment, HFF has focused significant resources on organic growth through our collegian recruiting efforts to enhance our team of commercial real estate analyst to fuel future producer growth.
At present, we believe this approach is a better risk adjusted strategy from both a sustained growth and a cultural perspective, yet it does not prevent us from pursuing strategic hires of seasoned transaction professionals. Industry performance in the second quarter and the first six months of 2016 continues to evidence investors general and economic concern related to domestic and global economic growth.
Investment sale transaction volume as reported by real capital analytics experienced a 13.7% decrease relative to second quarter 2015 and a 15.8% decrease relative to the first half of 2015. For our commentary of previous earnings call, the volatility of the public markets during the first quarter of 2016 as well as various global uncertainties which have since emerged has resulted in the investment community in general reconsidering how it defines the prices risk. In regards to the commercial real estate industry, the situation is generally referred to as price discovery provide investors and underwriting with a moderate growth assumptions relative to future economic activity which can affect pricing in some situations.
In addition to price discover, the investor market is also keenly aware of economic cycle risk, meaning decoration of this current economic expansion and as a result is mitigating that risk by diversifying investments across more individual assets versus large single asset transactions over portfolios. This combination of price discover and diversification strategies has played a significant role in transaction volumes decreasing during the first half of 2016.
It should be noted that some of the declines in the industry volume statistics are also due to timing. Meaning these factors have many cases elongated to closing timeframes with transactions as investors negotiate a middle ground on bid asked prices. Therefore in many situations closings have been delayed versus not transacted.
It is HF’s opinion that volumes of commercial real estate transactions should be viewed on an annual calendar year comparative basis, given the timing variances that inevitably occur quarter-to-quarter. However there are distinct offsets to the aforementioned, those being that commercial real estate remains a favorite asset class among the majority of institutional investors.
The impact of the negative interest rate environment, particularly in Europe, resulting in more European capital looking to invest in stable US real estate assets, and finally uncertainties created by the Brexit vote is likely to enhance the US commercial industry’s effectiveness across a majority of overseas investors.
Given the aforementioned volatility, we believe it is important to reiterate few key themes relative to the HFF business model. First, HFF is not in the real estate business but rather the real estate transaction business. HFF does not invest within or provide any services other than those of the capital markets and intermediary. Therefore the firm is not directly impacted by price movements in commercial real estate assets relative to the investment gains or losses from HFF’s sponsored investment fund given its lack of participation inside.
Additionally, some volatility above the norm in US capital markets has generally been beneficial to the firm, given HFF’s role as a real estate transaction intermediary because it can result in an increase in demand for our capital markets knowledge, advisory services and execution capabilities. However, it is also important to note that a period of sustained volatility in the US capital markets could result in the development of the divergence in bid/ask prices which could adversely affect US investment sale transaction volumes.
In the event a bid/ask gap develops in the investment sales business as a viable alternative for owners, we’ll be refinancing in the private debt markets. Second, HFF has virtually no corporate debt, a relatively low fixed cost structure and minimal working capital needs allowing the firm significant flexibility in terms of adjusting to any market environment and to take full advantage of potential growth opportunities. Third, the firm is highly diversified relative to its client base. In the 12 month period ending second quarter 2016 not one client accounted for more than 2% of capital market services revenue and our top 10 clients combined represented 13.1% of capital market services revenue.
As previously stated, the commercial real estate industry is an asset class and remains in favor with investors. Additionally, the composition of ownership is becoming increasingly institutional which we believe will positively impact transactional volumes in the future, subject to the help of the US economy.
This is best illustrated by the following points; effective in the third quarter of 2016, commercial real estate will be re-categorized for the broader financial sector and become a standalone category as the 11th global industry classification standard on [get straight] in vertical. The first distinct trading vertical created since 1999.
HFF [views] the emergence of commercial real estate as a core investment holding, ensures the industry will continue to benefit from consistent annual allocations of capital and then investing in the asset class as necessary in order to attain a diversified investment portfolio. Domestic institutional investors who are active in the private commercial real estate market have in the past been consistently under investing in commercial real estate.
As shown on slide 17, actual investment in the asset class is approximately 130 basis points below target, as a percentage of AUM. However, if devaluation in the public equity market persists without a corresponding price adjustment in the private commercial real estate market, and/or commercial real estate continues to outperform other asset classes on a relative basis, this corresponding numerator/ denominator conundrum will affect allocation models within institutional investors, and may require rebalancing which contemporarily reduce fund flows in to commercial real estate.
