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Brookfield Properties Corporation (NYSE:BPO)

Q2 2010 Earnings Call Transcript

July 30, 2010 11:00 am ET

Executives

Melissa Coley – VP, IR and Communications

Ric Clark – President and CEO

Bryan Davis – SVP and CFO

Tom Farley – President and CEO, Canadian Commercial Ops

Dennis Friedrich – President and CEO, U.S. Commercial Ops

Analysts

Ross Nussbaum – UBS

Sloan Bohlen – Goldman Sachs

Steve Sakwa – ISI

Michael Bilerman – Citi

Mario Saric – Scotia Capital

Karine MacIndoe – BMO Capital Markets

John Guinee – Stifel

Alex Avery – CIBC

Suzanne Kim – Credit Suisse

Neil Downey – RBC Capital Markets

John Stewart – Green Street Advisors

Joe Dazio – J.P. Morgan

James Sullivan – Cowen and Company

Sam Damiani – TD Newcrest

Shant Poladian – Canaccord Genuity

Jimmy Shan – National Bank Financial

Operator

Good morning, my name is Lisa and I will be your conference operator today. At this time, I would like to welcome every to the Brookfield Properties second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions) Thank you. Ms. Coley, you may begin the conference.

Melissa Coley

Good morning, and welcome to Brookfield Properties second quarter 2010 conference call. Before we begin our presentation, let me caution you that our comments and discussion will include forward-looking statements and information and there are risks that actual results, performance or achievement could differ materially from anticipated future results, performances or achievement express or implied by such forward-looking statements and information. Certain material factors and assumptions were applied in drawing the conclusions in making the forecast and projections in the forward-looking statements and information. You may find additional information about such material factors and assumptions and the material factors that could cause our actuality results performance or achievements to differ materially, set forth in our news release issued this morning. I would now like to turn the call over to Ric Clark, President and Chief Executive Officer.

Ric Clark

Thanks, Melissa. To accommodate those of you who wish to dial into the Brookfield conference call which is at noon, rough against a heart stop of 12:00 o’clock today, so because of that and in order to talk about the progress that we've made on our strategic initiatives, we're going to dispense with report from our division CEO's, Tom, Dennis and Alan, who are all on the call and they’d be happy to field your questions if you have any at the end of the call. So apologize for this. But I also, in order to get to everyone in the Q&A, we're going to have to limit questions to one with follow up for clarity, please hop back in the queue and hopefully we’ll be able to answer everyone's question within the one hour timeframe.

So with that, Bryan, why don't we jump into operating results?

Bryan Davis

Sure. Thanks, Ric. Good morning, everyone. This morning, we reported fund from operations totaling $209 million for the second quarter, this compares to $123 million for the same period in 2009, an $86 million increase or 70% on a per share basis, FFO was $0.40 per share compared with $0.32 for the same period in 2009.

The current period results include a $53 million realized return on an investment and debt, which Ric will touch on in his comments. In addition to that gain, this quarter benefited from an increase in residential results of $20 million and in commercial result, $13 million. Compared to the first quarter of this year, FFO is up $76 million, which in addition to the gain was due to an $18 million increase on our residential result and $5 million increase in earnings from our commercial operations.

Before I dig into the results, I did want to point out that we have now included in our supplemental our proportionate earnings including supporting schedules. The purpose of this is to present our share of earnings from those assets that we are now required to equity account for, under IFRS. With that as background, our commercial property operations earned FFO of $123 million, versus $110 million in 2009, representing a 12% increase. We had an active leasing quarter at rents higher than expiring and were able to maintain occupancy at a high 94.8%, in addition, we reduced our out year role over exposure.

Contributing to the increase in results with same store growth, contribution from property previously under development, higher recurring fee income, and the stronger Canadian dollar, this was offset by slightly higher interest expense and increase general and admin expenses due to the transaction costs associated with the formation of our Canadian REIT and our recent transaction.

Our net operating income for our continuing operations on a proportionate basis is highlighted on page nine of our supplemental with $265 million for the quarter, compared to $241 million for the same period in the prior year. This increase as a result of the reclassification of Bankers Court in Calgary, Bay Adelaide Center in Toronto and 225 Connecticut, Washington DC to commercial properties, which accounted for 12 million of the increase, we had termination income of 6 million on a take-back of space in downtown New York, we had an additional $1 million of recurring fee income and same-store growth of $11 million or 5. 1%.

This was offset by a reduction in net operating income from the sale of our two Washington properties in the fourth quarter. Our same-store growth of 5.1% benefit from the stronger Canadian dollar, which accounted for $7 million, in the quarter we had an average rate of $1.03 versus $1.17 in the same period last year. We also benefited from increased rental rates on new and modified leases; we had an increase in same-store occupancy of 80 basis points and the reduction in our operating costs.

Our residential development operations earned $33 million in net operating income, which compares favorably to $13 million earned one year ago. As highlighted in our residential slides, which start on page 31 of the supplemental, this increase was due to strong sales volumes on both lot and home sales.

Now shifting to the balance sheet, total assets on a proportionate basis increased to $19 billion from $18.5 billion at the end of the prior year. The fair value of our commercial office property totaled $14.8 billion or $332 per square foot, resulting in a 6.7% going in cap rate. Values during the first 6 months of 2010 increased by an aggregate of $426 million, which we highlighted on page 18 of our supplemental and this is primarily a result of the acquisition of a 50% interest and 77-K Street, re-class of 1225 Connecticut from development properties and valuation adjustments due mainly to increase cash flows as a result of current period leasing activity and timing adjustments.

Commercial development properties decreased $82 million since the beginning of the year to $540 million or $44 per square foot. This decrease is primarily due to the reclassification of 225 Connecticut, offset by our investment in the first quarter in Bishopsgate, a development site in London.

Our common equity increased from $6.5 billion to $6.7 billion or $13.37 per share on a pretax basis, so excluding our deferred tax liability, common equity at $7.2 billion or $14.36 per share. Now, before I turn the call back over to Ric, I did want to point out a new slide in our supplemental on page 17, called components of net asset value. In this slide, we've attempted to highlight the key opponents in determining our net asset value, including a normalized net operating income, the calculation of our implied going in cap rate and value per square foot based on IFRS value.

A summarized balance sheet for our residential development business and most importantly, the elimination of minority shares of the earnings and net assets of our Canadian REIT and U.S. subsidiary, which I know you all worked through. Hopefully, you'll find this helpful in migrating your models to the new IFRS world or if you have already done that, then as a helpful and quick reference point. As always, I'd be happy to walk you through anything in more detail after this call.

On that, I will conclude my comments on the financial results and turn the call back over to Ric.

