CWK - Jones Lang LaSalle: From A Spark To A Catalyst

Summary

• JLL is taking a leadership role in the proptech investment industry.
• This has allowed for financial performance to improve after a decade of declining margins.
• I now expect JLL to provide significant opportunity at the current low valuation.

Introduction

Jones Lang LaSalle ( JLL ), or JLL, is a provider of professional services in the real estate industry. The company has no single mode of expertise, and instead provides a range of services including brokerage, property & facility management, advising & consulting, development, and investment management. One example of their expertise would be the management of the Empire State Building retrofit project, where emissions were reduced by 40%. The primary public competitor in the space is CBRE, who is far larger, and uses inorganic growth to drive outperformance at scale. This has worked for the past 10 years, but times are changing after the pandemic.

This difference in organization and structure offer the opportunity for JLL to outperform in the coming years, without the need for the speculated disruptive merger between JLL and its next largest peer, Cushman & Wakefield ( CWK ). Instead, JLL is taking their market expertise to the start-up market by providing venture capital to Proptech firms, or technology providers for the real estate and adjacent industries. Financial performance is already improving, and when combined with a close to record low valuation, JLL is ripe for an investment.

JLL’s Tech Advantage

Commercial real estate has faced one of the worst black swan events in history with the pandemic as office employees found a new love of working from home. While some employers are pushing for staff to return, there is plenty of pushback from staff and this is resulting in record low office occupancy rates. Even Brookfield ( BAM )( BN ) and other major real estate firms like Vornado ( VNO ) have begun defaulting on properties in major economic centers like Los Angeles and New York. This creates a dilemma for a RE service provider like JLL: reduced performance across the market is detrimental to performance, but RE firms are also likely to continue seeking ways to improve their properties.

One area that can provide significant benefit is with property technology, or proptech. With a wide range of current offerings to improve the real estate experience, JLL is also investing heavily in technology solutions that can either entice workers back to the office, increase the operational efficiency of current properties, or reduce the need for property at all. The technology-focus is a way to drive competitive advantage for both JLL and their clients, allowing for growth despite the poor market environment. The success of proptech solutions will be a key deciding factor in the short-term operational performance of JLL, and so far the developments are positive.

In a broad look at the industry, there is data that JLL is the premier provider of real-estate focused technology solutions. According to sector research firm Verdantix, JLL is a leader of workplace systems integration , and holds company with major consulting firms Deloitte and Accenture ( ACN ). Also, note how CBRE ( CBRE ) is not listed amongst these peers as it has far less consulting exposure, instead focusing on direct property management themselves. While this increases JLL’s exposure to more cyclical revenues compared to recurring management fees, the chance to grow higher margin revenues allows for long-term investors to reap the reward of earnings growth.

Diving into the specifics of JLL’s tech offerings, the main thesis is based on diversified offerings across all sectors of the market. The major platforms are: JLL Azara, a cloud-native commercial real estate data analysis platform; Building Engines , a building operations and performance platform; Corrigo , a facility maintenance and management platform; Hank, an AI climate control and energy consumption monitoring platform; and more, relating to interior design, supplies, IoT, and more.

The proptech investments in turn will help JLL grow all main operating segments, as clients will want to work with a company that is able to provide the leading tech. Also, internal operational improvements will reduce costs and increase margins long-term via these integrations. As discussed in a Forbes article less than four years ago, JLL is certainly breaking ground:

So, is JLL Technologies big news? Well, yes, it is. Placing its co-CEOs on JLL’s executive board definitely shows that JLL is serious about PropTech. Will it translate into a big success for the company? That remains to be seen, and will depend on the one hand by how Spark’s investments perform, bearing in mind that these companies do have a head start on the competition through their access to JLL itself and to its clients. On the other hand, it should also be measured by how much the revenue from its internal technology products will grow from its current purported $100 million base [now expected to reach over $300 million by 2025]. And, finally, its success should also be measured by its impact on the global JLL business as a whole, both in terms of financial gains and whether it achieves the transition into a “tech company that does real estate”.

As discussed, the venture fund Spark, provides the opportunity for equity share growth in a variety of mid-market opportunities. Typically, these are larger firms than those that have been acquired and integrated as covered above, but remain innovative, high growth opportunities. The venture fund provides the chance for earnings growth through equity sales, but also is a key way for JLL to develop partnerships in the proptech industry and the insights can be redirected towards each operating segment. As per management, the key thesis is as follows:

Led by Managing Partner Raj Singh, the JLL Spark team focuses on five investment themes most relevant to JLL clients and the real estate industry, identified through client demand and adoption trends

-Construction technology – Building a better, safer, and more productive world

-Environmental, social, and governance ((ESG)) – Decarbonizing the built world

-Smart buildings – Delivering superior returns, useability, and impact

-Future of work – Reimagining the occupier relationship to their building

-Financial technology – Modernizing the economics of commercial real estate

For example, the investment in single-family housing rental platform, Roofstock, offers institutional scale investment capabilities for the investment management segment LaSalle. Another example is Alice Technologies, a platform for GCs to optimize their workflows and reduce costs, prevent downtime, and complete projects faster - a useful service across the entire industry. As of the last earnings, the fund has provided an IRR of 37% in just a few years despite the weak equity market. As funds are invested over the next few years, significant returns are possible down the road. For investors, this is a unique area of exposure that cannot be found unless adding money to venture funds.

Financials

The question now for investors is whether JLL offers a strong enough position to both continue developing innovation and provide a decent return as a result. First, we can compare the company’s balance sheet to the sector leader, CBRE. According to the two charts below, JLL is offering a competitive balance sheet, despite fluctuations in leverage from acquisitions. Both companies have been increasing FCF over time and have recently begun to focus on buybacks rather than the dividends (JLL canceled theirs a few years ago). Altogether, I believe that despite the larger size, CBRE is not offering a significant balance sheet advantage over JLL and this is not a risk point.

While the balance sheet is on par with competitor CBRE, where JLL stands out is in their profit margin improvements. Over the past five years, the EBITDA margin has risen over 3%, while the net income margin has doubled from around 4% to 8%. The upward trend is not seen at CBRE, although the downtrend in margins has steadied for the firm. For both companies, it is clear that competition with start-ups and other market participants has been difficult to manage, but JLL’s investments in proptech have been able to reverse the negative impacts, so far. If this pattern continues as they expand their technology offerings, I believe margins can continue to improve and provide significant earnings growth.

The final differentiating factor that will allow JLL to outperform is the current valuation. As I have shown, JLL’s balance sheet is healthy and margins are improving better than CBRE. However, at the same time JLL is seeing a lower valuation. Therefore, I believe that JLL will see far higher returns over the coming years as the valuation resets to in-line with, or above, CBRE. While CBRE has an advantage with scale, I believe that JLL can rapidly catch up and may deserve a significant premium due to their better margins.

Conclusion

Considering that management expects margins to continue improving to 16-19%, and underlying growth to remain strong, investors are sure to see favorable returns moving forward. Also, regardless of the operational improvements, continued historical performance at the current low valuations would still be an ample catalyst for shareholder benefit. However, it will also be important to continue assessing the health of the real estate market, and as long as sentiment remains poor, JLL’s valuation will remain suppressed.

For me, I believe that it is worth loading up on shares now and expect a significant return over the next 3-5 years. And, based on JLL’s current size, I believe the company is worthy of consideration as a long-term steady accumulation stock as they continue to drive operational improvements, expand equity growth in their venture portfolios, and increase SaaS revenues. Therefore, there is no rush to begin investing and I believe that most investors should begin to consider JLL for their portfolios.

Thanks for reading.

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