In the event rebalancing occurs, the scale or the probability of bid/ask gap forming increased. As illustrated on slide 18 and 19, the institutional investor participation in the private commercial real estate market continued a multi-year increase to 2015. Capital managed by institutional investors and real estate measured by assets held with closed-end and open-end funds has increased 90% and 69% respectively since 2007, suggesting both increased demand for the asset class and a larger denominator of assets which should be positive relative to future transactional volume.
An important source of capital for the US commercial real estate industry is the participation of the retail investor. Given changes currently being implemented by government regulators in this industry, a significant number of no load or low load real estate investment funds for private best-in-class real estate operators and investment management firms are emerging or are already investing.
HFF believes there are some sort of demand from the traditional retail investor universe as few retail investors have exposure to best-in-class private commercial real estate investment managers. Given the political and social unrest in many parts of the global along with concerns of the global economic slowdown, the flow of foreign capital in to the US commercial real estate market increased more than two-fold from 42.2 billion in 2014 to 93.6 billion in 2015 as show on slide 21. However foreign capital flows in to the US totaled 24.4 billion in the first six months of 2016, a 45.1% decrease from the same period in 2015 largely due to the overall economic uncertainty previously mentioned and the record amount of capital deployed by foreign investors in 2015.
In terms of future fund flows of foreign investment in to US real estate, the Brexit vote could be a net positive due to concerns about volatility in the EMEA in the near turn. In our opinion these trends are long term positives for the commercial real estate industry, and could help to partially offset the impact of volatility currently being experienced in the public and private US capital markets.
The aforementioned increases in AUM for both the close-end and open-ended fund markets suggest the market has a potential to sustain current transaction levels absent a significant deceleration in US economic activity. Of particular note is the transaction volume likely to emerge in the close-end fund market, as illustrated on slide 22, the average hold period for 64% of the participant in a close-end fund market is less than five years in duration due to the value add investment objectives, the underlying compensation structure of these funds and the need to post realized returns for future fund raising.
Finally, as shown on slide 24, the 1.06 trillion of maturing commercial real estate loans through 2018 should serve as a catalyst for investment sales and refinancing transactions. In regard to HFF, our investment sale transaction volume for the second quarter of 2016 totaled 7.4 billion, a decrease of 7.6% when compared to the same period in 2015. During the first half of 2016, our investment sales volume totaled 15.6 billion, reflecting a 14.7% increase over first half 2015.
As illustrated on slide 25, HFF investment sales transaction volume for the full year of 2015 increased 99% from 2007, as compared to a decrease of 5% for the industry.
Turning to our debt business line, volumes for the second quarter of 2016 totaled 8.5 billion, a decrease of 13.2% compared to second quarter of 2015 and 18 billion in the first half of 2016, an increase of 2.1% over the same period in 2015. As illustrated on slide 26, HFF’s debt placement volume for the full year of 2015 increased 63% from 2007 as compared to a decrease of 1% for the industry.
In summary, we believe there is ample availability of capital for both the debt and equity markets to sustain current real estate transaction volumes absent a precipitous decline in US economy activity. Commercial or real estate in effect houses the US economy and therefore its health is directly correlated to US job growth.
With that, let me turn the call over to Greg.
Thank you Mark. The information I will to discuss today is also set forth on slides 34 through 44. Beginning on slide 34, during the second quarter our revenue was 117.7 million, that’s compared to a 125 million in the second quarter of 2015. Total transaction volumes decreased 8.9% in the second quarter with debt transaction volumes down 13.2% and investment sales transaction volumes down 7.6% year-over-year.
With revenues down on an increasing cost base, operating income and margins were impacted in the second quarter. We continue to maintain healthy levels of liquidity and operate a highly diversified and fully integrated capital market services platform as it relates to both consumers and providers of capital.
Turning to slide 35 and 36, revenue for the first six months of 2016 was 235.2 million, which represents a year-over-year increase to 7.3% or 15.9 million. The revenue growth for the six months was driven by an 8.4% increase in transaction volumes, with debt volume up 2.1% and investment sales volume up 14.7% year-over-year. Operating income was 17.6 million in the second quarter of 2016 compared to 25.7 million in the same period last year.