Ric Clark

Thank you, Bryan. As Bryan pointed out our operating results were strong for the second quarter and for the first half of the year and you know, I'd say overall and in general the business environment that we’re operating in and continue to improve particularly in our three most important in major markets, New York city, Washington DC and Toronto we're almost 70% of our commercial net operating income from. We've seen meaningful core growth in our residential business year-over-year and quarter-over-quarter and year-to-date versus prior year results, those are up 153%.

We've shown core commercial property NOI growth after stripping out gains and lease termination payments of 7% with in place rent 11% below market rent. We think we're well positioned to continue to gain ground as we mature. So here's what we're seeing and hearing regarding the office sector landscape broken down by the principal business sectors driving the markets that we're invested in.

So first, on the financial services side, Q2 as reported by a number of the financial services and banks and investment houses versus Q1 with a bit more challenging. Consistent concerns were expressed about the near term piece global growth, about European solvent and credit risks and domestically over the impact of financial regulatory reform and the continuation of consumer deleveraging and it’s in fact, on spending.

Notwithstanding all of this, our experience and observations of this firms when it comes to space utilization and their activity has been that they are hiring, it is a bit modest and many of the firms are actually engaged in space discussions, many with us as we speak. Our baking season in these markets remains low and we are seeing activity coming from financial services firm.

On the energy sector side, notwithstanding how the Benson Golf activity continues to be pretty good in actually both of our markets, Houston and Calgary. There has been some shuffling of assets between energy sector firms, which is usually good for us, it creates activity and as we all know this – over building in Calgary which mitigates the activity that we've seen there. On the government sector side, Ottawa was just, kind of, steady I see no growth in government, but no shrinkage and Washington, DC appears to be expanding and that market performed very well.

So, with all that, it's just kind of minor high level background, again we had a good quarter on the leasing side, completing 1.3 million square feet of leasing and had a robust first half with 3.6 million square feet of total leasing transaction completed. As Bryan mentioned, occupancy remains flat quarter-over-quarter and it’s down 20 basis points for the year, but I think more importantly, activity within our portfolio continues to be strong as we are in the middle of serious discussion with about 4.3 million square feet of tenants.

So we expect to exceed last year's overall leasing of 4.6 million square feet by the end of the third quarter and may well exceed 2008 overall, completing leasing 6.4 million square feet by year end, although, it's a little bit early to say this with complete confidence. And I think it's worth a look at the performance of the real estate brokerage firms so far this year, particularly those that are publicly listed and have their call and earnings release just not long ago and among other things, they are reporting leasing demand fundamentals having turned positive and for the first time in ten quarters, they are reporting with U.S. office markets have post positive overall net absorption. Now, it's modest, but for the first time in ten quarters it has been positive.

Not being economists, we try not to predict where the market is going, but rather kind of give commentary on what we're seeing within our portfolio kind of, data point and certainly momentum and in our observation, New York city, Washington, DC and Toronto all these markets are major markets appear to be fully in recovery mode with decent and improving activity, improving economic fundamentals, modest job growth and no competition on the new supply side at least at the moment, under these circumstances, these markets typically experience meaningful well growth, once the equilibrium is reached and we’re closing it on that in this market.

The balance of the market appears to be at the beginning of what will likely be a slow recovery. But we're not expecting major changes at least in the near term. I didn't intend to get into further detail on any operating achievements, but as I said, Dennis, Tom and Alan are on the call and would be pleased to take questions at the end. So, for the rest of the call, I wanted to turn our attention to the progress that we've made toward our principal priorities in strategic initiatives, which we've been working on for several quarters and just as a reminder, during 2009 our focus was on preparing the balance sheet to address liquidity concerns and to set the stage for future growth.

For 2010, we began the year with $2.1 billion of liquidity, which we wanted to put to work both internally and externally as well. Our priorities for 2010 were just to list them here to delever and refinance U.S. office front deck, in advance of October 2011 maturity to address the 4.6 million square feet of October 2013 government has leased maturities and to begin to put liquidity to work on acquisition. So for the first one of those, U.S. Office Fund, as our earnings release mentioned Brookfield asset management through its lending operations acquired $570 million of the mezzanine dent of the U.S. Office Fund at a discount face value.

Through an agreement that we have entered to the net benefit of this will be received and transferred to Brookfield Properties. As a result, we believe we've have prefunded the block, it’s not all or more of the equities deleveraging required to refinance this portfolio. And with – lending markets improving, continuing to improve and more and more lenders entering the market and spreads tightening down to about 200 basis points on a 10-year loan and we're seeing this is a great time to do refinancing, we’re seeing all that rates being somewhere around or slightly above 5%.

Dennis in market have been actively working to refinance the properties in the U.S. Office Fund on a more conventional basis and to sell a couple of assets as well. So we hope next quarter but certainly by the end of the year to be able to report meaningful progress on these initiatives and so more to come in the near term. We saw in prior calls that the priorities in this portfolio – sorry the properties in the U.S. Office Fund portfolio have performed well, since acquisition and have experienced a meaningful NOI uplift over the past four years, largely if not completely offsetting any temporary rise in cap rate.

With this and the effect of the deleveraging that we have just set up and given the current lending environment, we expect that we will be able to secure investment grade financing for the portfolio. So the second priority that 2013 lower Manhattan lease rollovers and addressing that, we’ve talked a lot about this on prior calls, but I don't have a lot to say here I be a bit three, but I did have a few things that I just wanted to point out. And the first is the progress downtown on the construction front is advancing rapidly and there are visible signs of this, for any of you that have been downtown.

The media has picked up on this and what may be the best kept secret as to lower Manhattan's future is getting media attention and you might have seen a couple of expressways on this over the last week. We are in what we hope to be the final stages of planning for the redevelopment of the public and retail areas of the world financial center and hope to be in a position later this year to announce and commence this work.

Of the 4.5 million square feet of 2013, world financial center expiries, here is our current status. We have terms settled in our – in the documentation stage for 630,000 square feet of leases. We have another 200,000 square feet of leasing in what we call advanced discussions which we hope and expect will go to the documentation stage shortly. We also are in a very active dialogue with 3.2 million square feet of potential tenants, including existing tenants, new tenants and some new tenants, even essentially coming from midtown Manhattan. So sum it up, we have serious interest and activity on 90% of the space maturing at the world financial center in 2013.

So on the final priority, which is putting liquidity to work; paving the way for future growth, we have three things to report. As you would have seen in the press release and if you heard from Bryan, we booked $53 million gain, about 160% annual return on the acquisition of debt secured by portfolio of assets in Washington, DC. We saw there were no downsides on this investment and as it turns out that we are back quick at a very substantial profit.

During the quarter, we also drew a modest investment, gained 100% ownership of billings that we owned to 50% interest in Washington, DC. 77-K Street for a gross price of $39 million or $237 per foot, we subsequently completed $94 million refinancing of this property and are in advanced discussions to bring the leasing from 52% to 90%, so this should turn out to be a good transaction for us.

