HFF, Inc. (NYSE:HF) Q3 2018 Earnings Conference Call October 30, 2018 6:00 PM ET
Myra Moren - Director of Investor Relations
Mark Gibson - Chief Executive Officer
Greg Conley - Chief Financial Officer
Jade Rahmani - Keefe, Bruyette & Woods, Inc.
Stephen Sheldon - William Blair & Company
Mitchell Germain - JMP Securities
Good evening, and welcome to HFF, Inc. Third Quarter 2018 Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the call over to your host, Ms. Myra Moren, HFF Director of Investor Relations. Ms. Moren, please go ahead.
Thank you, and welcome to HFF, Inc.'s earnings conference call to review the company's operating performance and production results for the third quarter and first nine months of this year. Earlier today, we issued a press release announcing financial results. This release is available on our IR website at hfflp.com. This conference call is being webcast and is available on the Investor Relations section of our website, along with a slide deck you may reference during our prepared remarks.
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 a more detailed discussion of risks and other factors that could cause results to differ, please refer to our third quarter 2018 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 and available on their website. 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 earnings 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 will now turn the call over to our CEO, Mr. Mark Gibson.
Thank you, Myra. Good evening, everyone, and welcome to the call. As outlined in our earnings release, revenue totaled $161.4 million in the third quarter of 2018, and $446.7 million in the first nine months of the year, representing increases of 9% and 5.3% respectively, when compared to the same periods in the previous year. Net income totaled $29.6 million in the third quarter of 2018 and $71 million in the first nine months of the year, representing increases of 37.1% and 17% respectively, when compared to the same periods in the previous year.
We remain constructive on the fundamental drivers of the business, and are pleased with the performance of the platform and believe the results are a testament to the professional integrity and work ethic of the firm's capital markets advisors and our collaborative team culture. There continues to be a divergence in the performance of the U.S. commercial real estate capital markets by property type and by geographic region [per city] [ph].
HFF believes this divergence performance is due to a number of factors, including uneven job growth by region and the resulting persistent bid/ask gap in certain markets, where demand fundamentals are slowing. Increasing cost of capital, liquidity of the U.S. debt market, economic cycle risk, reinvestment risk and real estate being viewed as an excellent asset liability management tool for funds with long dated liabilities, which has to a limited degree elongated hold periods.
These factors resulted in the institutional commercial real estate market experiencing a period of price discovery beginning in 2016 and continuing in 2017, as evidenced by the 14% decline in investment sale transactions over the previous two calendar years as reported by Real Capital Analytics. However, as stated in our first and second quarter earnings call, it would appear the bid/ask gap continues to narrow between buyers and sellers as evidenced by investment sale transaction volume increasing by 11% in the first nine months of 2018, when compared to the same period in the previous year as reported by Real Capital Analytics.
As we have stated on previous earnings calls, we believe the institutional investor market remains quite disciplined in its collective underwriting of commercial real estate since the great recession. That statement is best demonstrated by the current bid/ask differences between buyers and sellers in markets where either fundamental demand, measured by absorption and rent growth or lack thereof is being reflected in buy side underwriting metrics, resulting in lower offered prices for assets. Stated differently, institutional investors have adjusted underwriting to take into consideration both moderating rent growth or increases in concessions and of course perceived risk if an economic cycle concerns.
This bid/ask gap has persisted for two years in certain geographies and cities, despite the fact that discretionary capital in close-end funds alone currently totals $182 billion, the largest amount of discretionary capital available to deploy in the industry's history and more than double the amount that existed in 2007. This was great and deployment of equity capital is being bolstered by three additional factors. Those being reinvestment risk, liquidity of the U.S. debt market and the attractiveness of commercial real estate assets as an excellent liability management tool for long-dated liabilities among pension plans, sovereign wealth plans and corporate plans.
In terms of reinvestment risk, some institutional investors are enjoying excellent cash on cash returns with their existing real estate investments and believe it will be quite difficult to replicate the same in the current environment. Additionally, they believe commercial real estate is in excellent long-term store value as per the metrics provided on Slide 16, and therefore represents an ideal match for long-dated liabilities thereby helping a given plans asset liability management strategies. These facts have resulted in an elongation of holding periods for some operators and institutional investors.
Finally, given the liquidity of the U.S. debt market for commercial real estate, if current pricing does not meet a given owner's view of value, an excellent alternative is to recapitalize or refinance the asset in lieu of the sale. However, in some cases, markets have previously expressed declines in transaction volumes have rebounded velocity as the bid/ask gap is narrowed due to greater confidence in the market in asset level performance. Such markets include New York City, Seattle and Chicago, which collectively increased transaction volumes by approximately 43% in the first nine months of the year according to Real Capital Analytics, contributing to the aforementioned increase in volumes year-to-date.