For the first six months of 2016, operating income was 34.3 million compared to 36.9 million. This decline in operating income for both the quarter and six month period is primarily attributable to the increase in the company’s compensation related cost and expenses associated with in part to 13.9% increase in headcount of a 105 net new associates over the past 12 months, including a related cost necessary to support this growth, such as the office expansion related occupancy cost, increases in other operating expenses and increase in stock compensation expense and an increase in depreciation and amortization which is primarily related to the increase in amortization expense associated with the initial valuation of mortgage servicing rights.
Operating for the second quarter of 2016 was 14.9%, compared to the operating margin of 20.6% for the second quarter of 2015. Operating margin for the first six months of 2016 was 14.6% compared to 16.8% for the same period in 2015. This decline in operating margins for both the quarter and the first six months period of 570 basis points and 220 basis points respectively is attributable to the increase in the company’s operating expenses primarily related to the investments we are making in our business as previously stated.
It is important to note that we typically have seasonality in our business, whereby the first half of the year is generally our weakest period relative to revenue and financial performance. As a result, increased operating cost to support the strategic growth initiatives can have a disproportionate impact on our second quarter and first six months operating income and adjusted EBITDA margins as compared to full year results.
The company’s adjusted EBITDA for the second quarter of 2016 was 28 million, compared to adjusted EBITDA of 35.3 million in the second quarter of 2015. For the six months of 2016, adjusted EBITDA was 52.7 million compared to 53.1 million for the same period in 2015. This decrease in adjusted EBITDA for the second quarter and six months period was primarily due to the decline in operating income.
Adjusted EBITDA margin for the second quarter was 23.8% compared to 28.3% for the second quarter of 2015, while the adjusted EBITDA margins for the six months ended June 30, 2016 was 22.4% compared to 24.2% for the same period of last year. This decline in adjusted EBITDA margin is for both the quarter and the first six months period of 450 basis points and a 180 basis points respectively is attributable to decline in operating margins.
Cost of services as a percentage of revenue was 57.4% in the first six months of 2016 compared to 57.3% in the same period of 2015. This percentage is relatively flat for the comparative six month period which highlights that while we have an increasing fixed cost component associated with our direct production cost, which is primarily related to an increase in salaries and other payroll related expenses associated with the increase in headcount. These cost increases for the first six months of 2016 relative to growth in personnel is fairly commensurate with our revenue increases for the same period.
Operating, administrative and other expenses were up approximately 8 million or 15.3% in the first six months of 2016, when compared to the same period in 2015. This increase was primarily due to increased compensation related expenses and other operating expenses due to higher transactional activity and the growth in headcount.
Also as shown on slide 35 and 36, interest and other income decreased 700,000 in the second quarter, which is attributable to a slight decrease in the quarter for agency related income. For the first six months of 2016 interest and other income was flat compared to the same period in 2015.
We had a record year in Freddie Mac originations in 2015. Originations continue to be strong in 2016, as the company’s Freddie Mac originations for the six months of 2016 were approximately 2.6 billion, as compared to 3.2 billion in the same period of 2015, representing a decrease of 600 million. It is important to note that originations for the first six months of 2015 included one transaction of close to $1 billion that was originated in the second quarter of 2015.
Earnings per share on a fully diluted basis was $0.41 compared to $0.55 for the second quarter of 2015, and with $0.77 compared to $0.80 for the first six months of 2015. The company’s effective tax rate for the first six months of 2016 was approximately 40%. Slides 38 to 40 relate to the balance sheet and liquidity.
Our cash balance net of client advances at June 30, 2016 was 168.3 million, compared to 159.1 million at June 30, 2015. As shown on slide 38 during the first six months of 2016, the company generated 80 million in cash from operating activities excluding a 1.9 million decrease in client advances. The company’s use of cash is typically related to the limit of working capital needs during the year and the payment of taxes.
The company has virtually none corporate level of debt to service other than that related to our Freddie Mac’s business which of course is offset with the mortgage note receivable. As shown on slide 39, our balance sheet as of June 30, 2016 included a 149.9 million of outstanding borrowings on 14 loans under warehouse credit facilities to support our Freddie Mac multi-family business and we also had a corresponding recorded for the related mortgage note receivable. To date, all but three of these loans have been purchased by Freddie Mac.
