The commercial real estate sector is set to boom again under former real estate tycoon Donald Trump, now serving a second presidential mandate. One of the main beneficiaries of the CRE boom will be CBRE Group Inc. (NYSE:CBRE), which is likely to continue outperforming the S&P 500.
CBRE Group Inc.: a Resilient Real Estate Stock With Growth Potential
CBRE is a long-term outperformer, supported by high growth in favorable real estate cycles, and with an impressive resiliency when the tide turns. The stock is up by +300% on a 10-year basis (vs. 200% for the S&P 500). The stock also outperformed on a 1-year basis with +54% vs. 17% for the S&P 500 and on a YTD-basis with +8% against 1.5%. I think the trend will continue based on major tailwinds for the CRE sector.
CRE Sector Overview and Growth Catalysts
In the last few months, I noticed a few policy shifts that could and should favorably impact the CRE sector valuations and market activity.
Firstly, after years of flexible working from home policy at federal level, Elon Musk, at the helm of the Department of Government Efficiency, ordered two million federal workers to return full-time to office presence. This will increase demand for federal leases. Additionally, this is part of a broader movement where numerous large corporations such as Amazon Inc. (AMZN) have also initiated the return to much stricter working from office policies.
A second policy change with the new Trump-Vance administration is the tariffs on imports from Mexico, Canada and China, with particularly steep tariffs on materials like steel, lumber and copper that will necessarily spike construction costs. New CRE will therefore be more expensive, driving up prices on the existing supply of real estate and heating up the CRE market.
A third tailwind is the withdrawal of the US by Trump from the Paris Agreement. This withdrawal unburdens the CRE actors from ESG and other compliance requirements, potentially supporting more activity and reducing bureaucracy and fines in the sector.
These tailwinds will benefit the CRE sector that has been suffering in recent years from covid-related working from home policies and high interest rates. Interest rates are also expected to come down according to the Fed dot plot.
CBRE Group Inc.: a Resilient Real Estate Stock With Growth Potential
Source: Economic Projections of the US Federal Reserve (December 2024)
Per the above, the Fed is expecting the labor market to remain strong with a low unemployment rate (supporting demand for commercial leases) and interest rate cuts over the next years (pulling valuations up). CBRE is in a great position to benefit from the above tailwinds, generating most of its revenue directly and indirectly from CRE.
Business Overview
CBRE's business model makes it resilient when the CRE market is weak, and soars when market activity picks up again. CBRE provides a wide range of CRE services: investment advice, property sales, mortgage options and refinancing, property management, project and construction management, building engineering, accounting, consulting, transactions management and valuations, to name the main services. The company is active in real estate since 1906, and is a well-established name in the sector.
Because of this century-long establishment, it managed to develop a wide range of services that are on demand both when there is an economic or real estate downturn (think property management, accounting, refinancing, valuations) and when real estate is growing rapidly. The diversification of services permitted for CBRE to survive the Great Financial Crisis of 2008 after the implosion of MBS and to rapidly recover from the Covid crash in March 2020.
Financials & Balance Sheet
CBRE's revenue growth on a 1-year basis and on a 10-year basis have both been approximately 14%, showing a reliable long-term financial growth trajectory. However, the business has been somewhat under pressure in terms of operating margin, dipping under 5% since 2022. The reason is the rapid increase of COGS caused by a tight labor market, significantly increasing wages (costs) within the business. In my opinion, this is a temporary headwind as inflation is expected to tick down and unemployment to rise slightly in the next few years, potentially relieving the margins. Although the company has a healthy balance sheet, the cost of debt also put the margins under some pressure. The debt weight is also expected to be reduced as interest rates drop in the next few years.
CBRE Group Inc.: a Resilient Real Estate Stock With Growth Potential
As observable in the above GuruFocus chart, the balance sheet is healthy: total current assets of $10 bn surpass the total current liabilities of $9.3 bn, giving a current ratio above 1. The debt to equity ratio of x0.79 is fairly low showing financial strength in addition to interest coverage of 6.44x, easily servicing interest payments on the company's debt. The $1.1 bn of cash in hand add additional comfort in case of unforeseen events. With a solid ROE of 11.6%, investors can expect the business to continue growing without any signs of financial trouble in the horizon.
Valuation
At first glance, CBRE is expensive, with a P/E of 45x, above both its historical and the sector medians of 25-30x. This is primarily due to lower earnings in recent years due to higher costs. As earnings improve, the PE mechanically drops without the stock price having to fall. For this reason, the forward P/E based on the company's earnings guidance is only 23x, at a discount of historical and sector valuation multiples.
In my opinion, this stock, because of the tailwinds described earlier and its long-term growth trajectory, deserves a forward multiple higher than the sector's or at least in par. The current P/S is highly attractive with a 1.2x ratio while the sector median lies at 2.4x. In my opinion, there is an upside of 20-30% in today's stock price if, and only if, CBRE manages to improve the margins and generate higher earnings relative to revenue.
Risk to my Case
The main risk for CBRE is its operating margins that are currently under pressure. If earnings remain low relative to revenue, indicating a longer term trend of low earnings, the markets could significantly correct the stock price. In my opinion, this risk has mitigants. The pressure on earnings is temporary because it is directly correlated to the current tight labor market and high financing costs, and both are currently easing and will likely continue to do so in the next quarters and years. Additionally, there are strong tailwinds in the CRE sector that will be reflected in the company's earnings in the near future, as activity picks up in the sector and CRE valuation multiples expand.
Bottom Line
The stock is a long-term outperformer with a strong revenue growth trajectory. Recent earnings have been under pressure, artificially expanding trailing valuation multiples. However, the stock is cheap on a forward basis relative to historical and sector multiples. Real macro tailwinds and favorable US policy shifts will, in my opinion, be reflected on the earnings of this well-established real estate company and ultimately on the stock price. This stock is therefore attractive for the medium to long term within a diversified investment portfolio.