In cities where rent growth is accelerating, the buy side investor base is reflecting those facts in its underwriting and therefore bid/ask gap does not exist in those markets and generally speaking transaction velocity is increasing. An additional factor to consider relative to transaction volumes is the increase in real estate M&A activity driven by changing business models for operators and institutional investors and persistent NAV discounts in the public REIT market for certain companies or property sectors.
The first nine months of 2018, 10 M&A transactions have been announced, totaling approximately $79.3 billion in gross value. Even if no more transactions are announce this year the $79.3 billion in transactions represents the second highest year of financed REIT M&A volume by transaction volume on record. If the pace of announced transactions continues in the fourth quarter, the industry could experience a record year surpassing the previous record set in 2006.
HFF use these conditions to be constructive for the industry in general as the commentary suggests that commercial real estate remains in favor with institutional investors due to their willingness to hold assets for longer durations and underwriting continues to be measured.
Additionally, HFF believes the following factors are important foundational or structural components of the commercial real estate industry, which would seem to be positive drivers for transaction volumes. The composition of ownership is becoming increasingly institutional, which we believe is and will continue to positively impact transactional volumes for select intermediaries as investors continue to consolidate service providers.
Effective in the third quarter of 2016, commercial real estate was re-categorized from the broader financial sector and became the standalone category as the 11th Global Industry Classification Standard, or GICS trading vertical, the first distinct trading vertical created since 1999, indicating commercial real estate's enhanced standing among global investors. It has resulted in an increase in the flow of capital into commercial real estate. However, while capital flows have increased as a result of the GICS designation, volatility has also increased due to the emergence of a relative new shareholder base and to shares in public real estate companies, utilizing quantitative algorithmic trading methodologies.
As a result, some public pension plans and other long-dated capital sources have begun to reduce the percentage of real estate investing via the public markets. HFF believes the recognition of commercial real estate as a core investment holding ensures the industry will continue to benefit from consistent annual allocations of capital and that investing in the asset class is necessary in order to attain a diversified investment portfolio. This is best illustrated on Slides 17 and 18 showing an approximate 84% increase in allocations to commercial real estate since 2010 and approximately $182 billion of discretionary capital raised in closed-end funds alone to deploy in the commercial real estate, a historical high watermark for the industry.
Additionally, actual investment in the asset class is approximately 90 basis points below target as a percentage of AUM. As previously mentioned, HFF believes the record amount of discretionary capital awaiting deployment, combined with a persistent bid/ask gap, is empirical evidence of a high level of discipline within the institutional investment was set.
As previously noted and as illustrated on Slide 19, capital managed by institutional investors in the commercial real estate measured by assets held within closed-end and open-end funds, has increased approximately 105%, net of price appreciation, suggesting both increased demand for the asset class in a larger denominator of assets to potentially drive future transaction volume. This statement is further highlighted by the fact that transactional volume in 2017 was down 14% from the 2007 transaction market peak of $568.9 billion, despite the almost doubling of AUM during that same timeframe.
Regarding near-term future transactional borrowing for U.S. commercial real estate assets, please note the size of the closed-end fund market on Slide 19. As stated on previous earnings calls, the closed-end fund market in the U.S. is generally defined as 10-year finite life funds, with a preferred return, promote based compensation structure. Given the limited life of these funds the compensation structure and the fact that investment managers will have great difficulty raising capital for future funds without realized returns, meaning the sale of assets within the fund, the largest investment managers of institutional real estate assets in the U.S. generally liquidate their portfolios every five to seven years on average. Stated differently, the closed-end fund market is structured to transact in order to recognize value and retain personnel.
Aside from the domestic institutional capital referenced previously, an important source of capital for U.S. commercial real estate is the participation of the retail investment, which in the past has invested via private non-listed REITs. Given the reforms implemented by government regulators of this industry, a significant number of low-load real estate investment funds from private best-in-class real estate operators and investment management firms have emerged.
HFF believes there is considerable demand from the traditional retail investor universe as few retail investors have exposure to best-in-class private commercial real estate investment managers. In addition to the traditional retail investor, large family offices have also begun to significantly increase their commercial real estate holdings. Many of these investors have the capacity of institutional investors and are therefore able to transact trades of significant size. Of note, both the traditional retail investor and large family office investors offer a non-correlated source of capital compared to the traditional institutional [funds] [ph].
Foreign capital flows into the U.S. totaled $63 billion in the first nine months of 2018, a 56% increase over the same period in the previous year according to Real Capital Analytics. The behavior and preferences of overseas capital generally reflect the same characteristics as those previously mentioned among domestic institutions. Additionally, the first nine months of 2018, HFF has witnessed considerable diversity among overseas investors contributing capital to the U.S. market with significant contributions emanating from Canada, Europe, Japan, Singapore, South Korea and Australia.