I would like to make a few comments regarding our production volume and operational measurements which can be found on slides 41 to 44. As noted on slides 41 and 42, on a year-over-year basis our production volume decreased by 8.9% or approximately 1.7 billion for the second quarter of 2016, and increased 2.8 billion or 8.4% for the first months of 2016. The total number of transactions decreased by 3.8% or 21 in the second quarter of 2016 and increased by 17 or 1.7% for the first six months of 2016.
The company’s loan servicing portfolio grew by 10 billion or 22.4%, when compared to the portfolio size in the second quarter of 2015. The loan servicing portfolio balance is at 54.7 billion as of June 30, 2016.
Slide 43 provides a historical summary of our headcount and also shows the second quarter comparison of the same period in 2015. Total headcount and transaction professional as of June 30, 2016 were up 13.9% and 8.7% respectively year-over-year. Slide 44 provides a summary select reduction in operational measures.
The revenue per transaction professional is relatively flat for the first six months of 2016 compared to the first six months of 2015 and is up 2.8% to 1,735,000 from 1,688,000 for the trailing 12 months which is evidence of continued productivity gains achieved by the company as measured on a full year basis.
In summary, the first six months of 2016 was a challenging capital market environment for a variety of factors as mentioned by Mark? This resulted in a subdued second quarter performance with revenues down 5.9% and decreased operating income and margins from increased operating cost when compared to the very strong second quarter 2015 performance.
The company’s operating and financial performance for the first six months of 2016 was more balanced with the 7.3% increase in revenue and relatively flat adjusted EBITDA as compared to the same period in 2015, as we continue to make strategic investments in our business consistent with our growth strategy.
We continue to work to be very disciplined, efficient and strategic as it relates to the management of our expenses and are always mindful of balancing our long term strategic growth initiatives with the current operating environment.
I would now like to turn the call back over to Mark. Mark?
Thank you Greg. As we look further in to 2016, we think it’s important to convey the firms strategic plan remains unchanged with previous years’ in terms of continuing to build out the company’s platform to ensure the HFF offices’ [down result] in major markets in the US have the full complement of our existing business lines and property vertical specialties.
Further our future growth will continue to be premised on our core guiding principles which we believe significantly differentiate HFF and the real estate industry. These core guiding principles are briefly described as follows: first is our client centric business model which avoids business lines or product services that directly compete with the business interest of our clients. Such as investment management, land lord and tenant representation and/or property asset management practices.
Our transaction professionals appreciate this lack of conflict of interest with their clientele. Additionally the firms’ sole focus on the capital markets business eliminates any internal competition with other business line for resources to both conduct and grow their business. Second is our player/coach leadership style whereby the firms leadership mentors are transaction professionals through being engaged in generating revenue for the firm actively originating in executing real estate transactions. Our transaction professionals prefer to be lead/mentored through transactional deal flow versus managed in a corporate context.
Third, is our pay for performance compensation structure which aligns the interest of HF’s leadership with the performance of the firm through our profit participation and armed with those compensation plans? Fourth, is maintaining an owner mentality versus an employee mentality, which is illustrated by the fact that HFF employees own approximately 13% of the outstanding Class A common shares of HFF, highlighting the importance of our adherence to an owner mentality is the firms’ granting of 750,000 shares in January 2014 and an additional 250,000 shares in February 2015 and February 2016 to our leadership team and transaction professionals based on value-add metrics, which vests over five years.
Our fifth guiding principle is risk mitigation. The company has virtually no corporate level debt service and we continue to maintain significant cash balances to fund our working capital needs, our future growth and to mitigate downside risks as occurred in 2008 and 2009. Once we have met these needs and have sufficient capital reserve to not only survive but thrive in a down market, the company led by the Board of Directors looks at all options regarding the highest and best use of its capital.
Over the recent past, this has been illustrated by returning capital shareholders on four previous occasions, in 2012, 2014, 2015 and recently in February 2016 in the form of special dividends totaling 260.7 million or $6.95 per share. The six guiding principle is the maintenance of our partnership mentality whereby the governing body of HFF, its executive committee is elected by the firms’ leadership team which is comprised of 64 individuals who run the firm’s 23 offices, its business lines and its property by verticals. This approach to governance reinforces our team partnership culture and significantly differentiates the firm from the industry at large.
