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Morningstar | Downgrading CBRE and JLL Moat Ratings to Narrow After Taking a Fresh Look at Real Estate Services

After taking a fresh look at the real estate services industry, we are downgrading our moat ratings for CBRE and Jones Lang LaSalle from wide to narrow. 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 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. This reputation also helps CBRE and JLL attract large multinational clients in the corporate outsourcing business. We think both companies also benefit from switching costs due to the difficulty involved in switching outsourcing providers. Both firms 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 firms to deliver excess returns in the foreseeable future.

Additionally, we are changing our fair value estimates for both companies after incorporating our updated outlook. We are increasing CBRE’s fair value estimate slightly to $54 per share from $49 and lowering JLL’s fair value to $181 per share from $185.

We think both firms should experience long-term growth due 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 in 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.