And finally and what we believe will be a very profitable move for us, we announced this morning a couple of transactions which will sort of lead the way for personal properties for the next phase. And we announced a plan to transform Brookfield Properties into a global expressway office company which includes, acquiring a high quality portfolio of 16 premiere assets and I'll show you from Brookfield asset management. It also, we also plan on the investment of our residential land and housing business, a name change of the company to Brookfield office properties and you know, just – I guess summing it up, these transactions collectively will position Brookfield Properties is the only publicly listed class-A office company that has a presence and for the roads most important developed countries and it’s scalable asset management model to service global tenant.

So getting into a little bit more detail on these and starting with the residential divestment in 2003, we spun off Brookfield homes to create a pure play, North American focus premiere office company. At the time, we did retain what was a modest investment in a largely Western Canadian based residential land and housing business, which was contributing about 15 to $20 million a year to our FFO. Through, I think, the hard work of the skilled management team, additional investments and the economic growth in Western Canada, this division grew to, to again become a very substantial contributor to Brookfield Properties FFO.

Leasing now, like we did in 2003 that this business – the office business would both be more valuable and operating separately and to complete the transformation of Brookfield properties a global pure play-offs company, we have begun initial discussion to the divest of our residential landed housing operation. So this – to this end, we expect to commence initial discussions with Brookfield homes, the division that we spun off in 2003, to re-combine the businesses through a merger, should a merger proceed we envision that Brookfield properties, equity interest would be monetized into a listed security in the merged entity which Brookfield Properties would dispose off through an offering to shareholder, we would also envision obtaining a commitment from Brookfield asset management to acquire any shares of the merged entity, that went otherwise subscribed for in the offering. This would give each shareholder an opportunities to participate if they like and for Brookfield Properties to receive full proceeds to re-in invest into the global.

So the final part of this repositioning is the acquisition of the Australian office assets from Brookfield Asset Management. And as I said, we have entered into a transaction with Brookfield Asset Management whereby Brookfield Properties will acquire damp interest in 16 premiere Australian office properties, comprising 8 million square feet in Sydney, Melbourne and Perth and these properties are 99% leased and have a current NOI of $206 million Australian, which is about 185 million U.S.

The properties have a total growth value of $3.8 billion Australian, just about 3.4 billion U.S. and BPO will pay to Brookfield Asset Management $1.6 billion Australian or 1.4 billion U.S. Now the funding of the transaction will come from available liquidity and from $750 million subordinate bridge acquisition – excuse me – facility which we provided by Brookfield Asset Management that will be repaid from the completion of some or all of the following and assets sales including sell down of Brookfield Properties equity interest in our publicly listed Canadian office company, Brookfield Office Properties Canada or other financing or capital activities.

This transaction is expected to be completed in third quarter of this year, following of the receipt of third quarter concepts and approval. Now, I'd say that Dam has done a great cooperate sponsors for Brookfield Properties in both Brookfield Properties and Brookfield Asset Management in each company's Board of Directors recognizes that related parties dealings can be very beneficial for all shareholders. However, careful consideration and transparency are obviously required. Accordingly, Brookfield Properties Board of Director established an independent committee to assess this transaction. They committee retained Morgan Stanley to help and to advise it. At the independent committee unanimously recommended that the Board of Directors approve this proposed transaction.

So our investment thesis on this transaction, I first make a few points on the Australian economic landscape. And the first thing I’d say is that, the global financial crisis has been left severe in Australia and from a technical standpoint, if the economy avoided recession, as the world's economy begins to emerge from the global economic downturn, I think the Australian economy has been in a stronger position than other exams the community. Driving the economy is a rich commodity and resource base and given proximity of strong trading relationship with Asia.

Asia is expected to experience the highest rates of growth over the next several decades and according to the IMF within five years, the economy will be 50% larger than it is today, accounting for more than one-third of global output. I’d also has to – Australia’s government entities are amongst the strongest in the developed world with very limited deficit and the expectations of reaching budget surplus is open over the course of the next couple of years.

Australia has a strong and growing pipeline in investment projects that will boost investments over the coming years. Now, all of the above should lead to a vibrant growing economy for strong job growth. I think the last point that I'd make on the investment landscape in Australia, particularly versus Canada, is that the Canadian dollar has meaningfully outperformed the Australian dollar in recent months closing opportunity time to increase exposure to Australian assets and increase exposure to Australian assets. Now, adding to our investment thesis, I'd say that Brookfield Properties strategies of owing high quality assets in the world’s most dynamic markets can be effectively deployed and select developed economies around the world.

Tenant synergies can be leveraged in other gateways cities such as Sydney, Melbourne and Perth and Australia. And we think that investment in these cities will produce more stable returns and growing returns than new North American markets for us. Entering new markets and taking on new people in platforms are risky, which is why we minimize this risk in advance of making this decision, Tom, Farley and several others from BPO have been involved with Australian management team for this portfolio and have been assessing the assets and the team for about a year. And this transaction has a large complementary property portfolio of high quality assets; it expands our geographic footprint into attractive new markets. It assembles similar portfolio, well, sorry – I missed the point, it’s assembling a similar portfolio platform overtime, would be much more costly and difficult if not impossible to replicate.

In our view, an opportune time in the real estate cycle to acquire and interest at the core assets in Australia and I’d – we’ll out point out that in 2007, a similar acquisition traded at a 5.2% GAAP and which is about 26% higher than the price we paid on this transaction. And lastly, what Brookfield Properties intends to do is to use this Australian management team and platform for future growth and we think that combining the strong operating base and teams, there will be ways to expand both and the existing markets to this assets, where the assets are in Australian and possibly markets into new markets overtime.

So I think those are the comments that I wanted to make about this transaction. And at this point, operator, we’d be happy to open up the line to questions.

Melissa Coley

Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Ross Nussbaum.

Ric Clark

Hello?

Ross Nussbaum – UBS

Can you hear me?

Ric Clark

Yes.

Ross Nussbaum – UBS

Okay. Can you help me get maybe an understanding of, did the independent directors of Brookfield Properties look at the Australian transaction on its own merits or was there some consideration given to the back stop that's been provided on the housing transaction, as well as the transfer of benefits on the U.S. Office Fund miss purchase, because I'm struggling I think with getting really to the bottom of what factors they considered the deal to be fair?

Ric Clark

This, transaction was independent of any other transaction, so the Australian transaction was reviewed by itself and on its merits.

Ross Nussbaum – UBS

And why didn't you roll in the U.K. assets or Brazil assets or even the assets since a Brisbane or New Zealand that bam owns, why Australia?