Finally our seventh core guiding principle is the maintenance of the firms’ value added loss fee which permeates every aspect of the HFF culture. Our leadership positions, compensation awards and executive appoints are based on long held value add principles which are developed internally and are communicated to all employees.
HFF’s ability to differentiate and build out its platform in a consolidating industry, as well as to continue to expand in to the real estate industry at large remains a primary focus of management. We believe these guiding principles allow the firm to recruit and retain best-in-class industry professionals. Evidencing this statement and as illustrated on slide 43, since year-end 2009 the company has increased its headcount by 487, representing a 129.5% increase and we have grown our total transaction professionals by 152, representing an increase of 95.6%. We have accomplished this profitably and at a sustainable measure pace.
HFF remains committed to protecting its culture of unwavering adherence to its deliberative hiring practices.
Operator, I’d now like to turn the call over to questions from our callers.
[Operator Instructions] our first question comes from the line of Jade Rahmani of KBW. Your line is open.
Wanted to ask what you could say about the level of visibility you currently have for the third quarter. For example in terms of total transaction volumes would you anticipate being able to generate positive revenue growth.
Jade, it’s a good question. As you know we don’t give guidance on these calls or in general from a practice standpoint. But as I stated in our comments from looking at the industry at large, we remain positive on the long term drivers for the industry at large, as illustrated through my comments, both capital availability and the equity in the debt markets. So on a relative basis the quarter and the volatility that we’re seeing has not changed our view of the industry at large.
Can you just comment on the relative visibility between the investment sales business and the debt placement business, and would you say that that placement is more predictable given the amount of refinance activity, may be you could give some color on how much of that business is refinanced.
Jade there’s really no evidence to suggest predictability being greater in one or the other. And again I would just caution as we stated in our commentary that it’s really best to look at the transactional flows in US commercial real estate both in the debt and in the equity markets on an annual calendar of comparative basis rather quarter-to-quarter.
So we can look at it trailing 12 and you can see the real estate capital analytics data that was published, the NBA data has not yet been published so we don’t have that information. It really is best to look at this long term. But from a - perhaps this may be helpful, if you go back and take a look at the slides that we mentioned, in the increase in AUM in both the closed and open-ended fund market that isn’t in effect the denominator of transactional volume.
So if you look on a relative basis to where we stand in AUM in those two investment vehicles versus where they were in ’07, it’s an interesting story from a competitive standpoint that should give you some indication for the industry at large relative to transactional volume in the future. And again those have increased 90% and 69% since ’07.
Just on the EBITDA margins, should we take your comments to indicate, first of all the seasonality of the business which suggest typically an improvement in EBITDA margins in the back half of the year. But in terms of comparisons with last year, given the current uncertain volume environment is it safe to assume EBITDA margin is likely to be worse in the second half versus last year.
Well I would say that it’s not safe to assume any of that because, A, we don’t give guidance relative to what our revenues are going to be in the second half of the year. All we can tell you is that it’s been a historical pattern of the company that 40% or approximately 40% of our total year’s revenue occurs in the first half of the year and 60% in the second half.
It’s also safe to assume that we have a certain fixed cost component and certain accruals that get made more evenly and on the cost perspective throughout the year. So the first half of the year these expenses have a disproportionate impact on margins in the first half of the year compared to the second half. So that’s been the pattern since the day we went public but for ’08 and ’09 when we had this significant downturn. So margins will be impacted from just that seasonality relative to the way transaction flow.
Secondly, we don’t control the timing of when transactions close. Clearly we’re in the transaction business and that is out of our control and that’s why we always caution not to take any inferences out of our particular quarter and try to extrapolate that for the performance for the year.
We are continuing to make investments in the business as you’ve seen in the first half of this year, relative to our strategic growth initiatives. Mark mentioned our positive outlook relative to the long term perspective in the commercial real estate industry. So we are 100% transaction oriented business, so our people and it is our CapEx that’s how we invest to grow and take market share and we’re continuing to have that as a focal point.
We’ve always said that margins overall on a year-over-year basis are going to be difficult to expand while we’re in this growth mode and continuing to invest in our business. You might get some incremental gains year-over-year as we’re able to spread some of those fixed cost over a higher revenue base, but that will all depend on the level of growth of revenue. So I just cautioned making any inferences relative to that and you have to understand these key points that I just mentioned relative to the seasonality of the timing of when deals close and the fact that we’re going to continue to make investments in our business.