Finally, an important factor impacting foreign investment in the U.S. commercial real estate industry is currency risk and the cost of hedging same as domestic interest rates diverge from those of other developed countries.
Another significant factor affecting the overall health of the U.S. commercial real estate industry is the supply of new assets being developed. As shown on Slides 29 and 30, supply remains largely in balance with demand relative to previous economic cycles. There are specific submarkets wherein completions of certain property types have exceeded demand, resulting in increased rent concessions.
However, HFF believes an environment of sustained job growth over the next two to three years could afford landlords additional pricing power, given the relatively modest scale of new construction, the lending community's conservative approach to additional construction. The economic cycle risk is negatively impacting build-to-core strategies and the compression and return on cost metrics, given significant increases in the cost of build new products over the last 24 months.
Given these facts and our views of the industry in general, we continue to invest in our core business as illustrated by the following points. We continue to add headcount to our firm evidenced by 8.6% increase in headcount over the past 12 months, resulting of 84 net new Associates, including 17 net new capital market advisers. As we have mentioned on previous earnings calls, our headcount growth is the result of both organic and external recruiting efforts.
We also continue to expand our London operation, which now totals 23 individuals. The HFF corporate M&A transaction group led by Steve Angeles continue to expand its headcount until 10 individuals and has successfully integrated into the HFF platform. We have significantly invested in the firm's general infrastructure, including additional administrative personnel in our accounting, human resources, research, and information technology support functions.
Related to technology, the firm continues to make significant investment in expanding our infrastructure to allow our capital markets advisers to more efficiently and effectively originate and conduct their business. HFF has a long history of embracing information technology fostering an innovative reputation by leveraging the full breadth of our technology resources for the benefit of our clients and capital markets advisers.
As a prime example and as outlined on Slide 13, CapTrack is a proprietary transaction in client relationship management workflow software developed internally by HFF. The firm is able to form insights from our pipeline of transactions and gain in valuable market intelligence derived from the more than 60,000 client relationships, which are housed in CapTrack. In an era, where real-time intelligence provides a significant competitive advantage, HFF will continue to develop unique and differentiating technology-driven solutions for our associates and clients.
As mentioned on our last earnings call on July 2, 2018, HFF entered into a risk transfer agreement with M&T Realty Capital Corporation, whereby HFF has agreed to indemnify M&T Realty Capital Corporation for all its credit risk associated with certain loans originated by HFF through M&T Realty Capital Corporation's Fannie Mae delegated underwriting and servicing loan platform program.
HFF [indiscernible] Chief Credit Officer of M&T Realty Capital Corporation, as Internal Credit Officer, who will with HFF's capital markets advisers in the structuring of loans with the M&T Realty Capital. The goal of the risk transfer agreement structure is to significantly grow our market share of Fannie Mae in the U.S. business.
On September 17, 2018, a direct wholly-owned subsidiary of HFF acquired a 50% interest in Kensington CA LLC, which operates as Kensington Capital Advisors or KCA. KCA has headquartered in Charlotte, North Carolina, and it is established in 2004 to provide professional advice to clients facing financial risks associated with changes in interest rate, currency, commodity and markets. Kensington's expertise lies in the analysis, structuring, valuation and execution of over-the-counter or OTC derivative instruments in the seasons transactions. And HFF's experience of these products are frequently used by HFF's clients, and KCA's insight and expertise will add another valuable resource for HFF.
HFF views these expenditures as investments to support the future growth of the firm. In keeping with the firm's long-term strategic plan, we will continue to add personnel to our offices, property verticals and business lines throughout 2018 and we will continue to invest in strategically beneficial businesses endeavor, subject to the overall performance of the U.S. economy.
In order to put this commentary in perspective, relative to the performance of HFF, we believe it is important to reiterate a few key themes from previous earnings calls. First, it's important to note that HFF is not in the equity real estate investment business, but rather the real estate transaction business. Additionally, HFF is not in the leasing property management tenant or landlord representation, corporate outsourcing or appraisal businesses. Therefore, all of HFF's resources and strategic planning are similarly focused on enhancing our capital markets advisers' capabilities and ability to service their client. We believe this is a significant differentiator for HFF and the retention and recruitment of talent.
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 third quarter 2018, no one client accounted for more than 2.1% of our capital market services revenue and our top 10 clients combined represented 9.4% of our capital markets services revenue.
In summary, we believe there is ample availability of capital in both the debt and equity markets to sustain current real estate transaction volumes, absent a precipitous decline in global economic activity. As we have stated on previous earnings calls, moderate volatility can result in an increase in demand for HFF's capital markets knowledge, advisory services and execution capabilities as investors see clarity in asset valuations and in determining the most suitable strategy for their commercial real estate holdings.
