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Downgrading Real Estate Services Moats

We still think JLL is undervalued, however.

After taking a fresh look at the real estate services industry, we have downgraded our economic moat ratings for CBRE Group CBRE and Jones Lang LaSalle JLL to narrow from wide. We still believe these companies have robust competitive advantages because of their reputation-based intangible assets and switching costs, but we are no longer confident that excess returns will persist for 20 years. Both companies operate in a cyclical industry that is rapidly consolidating, raising the prospect that they will compete more directly once consolidation eventually stabilizes. We are also cautious about the potential effect that technology might ultimately have on the broker/client relationship.

Nevertheless, we remain confident that CBRE and JLL can maintain their competitive edge for the next 10 years. Both companies boast strong reputations, which is incredibly important in real estate services, where relationships are paramount to the dealmaking process. These reputations also help CBRE and JLL attract large multinational clients in the corporate outsourcing business. We think both companies also benefit from switching costs because of the difficulty involved in switching outsourcing providers. Both are increasingly bundling various services as larger companies seek out a one-stop shop for all their real-estate-related solutions. We think these forces should endure, allowing both companies to deliver excess returns in the foreseeable future.

After incorporating our updated outlook into our models, we also changed our valuations for both companies. We increased our CBRE fair value estimate to $54 per share from $49 and lowered our JLL fair value estimate to $181 per share from $185.

We think both companies should experience long-term growth thanks to various enduring tailwinds, including consolidation, the growth of institutional money in real estate as an asset class, and the increasing tendency of corporations to outsource their real estate operations. At current prices, we think shares of CBRE are about fairly valued and shares of JLL are undervalued. We think the market is unfairly penalizing JLL compared with CBRE from a valuation perspective. While we do model slightly higher revenue growth rates for CBRE in the long run due to its larger scale, we think both companies are similarly matched in their ability compete for contracts. In the long run, this should allow them to benefit in tandem from the forces affecting the real estate services industry.

A Closer Look at JLL Jones Lang LaSalle has overseen a boom in the commercial real estate services industry since the nadir of the real estate driven financial crisis of 2007. As the second-largest player in the space by market capitalization, it has benefited disproportionately from various tailwinds that have underpinned its impressive run of growth. Key to this success has been the company's industry-leading brand reputation and a platform that melds complementary business lines in areas such as property sales, outsourcing, and leasing to serve its corporate clients.

Although JLL nominally reports its segments on a regional basis, it also discloses the amount of revenue coming from each business line. Among these, leasing is the largest with around 36% of companywide revenue. In this business, JLL’s brokers help owners and occupiers of commercial real estate with the leasing process, primarily by executing lease agreements. Similarly, the capital markets business, which contributes around 17% of companywide revenue, is where brokers facilitate the sale and purchase of commercial real estate property. These two businesses represent a higher cyclical risk to JLL because of their more transactional nature.

By contrast, property and facility management provides a more stable and contractual revenue source. This business, which contributes about 18% of companywide revenue, is where JLL provides many of the services needed by corporations that occupy real estate. Project and development services is where JLL helps companies that are looking to reconfigure their office space. Advisory, consulting, and other includes various services for corporate clients.

LaSalle contains JLL’s investment management business, which makes up around 8% of companywide revenue. Given its scale, JLL is one of just a few one-stop shops for multinational corporations that choose to outsource their real estate operations. As the company is buoyed by trends such as urbanization, the institutionalization of real estate, and the growing tendency of corporate outsourcing, we expect JLL to post healthy growth rates as it continues to take share from its smaller and weaker rivals.

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