Thanks and just a follow-up on that. The transactional headcount grew - the growth rate accelerated. Are you anticipating similar level of growth or is there anything in your business that would signal to you that maybe you should moderate the growth and headcount.
Well I would say a couple of things related to that. First and foremost, and as you know all the things we’ve been saying consistently since the day we went public is that culture is everything to our organization relative to how we operate our business and we aren’t growing for growth sake per say as it relates to transaction professionals.
We have a two pronged approach to it. A, we recruit seasoned professionals from other platforms when it makes sense, when it feels the need in a particular platform or location. And we’re also going long on analysts and hiring good young professionals out of college and trying to organically grow the business as well.
So you saw our headcount increase in total 105. A lot of that increase is coming from the fact that we’re hiring a lot more analysts than we have in the past relative to our focus on organically growing the business. But likewise we are recruiting transaction professionals from other platforms and that is a cultural issue.
So we’re really careful in bringing those people in and making sure that they are the right cultural fit, and that’s not something you can plan for and have a pattern to it just relates to when you find the right person and they check all the boxes relative to meeting our cultural fit that will bring them on board.
So, we don’t have aspirational goals relative to the numbers of headcount increases that we have. But that is our approach and how we’re going to continue to do it.
Our next question is from Brad Burke of Goldman Sachs. Your line is open.
On the organic growth investments, just wanted to get your thoughts how you’re thinking about the balancing the short term margin dilution against longer term growth potential. And when you ramp up these kind of investments, how do you generally think about the amount of time to get those new associates up and running and fully producing.
Brad when we look at the margins, so if you - and again just look at this over a six month timeframe and look at a 22.4% adjusted EBITDA margin, we think that is a reasonable margin relative to the investment that we’re making in the business to grow significantly in the future. So from a margin standpoint, again we could significantly enhance margin if we elected to not invest in the future of the company, which I don’t think would be in any of our collective interest as owners.
And again I’ll reiterate we’ll [own] 13% of the outstanding shares to Class A common shares as a group. Our employees do and management teams and our compensation models are extraordinarily unique and that we are primarily compensated through revenue generation. So we are clearly investing from an ownership mentality and looking very hard at how we do so in unlike most companies that you might follow to Greg’s point, our capital expenditure expense is in headcount and future growth. And the maintenance of our culture is key.
So what we’ve determined is we will fuel future growth vis-à-vis organic growth to a large extent by significantly ramping up the collegian recruiting efforts as well as the onboarding and training techniques. And our goal is to significantly reduce the timeframe, Brad to your point of getting a college graduate to the rank of a transaction professional.
We have not disclosed that timeframe publicly, but we are very focused on that as you can imagine. So probably not a direct answer to your question, but again in terms of margins if you just take a look at the 22% for the first six months and put that in perspective relative to our most significant investment in the business, over a 12 month period related to what we see is our strategic plan, it has been conveyed on previous earnings calls which is to build out the platform and its remaining or existing 23 offices both from a property vertical standpoint and a business line standpoint.
So there’s no need for us to do anything different than we’ve been doing for the last 20 plus years, and most certainly since we’ve been public.
And as we think about your ability to take the newer employees and ramp them up to become transaction professionals, do you have a sense to believe that the 311 transaction professional that you have currently how many of those came up organically through HFF versus being more experienced hires?
No, I don’t have that statistic for you Brad, however, I would point to one thing that Greg mentioned in our call and that is when you add as many young people as we’re adding and you are having the successive inference in to our transactional and professional ranks. It is quite interesting to us, and it should be to all owners to look at the increase in producer productivity that has happened through the trailing 12 months through the second quarter.
So as we relayed in our commentary, you’ve seen a 2.8% of increase to 1.735 million up from 1.688 million in terms of producer productivity. That is a little unusual as you would think in terms of bringing in younger collegiate entrants in to our transaction professional ranks and yet continuing to have that productivity growth. So I would attribute that to our focus on training and onboarding in the culture from a team orientation standpoint that we have been emphasizing vis-à-vis this organic growth.
So again, can’t give you a direct answer on the organic versus recruited number on the existing transaction professionals.
And I guess as we think about the timing of you making these investments, I understand that despite short term fluctuations the long term outlook is strong for capital markets, but the long term outlook has probably been good for a while. So what was the catalyst for you think about ramping up those investments now versus a year ago, two years ago or three years ago?