With that, let me turn the call over to Greg.
Thank you, Mark. The information I will discuss today is also set forth on Slides 34 through 47. Beginning on Slides 34 and 35, during the third quarter, our revenue was $161.4 million as compared to $148 million in the third quarter of 2017, an increase of 9% year-over-year. Total transaction volumes increased 13.1% in the third quarter led by an increase in debt originations, investment advisory and equity placement transaction volumes.
Operating income was $26 million for the third quarter of 2018, up $1.3 million from last year, while operating margins contracted 60 basis points. The change in operating margins for the quarter is primarily attributable to be increasing the company's compensation related costs, depreciation and amortization and other operating expenses.
We continue to strategically invest in our platform during 2017 and into the first nine months of 2018, including the continued investments are related to the startup of our London operations. We maintained 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 as no one borrower or seller client represented more than 2.1% of our capital market services revenue for the trailing 12-month period ending September 30, 2018.
Continuing on Slide 35 and 36, revenue for the first nine months of 2018 was $446.7 million, which represents a year-over-year increase of 5.3% or $22.6 million. For the first nine months of 2018, operating income was $50.2 million compared to $64.8 million, a decrease of $14.6 million, while operating margins were down 410 basis points. The decline in operating income and margins for the first nine months of 2018 as attributable to the increase in the company's compensation related costs and other operating expenses primarily related to the strategic investments we are making our business through growth in headcount, expansion of offices such as the startup and integration of our London operations.
The non-recurring cash payments related to the additional compensation award the first quarter and the increase in depreciation and amortization. These cost increases were partially offset by the income contribution from the 5.3% growth in revenue.
The company's adjusted EBITDA for the third quarter of 2018 was $43.8 million, an increase of $5.2 million or 13.4% compared to adjusted EBITDA of $38.6 million in the third quarter of 2017 due primarily to the growth in operating income. For the first nine months of 2018, adjusted EBITDA was $104.4 million compared to $103.9 million for the same period in 2017, an increase of 0.4%. This increase in adjusted EBITDA for the nine months period was driven primarily by the increase and interest and other income, net of the increase in MSR income, and partially offset by the decrease in operating income.
Adjusted EBITDA margin for the third quarter expanded 110 basis points to 27.2% compared to 26.1% for the third quarter of 2017, while the adjusted EBITDA margin for the nine months ended September 30, 2018 was 23.4% compared to 24.5% in the same period of last year. Cost of services as a percentage of revenue was 57.1% for the first nine months of 2018 compared to 57.4% in the same period of 2017, which is an improvement of 30 basis points.
Operating, administrative and other expenses were up by approximately $3.3 million or 9.5% for the third quarter, and up by approximately $20 million or 19.3% in the first nine months of 2018, when compared to the same period in 2017. These increases for the nine month period were primarily due to additional compensation related expenses, including salaries and payroll taxes, stock compensation, the non-recurring payment related to the additional compensation award in the first quarter of 2018, an increase in the interest on our warehouse lines of credit, and increases in other discretionary operating expenses due in part to the growth in headcount.
In addition, other operating expenses have increased as the company continues to make strategic investments in technology, which we expect will result in increased productivity over the long-term.
Also as shown on Slide 35 and 36, interest and other income increased $2.1 million in the third quarter, primarily as a result of an increase in income from higher mortgage servicing rights and interest in other related income, partially offset by decrease in other agency related income. For the first nine months, interest and other income increased $5.2 million, when compared to the same period in 2017, which is primarily attributable to higher mortgage servicing rights as well as higher interest and other related income partially offset by decrease in other agency related income.
The company's Freddie Mac business has been very strong in the past three years, but the record level of originations in 2017 of over $6.8 billion and originations of $4.6 billion and $5.2 billion in 2016 and 2015 respectively. We experience continued strength in the company's Freddie Mac business in the first nine months of 2018 with approximately $4.1 billion of loans originated compared to approximately $4.8 billion for the same period in 2017.
Earnings per share on a fully diluted basis increased $0.19 to $0.73 compared to $0.54 for the third quarter of 2017. Earnings per diluted share for the third quarter benefited by approximately $0.17 from the reduction in the statutory corporate federal tax rates from the 2017 Tax Reform Act. Earnings for diluted share for the first nine months was $1.77 compared to $1.54 for the first nine months of 2017. Earnings per diluted share benefited by approximately $0.33 from the reduction in the statutory corporate federal tax rates and benefited by approximately $0.11 from the additional tax deductions from the windfall adjustment that occurred in the first quarter related to equity compensation.