Ric Clark

The thoughts are, Sydney, Perth and Melbourne are market that are similar to the markets that you'd experience the most, best the results in North America and/or consistent with strategy of owning high quality assets in markets whose economies are primarily different by tenants in the financial services, energy, resource or government sector. And those are the three markets that kind of fit that bill. The assets that were left out, were either, were some – they were either markets that we didn't think were consistent with that strategy or assets that had other issues that needed to be dealt with. So those weren't captured within the portfolio. So, Ross, with, did I miss part of that question?

Ross Nussbaum – UBS

Yeah. And I think the other question was relating to the U.K. and Brazil. Why are Australia, if you're going to become a global office region and you’re trying to sort of become little more focused here, why not just do the whole thing and roll in U.K. and Brazil and separate Brookfield from them?

Ric Clark

So, In Brazil, BAM doesn't own any office assets. So, there was nothing really there that to consider and in the U.K., it’s just not something that was considered at this time. I think the BAM’s ownership in the U.K. is a little bit different than what we have in Australia, which is portfolio of assets which are actively managed by the management team down there. So it's not to say there won't be an opportunity to do something in the U.K. at a later date, but for now, I think this transaction is what made sense for us.

Operator

Your next question comes from the line of Sloan Bohlen with Goldman Sachs.

Sloan Bohlen – Goldman Sachs

Hi. Good afternoon. Just questions on the Australian portfolio…

Ric Clark

Operator?

Operator

I'm sorry?

Sloan Bohlen – Goldman Sachs

We're having a little bit of trouble with the line here.

Operator

There's no response from that line. Your next question comes from the line of Steve Sakwa with ISI.

Steve Sakwa – ISI

Good morning. Just wanted to, I guess follow up on the Australia. Ric, I'm trying to understand, I guess, two things. One, you're buying this at a 6, 7. The debt comes at 7, 4. There is a sort of negative arbitrage in this market, so kind of can you help us understand, I guess, the pricing on this deal?

And then secondly, I guess kind of help us understand sort of the global synergies that you get from operating in multiple markets. We know Sam Zell tried to build a national office footprint here and I think ultimately came to the conclusion that sort of bigger wasn't better and it didn't make it more profitability. So, what do you see on the global front, I guess, that gives you confidence that you're going to make a global footprint more profitable?

Ric Clark

Let's start with the last part of your question, which is comparison to equity office. And I say the strategies between total properties and equity office are very meaningfully different. Sam intended to be offerings to all people, all throughout North America. So, he had large assets in every, every major city in North America.

Brookfield Properties is a focused company. We only invest in cities that consider gateway cities, whose economies are dynamic, vibrant, resilient and driven by tenants principally in three market sectors. And his focus – you've made the point that you can buy toilet paper cheaper. We're not – we don't see expense synergies, we see actually see revenue synergies. The people that has four or major businesses that are involved in real estate decision making, we find are located in one of our major cities. They’re located in New York. They are located in Houston. They are located in Colorado, they are located in Calgary, they are located in London, they are located in Sydney, Melbourne or Perth and it's typically one person who is in charge of those things and in our experience, including recently with our announcement of the 100 Bishopsgate development opportunity in London, we're seeing that we know the people that are making the decision.

So any U.S. banks, for example, of course, to making a decision is probably located in New York city and we have a strong relationship with them. So absolutely on the revenue side, there will be synergies in this strategy.

Steve Sakwa – ISI

And the first question, the first part of the question?

Ric Clark

Sorry. Would you repeat it?

Steve Sakwa – ISI

Yeah. I guess, I'm just trying to understand in most markets, I guess in this case, the leverage is upside down in terms of there being negative arbitrage and normally, you don't want to buy at a higher cap rate and finance it with cheaper debt. Australia seems to be kind of the reverse. You are buying at a 6, 7 cap. You’ve got higher cost debt and that market tends to have high cost debts.

So, you are, sort of, I guess, upside down, day one, in terms of that situation. There's not a lot of space for rolling, so I'm just trying to understand the economics behind this deal and how you got comfort with a 6, 7 yield.

Ric Clark

Yeah. So the negative arbitrage is actually one of the disadvantages from investing in the Australian market and there's no question about that, but in our view in our analysis, that is offset by the upside potential in the market. And I think it's a combination of things, one is this is a very strong well-positioned economy which is going to experience very above average growth over the next couple of decades in our view, given its proximity in trading relationship with Asia and the growth that Asia is likely to go through.

So – and then also, it's a market that is well in balance from a supply and demand standpoint, and we think there's huge potential for spiking of rental rates in the near term, and finally, I think, under leadership and management of Brookfield Properties, by exploiting our systems, asset management techniques and ideas and relationships, there is very meaningful upside to be experienced versus the going in cap rates. So I think there is lots of reasons why this is going to be very valuable accretive acquisition for us and we’ll offset the negative arbitrage.

Operator

Your next question comes from the line of Sloan Bohlen with Goldman Sachs.

Sloan Bohlen – Goldman Sachs

Hi. I'll try this again. Basically, just, a question kind of along the same line of Steve, just wondering, if you could maybe put some numbers around how you kind of make up for that gap in the negative arbitrage, what you underwrite for rent growth, going forward. There isn't a lot of roll in the portfolio over the next, basically four years and maybe walk us through that. And then I got a question on, I guess, the sources of liquidity from the deal.

Ric Clark

Hey, Sloan, can I ask you a question? We seem to be losing people abruptly in the call. Are people hearing the full comments, well?

Sloan Bohlen – Goldman Sachs

We can hear you on our end or at least I can.

Ric Clark

All right. So, you know as far as the underwriting and rental growth, I don't have the assumptions with me. But I'd say we were somewhat modest in our rental growth projections. They would have been higher than what we expected in North America over the next couple of years, but not – we did not underwrite large rental rates spikes. I can't tell you exactly on this call what they were, but they probably averaged 3% or 3.5 or 4% and not much more than that over a 10-year period. Let's see, sorry. Sloan, what else?

Sloan Bohlen – Goldman Sachs

Yeah, the second question, just on how far along on the sales of the residential division and I guess you're thinking the Canadian listed entity, when can we see that kind of, I guess, set the time for the third quarter but how far along in the process are you there?

Ric Clark

We're not far along on that. So that was merely an announcement of our intentions to engage with Brookfield homes on a transaction. So, it's something that we hope can be completed by year end or suddenly by the beginning of the next year, but we are only at the very initial stages of working through that.

Sloan Bohlen – Goldman Sachs

And I guess the sources of liquidity in the meantime, that's the reason for the total return swap? And may be if you could just touch on that a little bit.

Ric Clark

The main reason for that was to preserve and place financing.

Sloan Bohlen – Goldman Sachs

Okay. Okay. I'll probably follow up on.