As you know that’s a great question Brad, so thank you. As you know we don’t manage the business quarter-to-quarter, I don’t think that would be in ones’ interest. But we look strategically long term. And again if you look at the industry statistics that we keep emphasizing on those earnings call specifically regarding AUM relative to ’07 and translate that back to ’07 production volumes, and begin to analyze the facts relative to institutional investors allocation to commercial real estate both in the private market and in the public market considering also the 11 GICS vertical that’s been created this coming quarter, the first since 1999. I think when you consider all those together from an overall industry perspective; one would come away with a constructive view of that long term.
You will have a short term volatility in the public markets, has happened in the first quarter. And let me just state that generally speaking has happened in the third quarter of 2015 where we had a very similar discussion that we’re having now. When the bond market gaps out a 100 bp in general and you have multiples compressed particularly in the real estate industry, significantly has happened in the first quarter.
It’s a natural reaction for investor to pause and determine where are we, and as this is a long term secular trend, are we entering in to a significantly declining US job growth market, which is going to determine commercial real estate’s fate as we know or not. So what does it look like? And then they determine what that may look like and as you know things have moderated since the first quarter, but it’s prudent and logical for people to pause for a minute relative to what they’re doing in their strategic plans and access the current environment.
Again we had a very similar event that happened in the third quarter of 2015 when through the summer of August and September in particular not nearly as aggressive as the first quarter of ’16, but certain impactful in 2015 as well. So again we’re looking long term, we’re looking at the middle drivers. No one is ever 100% right, clearly not us, but when you look at the data and we’re information centric and we’re very [quantitative] oriented relative to the data and again look at the key drivers we’ve have not changed our view on those drivers.
Our next question is from Mitch Germain of JMP Securities. Your line is open.
Mark you referenced longer deal time, so I’m curious maybe if you could quantify that, and also maybe get some perspective in terms of are you seeing deals repriced or even deals terminated or foreclosure.
Mitch in terms of elongated positions that is just a natural logical thing that happens when you have a disruption like we had in the first quarter. And again our business lags a little bit as you know quarter-to-quarter, and so we are impacted by that volatility that happened in the first quarter where you hit a pause button. So that is really what I was referencing in my prepared comments was the volatility causing many investors certainly not all investor, but many investors to pause a minute and rethink risk and define it.
Relative to pricing, it is very difficult Mitch to answer the question of pricing with a sound bite, because it has changed, in some cases its gone up depending upon where you are and what product type we’re talking about and what geographic location you’re in and in other situations risk is been repriced as we stated in the prepared comment.
And when we talk about risk being repriced, its nothing more than people recognizing where we are in an economic cycle, moderating growth statistics in terms of perhaps rent growth or other things that might be impacted overtime and taking a more measure view which frankly from our perspective has been somewhat measured from the end of the great recession to where we are today.
So they are taking a little more moderate view both in terms of underwriting future growth, which in some cases and certainly not all cases but in some cases does affect price. And then you also have a mitigation strategy we’ll call it economic cycle risk by taking a smaller bets along more assets versus large concentrated bets and single assets or large portfolios. And you saw that in the RCA statistics as well.
So the combination of the volatility in the first quarter has caused people to rethink some of their strategies relative to managing risk.
Given that we’re in an election year, is that changing anyone’s willingness to put capital to work or are they pausing a little to see where that lines up?
We have asked, you know clearly that’s above my pay grade Mitch. But we’ve asked that question to many large institutional investors and the commentary back is its neutral regardless of who wins from their perspective, from their investment perspective. So I’m just a conduit with that. Not my opinion, just given you the feedback to what you want.
Maybe historically speaking have you seen a change in willingness to deploy capital ahead of an election over the last may be four or five cycles.
We have not seen that cycle Mitch over my timeframe in the business. It certainly is a lot of conversation always, but we really haven’t seen it demonstrated in terms of actions, and at least from our perspective in the commercial real estate industry.
And last one from me, obviously there’s some new regs that are going to be hitting the CMBS market, I’m just curious about your view and the outlook there.
CMBS as you know has for a number of the regulatory inputs it has impacted the business, people are figuring it out. It is generally going to result in the larger getting larger and the smaller players unable to compete without a significant balance sheet given the risk retention roles that we’re seeing in other elements that are there. I think there will be other changes that would help dealer inventory levels and various other things that are maintained there.