The company's effective tax rate for the first nine months before consideration of the impact from the additional tax deductions from the first quarter windfall adjustment and the effect of the deferred rate change was 27.8% for 2018, as compared to 40.7% for the same period in 2017. This rate differential is primarily due to the impact of 2017 Tax Reform Act.
Slide 38 to 40 relate to the balance sheet and liquidity. Our cash balance, net of client advances at September 30, 2018 was $225.5 million compared to $265.7 million at December 31, 2017. As shown on Slide 38, during the first nine months of 2018, the company generated $72 million in cash from operating activities, net of a $3.9 million increase in client advances. The company's use of cash is typically related to the limited working capital needs during the year and the payment of taxes.
As stated in our previous earnings call on July 2, 2018, we invested $25 million to purchase of preferred stock interest in M&T Realty Capital Corporation to facilitate the risk transfer agreement. The company has virtually no corporate level debt to service other than that related to our Freddie Mac business, which is offset with the mortgage notes receivable.
As shown on Slide 39, our balance sheet as of September 30, 2018, included $632.5 million of outstand borrowings on 30 loans under our warehouse credit facilities to support our Freddie Mac multifamily business, and we also had a corresponding asset recorded for the related mortgage notes receivable.
To-date, 14 of these loans have been purchased by Freddie Mac. The remaining 16 loans on our balance sheet at September 30, 2018 to be delivered to and purchased by Freddie Mac as well as any other fourth quarter 2018 loans originated could be held on our balance sheet for a period longer than the normal delivery process. Freddie Mac has discretion to extend the whole period into the first quarter of 2019, as they need the flexibility to manage the anticipated large volume of loans to be closed by their seller services in the fourth quarter.
I'd 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 increased by 13.1% or approximately $2.9 billion for the third quarter of 2018, and increased $800 million or 1.2% for the first nine months of 2018.
The total number of transactions increased by 5.5% or 33 in the third quarter of 2018 and increased by 6.7% or 112 for the first nine months of 2018. The company's loan servicing portfolio grew by $10.1 billion or 15.4%, when compared to the portfolio size in the third quarter of 2017. The loan servicing portfolio balances $76 billion as a September 30, 2018.
Slide 43 provides a historical summary of our headcount and also shows the third quarter comparison to the same period in 2017. Total headcount and capital markets advisors as of September 30, 2018 were up 8.6% and 4.6% respectively year-over-year.
Slide 44 provides a summary of select production operational measures. The revenue per capital market advisors increased 0.8% for the trailing 12-month period to $1.65 million from $1.66 million for the same period in 2017. However, the revenue per transaction professional of $1.5 million for the trailing 12 months, as of September 30, 2018 is up sequentially from the trailing 12 months as of June 30, 2018 of $1.63 million.
In summary, we are pleased with the company's operating and financial performance for the third quarter of 2018 with revenue growth of 9%, an increase in operating income of 5.4%, and increase in adjusted EBITDA 13.4%, and 110 basis point increase in adjusted EBITDA margins. While the company's operating performance was soft in the first quarter of 2018 due primarily to the continued investments we've made in our platform, which include the London startup and the additional compensation award as previously discussed. We have seen continued improvement in our operating performance in both the second and third quarters of 2018.
As we have stated consistently, we view our business on a long-term basis, as we do not control the timing of when transactions close. And we have seasonality relative to the timing of revenue and expense recognition, which can result in a lumpy quarter-to-quarter performance. As always we continue to be very disciplined, efficient and strategic as it relates to the management of our expenses and are always mindful balancing our long-term strategic growth initiatives with the current operating environment.
Operator, I would like to now turn the call over to questions from our callers.
Thank you. [Operator Instructions] Our first question comes from the line of Jade Rahmani with KBW. Your line is open.
Thanks very much. If it's - raises interest rates two to three more times as expected. What do you think the impact of transaction volumes will be?
Jade, it's Mark. I would say that the Fed has indicated they will do so. The forward curve in the market is suggesting that there is a somewhat disagreement with the fixed income market. So will be interesting to see what happens relative to that progression of rates. But to date, I can't really predict the future, but I can tell you what has happened to date with the increase in rates. And generally what has occurred is the preponderance of the base increase in interest rates has been absorbed by a spread compression with the various lending models and business models throughout the fixed income market for commercial real estate.
So the relative impact to the consumer of capital has been very moderate, so out of 70 basis point plus or minus increase. The consumer of capital has perhaps [borne] [ph] 30 BP or 25 BP depending upon the type of risk that the lender and the borrower are taking. To date, we have had very little in the form of retreats that would happen. Generally speaking, in a rate environment like this, and we do believe that there was probably some spreads compression remaining in the market in general, which would give some runway to base rates increasing. But at this moment, we don't know.