Bryan Davis

Yeah. I could make one comment on sort of the cash. And I think you were getting that, our liquidity position, we do have $1.3 billion, as we sit on our balance sheet, $500 of that is pure liquidity, $150 of cash, $280 million of our deposit and then we also have capacity within our lines, within our Carma division.

So we do still sit even with our investment in repurchasing, through BAM on the U.S. fund debt with a fair amount of liquidity that will be allocated to completing and closing out this transaction in the third quarter.

Sloan Bohlen – Goldman Sachs

Okay. Thank you, Bryan. I'll probably follow up with you.

Operator

Your next question comes from the line of Michael Bilerman with Citi.

Michael Bilerman – Citi

Hi. Good morning. And Ric, just two part. As you think about…

Ric Clark

Michael?

Operator

I'm not sure.

Ric Clark

Operator, could you check the status of this line?

Operator

Yeah, sir. One moment.

Bryan Davis

Michael? Operator, maybe we should go to the next question. I’m not sure, if this guy disconnected.

Operator

Okay. Your next question comes from the line of Mario Saric with Scotia Capital. Mario, your line is open.

Mario Saric – Scotia Capital

Hi. Good morning. Just with respect to the Australian acquisition, Ric, perhaps you can maybe talk little bit about the fixed print review process and how that works?

Ric Clark

You know, basically, let's see, Tom, are you on the call? Maybe you want to talk about that.

Tom Farley

Yeah. Actually, the one of the fundamental differences between leases in Australia and what we typically see in North America is that in this portfolio, as an example, 85% of these leases have an automatic escalator, once per year and the average of that increase is 4%.

So to jump in and to just to clarify gross rate assumptions, we do have an automatic increase on 85% of the income of 4% per year, and then certainly leases depends on what has been negotiated would have a market review mechanism at some point through the lease term, and of course, it does vary from lease to lease. However, the automatic escalator and the automatic growth feature is unique to Australia, compared to the North American markets.

Mario Saric – Scotia Capital

Okay. And then Ric, perhaps, just on the acquisition front, when you initially raised a billion of capital back last August and you become an opportunistic buyer of real estate, these yields are falling below, I guess, initially sets target threshold. So, can you maybe just through kind of how that reconciles to the overall acquisition as it stands today? And are you seeing less opportunities elsewhere or is there going to be more focus going forward on core assets?

Ric Clark

Well, let’s say, couple of things, one is as you know, there hasn't been a whole lot of transactions in North America at all, in the office sector so far. We do still think that there will be opportunities monetary policy has been such that 100s have been incentive wise that basically delay kind of dealing with the inevitable. So there will be some opportunities at some points over the course of the next couple of years. How many can be if you seen.

As far as this transaction goes, the initial returns are more core like, but our intention is that at some point to bring in partners like we do in North America either at the asset level or in a wholesale fund or do some kind of an idea with the assets at a subsequent date and we think, at that time that we'll greatly enhance our returns, and we don't view this to be simply kind of that for us.

Mario Saric – Scotia Capital

Okay. Thank you.

Ric Clark

You're welcome.

Operator

Your next question comes from the line of Michael Bilerman with Citi.

Michael Bilerman – Citi

Hi. We’ll try this again. Can you hear me?

Ric Clark

Yes. We can hear you, Michael, sorry.

Michael Bilerman – Citi

Great. Ric, I'm just trying to determine sort of your role in all of this and when we buy public companies, we expect the CEO, who is driving strategy, making decisions as to what are the appropriate investments. You, because you're sitting at CEO, properties, you are the head of BAM real estate, you sit on the board. Brookfield Multiplex, which actually hold this asset and at some point you can’t refuse yourself from everything and if you do refuse yourself from each part of the transaction then there's really no one that we as minority shareholders in Brookfield Properties know that we're getting a great deal.

So I'm trying to figure out how at the end of the day that you can sort of say that this is a win-win effectively for everyone, on any side of the deal, you’ve got to be feeling that, especially as you being an opportunistic investor, you want to get a good deal for your shareholder.

Ric Clark

You know, first of all, I think it was a fantastic deal for Brookfield Properties and yes, I was a major advocate for this international strategy and for acquiring this portfolio of assets. And, I just would say, although with the significant investment in much Brookfield asset management and my dual role as Head of Global Real Estate for Brookfield Asset Management, certainly, the potential for conflicts are the – at the very least appearance of conflict.

But Brookfield Asset Management has been a fantastic corporate sponsor of Brookfield Properties. If you just look back in history and I just remind you of the Tirsic transaction where over the course, which was done over the course of a four-day period and a dozen acquisition and restructuring professionals were loaned to Brookfield Properties to complete the transaction in addition to the billion dollar bridge loan.

So just the history and experience has been that Brookfield asset management has been very supportive shareholder to Brookfield Properties and it’s benefited all the shareholders, and I think this is a great transaction, but just to make sure that that there was no confliction or self feeling anything like that, an independent committee was formed, there was no BAM related directors involved in that at all, they had expert advice from an outside advisor, Morgan Stanley. The committee met directly with Tom Farley who has no direct involvement with Brookfield Asset Management and had – who had been the man on point down in Australia over the course of the last 12 months, assessing management and assessing the assets, so we didn’t make any mistakes and he reported directly to the committee without my involvement. So that's probably the best I can do in response to your question.

Michael Bilerman – Citi

Let me ask it a different way. Brookfield Estate Management obviously has interest in properties, has interest in the assets in Australia and everywhere. So at some points, the benefits, the revenue synergies that you are talking about could have been garnered without properties having to go in at a very, very low FFO yield which you're selling residential likely will result in a lots of delusion, but that side. The revenue initiative has been there because all these assets somehow or not are already underneath the Brookfield Asset Management Empire where you could be sharing that knowledge and those tenants and things like that?

Ric Clark

Well, I think Brookfield Properties shareholders are going to benefit greatly from this investment. There are great synergies between that from place to place and I think it’s going to – and I think a pure play global office company. This is a unique investment vehicle and it will – it should attract attention from international investors. Anybody wanting to invest in high quality premiere office properties and the world’s most important developed cities, this will be a very attractive investment vehicle for them.

Michael Bilerman – Citi

Okay. Thank you.

Ric Clark

You're welcome.

Operator

Your next question comes from the line of Karine MacIndoe with BMO Capital Markets.

Karine MacIndoe – BMO Capital Markets

Hi. Thank you. And just wondering if I share some of comments about the Australia market in terms of above average growth, approximately to Asia, I would imagine the buying of commodities, natural resources from Australia.

And how that kind of compares can trust with your views of the Canadian market, given that we still have, meaningfully positive spreads in Canada versus the negative spread investment being made here? And how you can kind of maybe shed some light on, pulling capital out of Canada, selling down your ownership in box and redeploying capital into the Australian market?