So I believe CMBS will continue to be a viable market. It needs to go through this adjustment period and adjusting to these regs and finding the right price levels to participate in the market. However a larger story here is the shadow bank market and I would keep watch on large institutional investors forming mortgage vehicles in many different constructs to take full advantage of what they perceive to be an opening or a vacuum that’s been created by some of these regulatory overhangs.
We have a follow-up question from Brad Burke of Goldman Sachs. Your line is open.
Want to ask about London, I know that you had talked about, your thought about entering that market for a while, and just how Brexit changes your thought process on that.
Brad I really can’t comment on one or anything like that, just simply because of guidance and always looking at [arc] across the US and other. I would tell you though that we have clearly tremendous amount of business with European investors and overseas investors throughout the world, and I would think that it would appear that a lot of investors are absorbing the information. There is a long road ahead in terms of impacts that would happen there.
Recently you have seen an attraction back to London with some overseas investor that here before have been priced out, so that in and of itself is making a statement. What we’re going to have measured uncertain - certainly relative to the EU, which I believe short term it would have a positive impact on the US, and that has been relayed both in the press that has been out there or in many different publications, but it has also been relayed to us by the many (inaudible) investors that they are focused on the US and allocation to the US to increase over the short term here. Due to that uncertainty that exists to the vote.
And then I appreciate the comments on CMBS credit availability just interested in what you’re seeing from a bank lending market, and then also if you could touch on your GSC business. Any way to think about how you’d expect to trend there over the remainder of the year?
So on the bank lending market there have been very strong real estate sector. I would tell you that based upon our conversations with many of the banks and COOs across the US, being constructive on commercial real estate and again as I have mentioned on previous earnings call, we believe the underwriting metrics that have been used by both lenders and equity market participants have been measured since the great recession which is a significant improvement over what existed in the earlier part of the 2000 decade particularly leading up to 2006 and ’07.
Significantly differentiated from a conservative approach to both lending and investment (inaudible). In our opinion and in many others opinions the banks’ balance sheets are very strong relative to LTV [risk] bubbles to commercial real estate, perhaps they’re strong as they’ve ever been.
Having said that, there are allocations to commercial real estate and certain product types and certain geographic areas are of concern to regulators in general. So in certain situation vis-à-vis product types and in certain geographic areas recruiting approach relative to further exposure of (inaudible) until you have movement either advancing in to permanent equity source.
So I think the summary of all that on a relative basis to the banks is they’re going to remain a significant factor in finding commercial real estate, and I would expect you to see more term originate lending and away from construction as we have been noting over the last 12 to 24 months for a variety of factors which we think long term is very positive for the commercial real estate industry.
It is difficult to obtain construction financing depending upon what market you may be in and what product type you may be in, unless you’re truly best-in-class sponsor and a best-in-class real estate project, and we think long term that’s very positive trend for the industry.
In regard to the agencies, Greg do you want to handle that question.
Sure. And Brad as you know with the agency business I mentioned in my remarks that we had a record year last year with Freddie Mac and we’re one of the top program plus seller servicers and have been for a number of years. And last year was a record year for us in the originations that we did with Freddie Mac.
Obviously we have an excellent partnership and relationship with Freddie Mac on the multi-housing front, and this continued to be very strong in the first half of the year as I mentioned. The only difference was that very large deal in the second quarter of last year that obviously hard to replicate this year. But again we’re still on pace to have a very strong year given the first six months of originations.
Freddie Mac, all I can say about for the second half of the year, we don’t give guidance. But as you know, Freddie Mac has and Fannie Mae as well have increased caps last year to 30 billion each and this year they increased their cap initially by 1 billion each at the beginning of the year, and then as we got in to the beginning of the second quarter they increased it again. So they both stand at 35 billion, their cap business for the full year.
So there is increased liquidity relative to what they have made available in the market place from last year, and we’re continuing to be on pace (inaudible) the first six months. So again we don’t give guidance so I can’t tell you exactly what the second half is going to be, but Freddie Mac is going to continue to be a significant player and have plenty to put it in the market place on the multi-housing front.
Thank you. And that does conclude our Q&A session for today. I would now like to turn the call back over to Mr. Mark Gibson for any further remarks.
Thank you, Operator. Thank you all for attending the conference today, and we are looking forward to speaking again in the third quarter 2016 call. Thank you.
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