We did experience a similar run in 2013 from May to August, and we had a very similar result where we had virtually no re-trading activity in the investment sale environment with the exception of high levered transactions that were taking place at the time.
Okay. Yeah, it seems somewhat unusual to me in terms of the market reaction and potentially an indication of excess supply of capital allocated toward real estate. Wanted to see if you have any insights into the weighted average in place mortgage rate unstabilized commercial real estate? Not sure if the data you track has any indication? But in the housing market, for example, it's thought to be in the mid-to-high 3% range versus a current mortgage rate of now over 5%. And a lot of people do believe this is impacting current real estate transaction volumes. So just wondering, if you have any views on that.
The data would conflict that at least in the commercial real estate sector, because we're up 11% year-to-date. These are the [RCA] [ph] statistics, and as you know, transaction volume in the investment sale market decline 40% over the last two years.
So ironically, what we're seeing in 2018 is we're seeing an increase in transactional volume. And that I believe is due to the bid/ask gap narrowing. As fundamentals stabilize or begin to increase in the buy side is moving more to the sale side and we're meeting in the middle. So the data seems in conflict with that in the commercial real estate, Jade, I am not confident, we're in that familiar with the residential single-family market and the mortgage market, but relative to the business that we're in day-in and day-out is not impacted transactional volume today.
Just looking at the production volume by mix, it's clear that the equity placement production dramatically outperformed. Wanted to see, if you can give any insight into what drove that, and also if you can clarify whether that includes equity advisory M&A transactions, you did the robust levels of REIT M&A deals so far this year. And I just wondering if that flows your business in that space close to the equity placement line or the investment advisory line.
So on the outperformance so to speak of equity placement it really is driven by several factors, but the primary factor is as we stated in our earnings script. If you have a bid/ask gap in a marketplace and buyers may or may not be willing to underwrite certain demand drivers in the market, and there is a disagreement over price. The institutional investor market is having a very difficult time, redeploying capital if they get a return to that. So reinvestment risk is actually become more of a concern than end of cycle risk in many situations.
So rather than sell at a value that they believe would be below market, because they obviously would believe that demand will rebound in the near future, and they like the quality of the assets they are recapping the asset. And that's why you have seen the [MBA] [ph] data that would show that volumes disassociate with investment sales volumes, which is the first time that's happened in quite some time over the last couple of years. And that is just evidence that people are recapitalizing or refinancing assets over sales, if pricing is not meeting expectations.
And I would tell you, Jade, that you mentioned an abundance of capital, which is true. We do have plenty of availability of capital, but in my career, which spans over three years. I've never seen this much discipline in the marketplace, when you have this much discretionary capital to be deployed, and yet you have a bid/ask gap occurring in a marketplace, so buyers are unwilling to underwrite anything but fundamental demand, that is extremely unique in the commercial real estate market.
So when you think about the equity placement activity, and you think about recapitalizing taking the risk of holding assets longer, almost all of this is institutional capital, that give you some indication of what they think future demand is likely to be a marketplace.
So the equity placement outperformance was driven by fund raising activities? Or I guess, driven more transactional-based activities?
More transactional-based activity.
And then, Do you give any sense or color you could provide, I'm sure, you do have a strong sense. But just the mix of business that HFF receives from private equity fund investors as well as that funds?
Jade, we really - I just don't have the data in front of me here.
Okay. Just last question, when you guys make new hires to what extent do you use forgivable employee loans, upfront payments that are amortized through the income statement as part of you compensation strategy.
It is rare, but we have utilized it - will continue to utilize it depending upon the individual in the market we find ourselves. And again, our headcount growth, Jade, has been both organic and recruiting and it depends upon the cycle that we find ourselves in. But generally speaking, it's pretty balanced between the two, I would say, over the last few years. The majority has been organic growth, which means, hiring individuals out of college, putting them through a robust training program just from our perspective it enhances culture and is a more predictable way to grow a firm, as recruiting is dependent upon cycle and timing and various market conditions.
Thanks very much for taking the questions.
You bet, Jade.
Thank you. Our next question from the line of Stephen Sheldon with William Blair. Your line is open.
Thanks. Hi, Mark and Greg. I appreciate you to taking my questions. So you get some color, I guess, on the overall interest rate sensitivity, but I wanted to ask how interest rate sensitive you view your debt placement has been at this point? You tell that very well. I know there's been a lot of refined recap activity that's been going on, but could activity in that business slow down significantly if interest rates continued to move up? Or move up at a quicker than expected pace?
If it so - Stephen, it's a great question. The answer is, if there is a fast move up then you generally have a pause in the marketplace, so that could impair transaction volumes as people decide whether it was an anomaly or a trend. So that does happen if you have a sharp movement up, where people want to see, what caused it. Is this a trend or is it whatever. Relative to overall transactional volume, what we generally see in a rising rate environment. The spread compression, which has been very consistent over a number of cycles, and as I stated, we think there is more there - here in the current environment.