Ric Clark

Well, I think, in the case of the Canadian market, as you know, a lot of the high party assets have transferred into the hands of institutional owners and there's been very little transactional activity, this is not the ability to acquire many more assets. At the same time, there's also some development going on in Western Canada, there will be more development going on in Toronto, and we thought that the prospect for growth over the next 20 years aren't as compelling as they are with Australia and given the trading relationship with Asia, all the money being spent on infrastructure, we think this markets is poised for very meaningful growth over the next couple of decades.

So not to say Canada won't be a good market, but there's been very little transactional activity and very little ability for us to make sort of accretive acquisitions there. At the same time and comment on the ramp up in the Canadian dollar versus the Australian dollar, and I think given that, it is also good time to redeploy capital there.

Karine MacIndoe – BMO Capital Markets

Okay. And so, what do you see that 6.7 implied cap rate for this portfolio being in five years and is the 7.4 on debt. Is that a mark-to-market rate on this? Is that what you can get on debt at this stage in that market?

Ric Clark

That's probably a little bit more expensive than that in this market at this time and Bryan, I don't know if you have any comment?

Bryan Davis

Yeah. I'd say the debt is fairly close to that rate in this market. It is somewhat of a shorter term, floating rate debt market although on 7.5% we take 76% of that. But the rates may be a slightly more expensive, but they are in and around that ballpark range.

Karine MacIndoe – BMO Capital Markets

And what's the weighted average term on this?

Bryan Davis

I think it's two and half years.

Karine MacIndoe – BMO Capital Markets

Okay. So you’ve got that exposure coming up. What do you envious 6.7 being in year three to five?

Bryan Davis

4% growth annually, at minimum on 85% of the portfolio.

Karine MacIndoe – BMO Capital Markets

And occupancy, you're expecting to be maintained at 99%?

Bryan Davis

Maybe 100%.

Ric Clark

That’s why. We expected to be high there are some lease overall, but average age life about eight-year or so, it's not a lot of churn in the near-term.

Karine MacIndoe – BMO Capital Markets

Okay. Thank you.

Operator

Your next question comes from the line of John Guinee with Stifel.

John Guinee – Stifel

Ric, not to beat a dead horse, but is 6, 7 the right number, because, I thought I heard you saw – $3.4 billion acquisition against $185 million of NOI?

Bryan Davis

Ric, I can comment on that. There is one development property that’s included in the $3.5 billion that isn't going to be spitting out NOI until partway through 2012. We did sorts of highlight that on I think it slide five in the transactional package is about a $900 million asset, so if you back that out, multiple by $6.7, you get to the slightly less than the $185 that Ric had alluded to, but that 6, 7 is on cash NOI, and there are straight line rents that are included in the number that Ric had alluded to.

John Guinee – Stifel

Okay. Can you talk through just for us who don't spend a lot of time in Sydney or Melbourne, the overall size of these markets and just a rough comparison? It's obviously not Midtown Manhattan or West L.A., Houston that like Minneapolis, is like Atlanta? How would you characterize the total square footage replacement cost, what it costs to build in this market, et cetera?

Ric Clark

So, just, let see, starting with Sydney, so the Sydney, Tom, do you want to comment on the Sydney market, you want to start now.

Tom Farley

Sure.

Ric Clark

Yes. About, yeah, go ahead, Tom.

Tom Farley

Okay. So, the Sydney market, first of all, there's about 5 million people that live in Sydney. The downtown, well, CBD [ph] office market is about 51 million square feet, and it’s about 1.9 million under construction.

Today, it has a vacancy rate of about 8% and we consider the market to be very strong. Replacement cost numbers, I don't have right in front of me, but we could certainly get them. Melbourne is a city that is approximately 4 million people that has an office market of about 45 million square feet in the CBD and the vacancy rate is 6.3%.

And I should say by the way, Sydney is when you look at that market, it's primarily the financial industry that drives that economy where in Melbourne, it's a combination of government and financial services. When you go to Perth, Perth is a – it has a population of approximately 1.5 million people, the CBD is 16 million square feet, it has a vacancy rate today of about 7.7%. And the driver in that economy is natural resources, primarily focused on iron ore with oil and gas.

John Guinee – Stifel

And our hard costs and land costs roughly the same as the Midwest?

Ric Clark

No. You know, they're probably owning a little higher. Again, I don't have the exact numbers here, but the rents are higher as well.

John Guinee – Stifel

Okay. Thank you.

Dennis Friedrich

Sir, could I just make a couple comments? Sydney would be like Toronto or New York, Perth would be like Calgary or Houston, and Melbourne is kind of somewhere in between where it has a good combination of financial resources and government tenants. And it also looks most of the superannuation funds, located in Melbourne. Generally, on average, I'm going to say new replacement costs are probably something like $900 a foot. We can get better clarity for that. I don’t think any of those have those numbers bullish here but that's sort of the ballpark.

John Guinee – Stifel

Okay. Great. Thank you.

Dennis Friedrich

Okay.

Operator

Your next question comes from the line of Alex Avery with CIBC.

Alex Avery – CIBC

Can you hear me?

Ric Clark

Yeah. We can actually do.

Alex Avery – CIBC

Hello?

Ric Clark

Yes. Go ahead, Alex, sorry.

Alex Avery – CIBC

Okay. Thank you. Just on the, I guess, slide five in the Australian supplemental, just looking at the 6.7 going in cap rate in the 6% levered FFO yield, that's not, I guess that's on the basis that you just are looking at the 1.4, the yield on the 1.4 billion? That would be the assumption there?

Bryan Davis

That's right, Alex.

Alex Avery – CIBC

Okay. And then, I guess, as you look at funding that, you've noted $750 million subordinated acquisition facility from BAM, is that at a similar rate to the $300 million line that you’ve got? I think that was last quarter at about 4%?

Bryan Davis

Slightly, lower rate, you know, the market, of course, is coming for, you know, corporate sort of credit as you know and so we have got a rate LIBOR plus 300. So we’re closer to the 3.5% rate on that one. But it will be ultimately priced, very similar to when we go through the process of renewing our bank line, something around the range where the market is today, not when we had renewed them back in early – late 2008, early 2009.

Alex Avery – CIBC

Okay. And you've got a lot of transactions going on right now, I guess, Brookfield homes is big or the residential Carma Brookfield Homes. It would be a big sort of question mark there. Presumably, if you had the capital, you would prefer to reduce the indebtedness to BAM?

Ric Clark

Yes.

Alex Avery – CIBC

And on that transaction, I guess, there's been a little bit of discussion about related party in the perception of conflicts of interest, with Brookfield homes and Carma, it sounds like it would seem to present and even greater challenge from that perspective. Can you just talk about maybe some valuation goal posts and perhaps how you plan to manage that process?