Number two is we see managing of duration of terms. So if you're going to finance ten years, you may finance seven, you may finance five, in an upward slope in yield curve, it's essentially is managing the yield curve. And in this environment, I would also say that it's a little unique today that the forward market is as flat as it is currently, which is intriguing to a lot of people in the fixed income environment. So you can get a floating rate loan, you can go forward with various derivatives, the cap or swap markets on a fairly efficient in price appealing basis today.
So interest rates and cap rates are probably [access] [ph] 0.5% to 1% correlated over a long period of time. But relative to the mortgage market, it really depend upon how fast these rise. And then, how that affects the overall base increase in cost of capital to the consumer, which again the vast majority of this has been absorbed by the spread compression today.
Okay. Got it. And then just looking at expenses, operating, administrative and other expense was down quite a bit sequentially. Anything specific driving that? And would you expect the kind of normal seasonal ramp back up in the fourth quarter?
Greg, you want to take that?
Sure. Well, as far as the third quarter is concerned. We - as we talked about earlier in the year, we had some of the big increases that occurred in the first quarter and we talked about some of those already. In the fourth quarter, there's nothing really unusual that's going to occur in the quarter rather than the business activity is typically higher in the fourth quarter. So you do ramp up some of the cost that go along with the increased business activity like TNA and supplies and research and things of that nature.
But as a percent of revenue perspective, I think, we trend pretty much similarly as we have in the past. So there's nothing unusual than we're anticipating at least in the way we operate the business. And how the trend of those cost categories, typically play out during the year. The one item in particularly that you'll see when you get 10-Q is that we did have a little bit of decrease in the TNA expense category, which was a big driver down for that cost category overall in the third quarter.
Okay. That's helpful. And then, how are you thinking about just in general hiring here over the next few quarters, I'm asking that from the standpoint of both the ability to find talent out there that may want to switch platforms and your level of comfort with bring in more producers on your platform at this point in the cycle.
It's a good question, Stephen. We are adding headcount to the platform, our only constraint to growth really is finding people of high integrity character that are best-in-class professionals and best-in-class individuals. So we are consistently and will be consistently in the market that producers to the platform, subject to those character traits being found.
And as you saw, we are adding and continuing to invest in the platform being a services company. I think it is instructive as you look at our firm to see what we are doing and we are continuing to invest both. As we have stated in the past with M&T friendly relationship, we recently just announced on this earnings call the Kensington investment. We talked about London. We did last year and we talked about corporate M&A.
And so at this moment, we see opportunities in the marketplace and we're continuing on our normal hiring process. And again, we're focused both on recruiting as well as organic growth, and ultimately just looking for the best athlete that we can find in the marketplace.
Great. I appreciate the color.
Thank you. Our next question comes from the line of Mitch Germain from JMP Securities. Your line is open.
Good evening. Mark, just on Kensington, is it adding a new capability that you can leverage for your team or is it possibly also trying to maybe get your hands on customers that they work with that are not part of your typical customer base.
Well, maybe a little bit of both, but primarily, Mitch, we have been researching this, as you know, for the quite methodical about investing. So we've been researching this market for well over four years. And have been very impressed with Kensington in their ability to enhance our clients' needs relative to these derivative products. And so most floating rate lenders will require some derivative the being acquired in the marketplace, it was a natural fit for us. We don't compete with our clients and rather bring in a service that would be enhancing to their business.
And it makes all of our transactional advisors that much more intelligent about the financial markets services that we can provide, which again when you look currency risk today and you look at interest rate risk in these various risks that come through the financial markets views of the commercial real estate. It just give some another arrow in the quiver to win more business from clients.
Go you. You talked about elongated hold reinvestment risk. How does some of that drive - how do, I know it's a record levels. But how does that backlog break up here?
It actually a good question, Mitch. And - it's why I made the point to Jade, when he asked the question, because I've never quite seen the market like this, where you have this much capital to be deployed, most of which is on a three year deployment cycle. And yet, you see this much discipline in the marketplace. And I think it's a really interesting tension, that we're seeing in the market at large, where you have the financial market by and large.
Very concerned about in the cycle risk and various other risks that we've all been talking about for four plus years. And yet, you see the demand on mainstream in terms of hiring and in terms of plant and equipment investment being very robust. So it is an interesting time I think. And I think, it's really healthy to see this much more strength caused by understandable concerns in the financial community at large.