Ric Clark

At this point, we can't really – it's early on, so we can't really give valuation metrics. But I would say that it is a similar process to Australia in that the independent committee will have an advisor, it’s actually the same advisor, who will work closely with them on values that are presented by management. And they will, you know, reach their own conclusions. So, but it’s certainly kind of early stages for that.

Alex Avery – CIBC

So, the – I guess, the valuation process, as you were mentioning the Australian run was a standalone valuation process in the case of the residential developments, would it also incorporate, I guess, valuations of Brookfield homes relative to its book valley or relative to what you perceive its value to be, given that you’ll be receiving shares instead of cash?

Ric Clark

Yes, yes. The valuations of these entities would have to be done on a consistent basis. There's work to be done there.

Alex Avery – CIBC

Okay. Thanks a lot.

Operator

Your next question comes from the line of Suzanne Kim with Credit Suisse.

Suzanne Kim – Credit Suisse

Could you provide me – give some more detail about you JV you’re doing with Great Portland?

Ric Clark

Sure. We bought a 50% interest in a development side, 100 Bishopsgate in downtown London. At this point, we are kind of working to finalize the planning on the developments and seeking to find anchor tenants in order to kick off the development. The site will be positioned to proceed with the demolition of what's on the site currently on or around March or April of next year. So, at this point, we're just in the planning and advancement stages and looking to secure anchor tenants.

Suzanne Kim – Credit Suisse

I guess what I'm trying to get at, is there a larger plan that you're trying to get into London? Is it the beginning of a relationship with Great Portland, or do you, take after going to Australia, that you're going to expand in London in a larger way?

Ric Clark

London is a market that we believe there is synergies similar to the Australian synergy with the core strategy and holdings with Brookfield properties. So it is a market that we're committed to growing in and working hard at it. As to whether or not we do more things with Great Portland, I think they're an excellent company, have a great management team and we would be delighted to do more with them. But we're also looking to do things on our own. And at this point, we have nothing really to report as far as things that are eminent, but we've been spending a bunch of time in London looking for things to do we think will be complimentary and accretive to Brookfield.

Suzanne Kim – Credit Suisse

Are there Asian in that cities that you are looking at right now to expand here?

Ric Clark

At the moment.

Suzanne Kim – Credit Suisse

Given to your comment earlier in the call.

Ric Clark

Yeah, I know – Asia is obviously an area of the world that is going to go through very substantial growth and I'm sure there will be the opportunities for firms like ours. At the moment, we don't know much about their market and it isn't a principal area of focus for us.

Suzanne Kim – Credit Suisse

Okay. Great. Thank you.

Operator

The next question comes from the line of Neil Downey with RBC Capital Markets.

Neil Downey – RBC Capital Markets

Hi, all. Good afternoon. Firstly for Bryan, turning back to the Australian assets, you would seem to have implied there's maybe a $10 million straight line rent adjustment between GAAP and cash NOI. Could you further on to that help us think about how we might think about AFFO in terms of normalized tenant inducement leasing costs, non- recoverable CapEx on the $3.4 billion of gross assets?

Bryan Davis

I think you're right as it relates to your estimate on the straight line components and the numbers that we've presented. I don't know if I have in front of me necessarily all the various different things, you know, that would otherwise go into the calculation of AFFO, you know, in the terms of sustaining CapEx. I don't know if Tom can mention it; probably not much different than operating similar properties that we have in the North American market.

Tom Farley

I think the other point is that the agent of this portfolio is, it's a quite young portfolio, it's not very old. And so you know, that's another great compelling factor.

Neil Downey – RBC Capital Markets

Okay. I know it's very early days on the proposal with Brookfield Homes. But presumably, you believe there's the ability to firstly affect them – a merger with your home building and land development business with Brookfield Homes on a tax deferred basis?

Ric Clark

Of course, tax is one of the areas that we will definitely look at with respect to this transaction. Ultimately, when, if the intention is to convert our position into cash, once you do that, you can no longer defer, but at the end of the day we do spend a lot of time insuring that we had sufficient losses within the system, so that we could structure transactions in the most tax efficient manner and will continue to focus on that as it relates to this transaction and the evolution of this transaction.

Neil Downey – RBC Capital Markets

I guess that release will start to go to the next part of my question actually, Bryan. Your equity in the home building business is about a billion one at book today. I think you may have hinted in the past your view or you certainly articulated that that is in effect a historical number. Do you believe that Brookfield Properties can realize net cash, or at least a billion one, even after some potential tax friction, or is that something you simply can't comment on at this point?

Bryan Davis

I'd say it's probably something that's too early to comment on.

Neil Downey – RBC Capital Markets

Okay. Thank you.

Operator

Your next question comes from the line of John Stewart with Green Street Advisors.

John Stewart – Green Street Advisors

Thank you. Ric, can you let us know what percent of par BAM paid for the mezzanine debt? And when you say that they are essentially going essentially transfer the net benefit to you, how does that work, do you buy it from them at their cost? Can you give us some color there?

Ric Clark

So the second part of the question is no mark up on it. BAM was the facilitator. They have debt operations so this is kind of a natural for them. They were kind of in the mix on these kinds of things. As far as what we paid as a percentage of par, I don't think we can disclose that at this point. So hopefully in course of time, we will be able to but there is no mark up there. There is no mark up to bam, is that's what you're asking?

John Stewart – Green Street Advisors

Yeah. That was definitely part of the question, so essentially, BAM gives up half the upside I guess, but Bryan, can you give us any color on the total return swap?

Bryan Davis

As it relates to?

John Stewart – Green Street Advisors

Multiplex.

Bryan Davis

So ultimately the transaction is structured in a manner where we are buying an economic interest in the underlying portfolio – it’s BAM'S entire economic interest. The total return swap is a mechanism that allows us to receive the earnings underlying the properties, as well as any value appreciation or depreciation underlying the properties. I know we put a slide in the package that we had published this morning that attempts to walk through that structure, but it was in position where we make an investment today and we participate in the economics going forward.

John Stewart – Green Street Advisors

Okay. Thanks.

Operator

And your next question comes from the line of Anthony Paolone with J.P. Morgan.

Joe Dazio – J.P. Morgan

This is Joe here with Tony. Sorry, if I missed this earlier, can you walk through as it relates to the Trizec debt and BAM buying at a discount, how that equity quarter-on-quarter equity that was created but then buyer discount was transferred to you guys? Is there any cost that you bear in order to do that?

Ric Clark

There's no additional costs other than the purchase plies for the debt, which I believe is your question. And the debt has not been transferred at this point and it's more for tenant for reasons. I don't want to get into the details on the call, but I think BAM was a great kind of facilitator of what we were trying to do, which was achieve the early deleveraging of, for the, in anticipation of refinancing of this measuring debt.