And yet we see depending upon what geography we're talking about, very strong demand in various markets around the U.S. So what breaks the logjam, I think, it's just, I'm not sure it breaks the way that we have seen it in the past in commercial real estate, I think, it just remains measured and disciplined. And remember that a large amount of this capital was in the closed-end fund market, Mitch. And those managers don't make any money to pay their people and retain and raise additional capital unless there's profit, so it's a promote structure to achieve above a profit. So they're being very cautious.
And I think that's an outpouring result, what happened in the great recession, and everyone still remember. It's an unusual situation and it's something that we have talked about quite extensively. And we really haven't seen this much discipline in underwriting with this amount of capital available, while I haven't seen it in my career.
Got you. It seems like there's been a bit of a shift in over the last 12 months or so in terms of how you're hiring in looking at kind of like the next generation of producers. I guess, I'm curious about productivity and the way that you guys measure it on a historical basis, I mean, is it safe to say that the revenue per advisors is likely to stay below recent levels, because of the change in hiring from individuals that have really established books to may be individuals that are coming in a little more junior level.
There is an excellent point, Mitch, so just a couple of statistics on that. We have increased headcount approximately 84% since 2012. When you look at just the producer headcount approximately 38% of our existing producer, roughly 390, have been producing less than three years of HFF. And yet, the revenue per producer number has remained fairly constant during that timeframe. So there are a number of conclusions you could draw from that, but when we talk about technology spend and maybe how you might measure the efficiency and effectiveness of that that's one of the metrics we look very hard at in terms of how efficient we can become.
And I think we have stated multiple times of previous earnings calls that it generally takes us three to four years for a given producer at mean production level within HFF. So the statistic you're focusing on is a really good one to focus on relative to efficiency, and the fact that we have a very robust and growing bench of young producers that are coming through HFF, and most of that is through organic growth over the last four or five years.
Thank you. Nice quarter.
Thank you, Mitch.
[Operator Instructions] We have a follow-up with Jade with KBW. Your line is open.
Thanks very much. Can you share your thoughts on HFF's outsiders cash position, the potential for a special dividend. But just generally, the conservative nature of management you guys don't have a historical track record or a history of doing a large scale M&A transactions? So just curious, if perhaps you think management is being overly risk averse by retaining such a large cash position given the increasing servicing portfolio is there potential - for potentially a regular quarterly dividend or stock buybacks things of that nature. So if you could make any comments on capital allocation strategy?
So Jade, that is also a very good question. So you had several parts to the question, let me address the special dividend first, as you know, we don't give guidance. In the way, we think about our cash position, is that we have reserves for our working capital needs, we have reserves for the funding of the strategic plan that is set out at the beginning of the year. And then, we reserve for an event such as  [ph].
And if there is any leftover and subject to our Board of Directors approval, we give the excess capital back to shareholders. don't know what that looks like. For this year, we also balance that capital relative to the strategic opportunities. That we see in the marketplace. And as you noted, we've made several over the last 12 to 18 months. And we have reserved cash well in advance to do that. So nothing has changed in terms of how we think about capital allocation and I would think about cash outlook, that's how we run the business for a long period of time.
And again, I'll just reiterate that we have no debt item, relative to being too conservative, it may be a valid point. But we would rather be able to take full advantage of any market environment comes our way. Both in terms of going on offense, when many others maybe on defense, but also we see the interesting opportunities frequently in the marketplace. And we want to have the capability if needed to do so ourselves without any third party financing or capital raising.
That's about the best, I can do, Jade. Does that answer your question?
Okay. Just on the tax rate. Wondering, what drove the low third quarter tax rate, and what you continue to expect on a full year basis now that you've had several quarters post the tax reform legislation to fully evaluate?
Well, Jade, the third quarter tax rate as I mentioned, it's largely driven with compared to last year from the reduction in rates in the Tax Reform Act. The third quarter rate itself was primarily that the - we've also had a re-measurement of the deferred tax asset this quarter as we do every third quarter. And as you know that the real big re-measurement of deferred tax asset occurred last December. But every third quarter, we do look at that we finish filing our tax returns for the year. We look at where the prevailing rates are in the allocations of our revenue streams from the different states and come up with new prevailing rates to re-measure that deferred tax assets in this year had 1.4% reduction in the overall rate for the third quarter.
So - but where we believe the rates going to be at the end of the year given, how the years progressed, we - I think at the [outset] [ph] stated that we thought the rate was going to be in the range of 27% to 30%. We still believe it will be in that range, however, we think it will probably be on the lower end of that range as opposed to the higher end, whenever we finish out the year.
Thanks very much.
Ladies and gentlemen, that concludes the Q&A session. I'd now like to turn the call back over to Mark Gibson for his closing remarks.
Thank you, everyone. We appreciate you joining us today and hope that you could join us again for fourth quarter 2018 call. Have a good night.