Joe Dazio – J.P. Morgan

All right. Thank you.

Ric Clark

You're welcome.

Operator

Your next question comes from the line of Jim Sullivan with Cowen and Company.

James Sullivan – Cowen and Company

Thank you. I wanted to follow up on the issue of the Australian lease profiles and particularly, the focus on the issue – so called fixed rents review. This is not in the nature of fixed steps, I believe. Is this something where the rents is actually reviewed and increased every year based on a variety of stated contingencies and simply average 4% over time?

Ric Clark

No. In fact, it's an automatic escalator. And certainly leases may have a subsequent mark to market partway through their least that would be depend on the variables of that time, but generally 85% of the portfolio is an average 4% automatic escalator.

James Sullivan – Cowen and Company

Okay. So that's essentially the driver of the straight line number?

Ric Clark

Yes.

James Sullivan – Cowen and Company

Okay. So when we talk about the FFO yield, that FFO yield includes that straight line accrual?

Ric Clark

Yes.

James Sullivan – Cowen and Company

Okay. And the mark to market I think currently per the hand out, I think was about 6 or 7%? Is that right?

Ric Clark

Mark to…

James Sullivan – Cowen and Company

In near terms of – I think it indicated in the handout a mark to market of roughly 6, but I think a $3 difference per foot, I want to say. I was just trying to calculate the role, the positive impact on the growth rates for the roll, 10% of the leases roll into the next two years and in place, it's about, no, sorry, 6% below market, right?

Ric Clark

Right. Correct.

James Sullivan – Cowen and Company

Okay. Okay. Shifting to New York, the downtown market, in your prepared comments, I think the bottom line was 90% of the 4. 6 million square feet in various stages of activity and I think the summary language talks about a combination of new and existing and also made reference to the possibility of some tenants who were currently based in mid-town moving downtown. I just wanted to make sure to the extent you're including existing tenants in that 90% number. Is that by that, do you mean tenants who are existing subtenants of Maryland and the same space?

Ric Clark

Yes.

Bryan Davis

Yes.

James Sullivan – Cowen and Company

Okay. Very good. Thank you.

Ric Clark

You're welcome.

Operator

Your next question comes from Sam Damiani with TD Newcrest.

Sam Damiani – TD Newcrest

Thank you. Just on the mezz loan discounts, that benefit being transferred to Brookfield, what is BAM getting in return for giving that up?

Ric Clark

Nothing. They are getting the benefit of their 50% investment through the ownership on properties, basically.

Sam Damiani – TD Newcrest

Other 50%, they are just giving it up or they are asking in return?

Ric Clark

No. No.

Sam Damiani – TD Newcrest

That's totally independent of any sort of negotiations on the Carma sale?

Ric Clark

Maybe kind of put a little light around it, as you can imagine when you do financing, the borrower is not typically committed to buy back the debt. So hopefully that explains it. We weren't permitted to buy it. Properties was not permitted to buy.

Sam Damiani – TD Newcrest

But did you effectively lend BAM the money to buy it for you then or?

Ric Clark

In effect, yeah.

Sam Damiani – TD Newcrest

So when do you think that loan will be transferred?

Ric Clark

Whenever we wrap up the refinancing.

Sam Damiani – TD Newcrest

Anytime within the next 12 months basically.

Ric Clark

Between now and October, 2011 is the expectation.

Sam Damiani – TD Newcrest

Thank you.

Ric Clark

Okay. Thank you.

Operator

Your next question comes from the line of Shant Poladian with Canaccord Genuity.

Shant Poladian – Canaccord Genuity

Hello?

Ric Clark

Yes, Shant.

Shant Poladian – Canaccord Genuity

With respect to that debt on the Australian, there's only 2. 5 years with the term. If you guys, you can access that multiple market, obviously, you can get debt cheaper in Canada or you can do press and you can do currency swap. How should we think about this debt in a couple years?

Bryan Davis

This is Bryan. Again, we don't, we always say we don't have a crystal ball ahead of us, but that's one of the things we think about, who knows ultimately what the Australian market looks like from across the capital perspective going two years out, but as we think through the refi of this underlying debt, we are definitely thing through some of the other synergies that we may get from this transaction that may involve the right side of the balance sheet and whether or not we can access capital in other sources against that same security at a cheaper rate.

Shant Poladian – Canaccord Genuity

What kind of levered are you thinking about this investment over your time horizon?

Bryan Davis

I think over a ten year time horizon at a minimum, it should be – in keeping with our overall goal of delivering something like a low teen return to investors, so I think at a minimum of that but possibly better.

Shant Poladian – Canaccord Genuity

So basically looking at a negative spread on debt, one that is really missing the point, right?

Bryan Davis

Yeah.

Shant Poladian – Canaccord Genuity

Okay. Thanks a lot.

Bryan Davis

Yeah.

Operator

Your next question comes super the line of Michael Bilerman with Citi.

Michael Bilerman – Citi

Just a follow-up. Somebody else – They don’t buy property fund which is Morgan Stanley. How do that conflict also in terms of managing that process.

Ric Clark

Michael, it's just a fortunate coincidence they have similar names. It's actually not Morgan Stanley. It's a publicly listed vehicle of which the former multiplex group owned the majority of it. And I don't know if I have that percentage of funding. But it has nothing to do with Morgan Stanley.

Michael Bilerman – Citi

Okay.

Ric Clark

We bought BAM’s interest in that.

Michael Bilerman – Citi

Okay. And then typically when companies make large acquisitions, you start talking about how it will impact the numbers, accretion or delusion, I'm just curious, I know there's still a lot of things to get done. But on the surface, these or when you take all the transactions together which seems to be a pretty dilutive event, just given the FFO yield on and the assets you’re buying the high FFO yield of the assets you're planning to sell and likely still financing that you need to get in place. So how should we be thinking about how all this nets down to ultimately your earnings profile?

Bryan Davis

I think the goal is to redeploy capital that's being generated at lower cap rates, at about the same or lower cap rates than what the initial cap rate is for the Australian assets for one. For two, when it comes to redeploying capital that we take out of the residential division, there's no question that will be dilutive and expectation and we focus that the multiples that are given to the earning is coming out of the residential division, are very meaningful less than the more pure and consistent in Trizec you would get from an office asset. So that's how we're thinking about it.

And we think, just assuming for a second, hypothetically, that we are generating capital at 6.7 cap rate and reinvesting at 6.7 cap rate. Our view is that the upside in Australia, at least over the next decade is great and that can be achieved in the North American market.

Michael Bilerman – Citi

And then, one of the things you have in your presentation is that by doing this total return swap, you'll be able to benefit the property financing or you can transfer this portfolio to future dates and to different ownership entity, either through a public or private fund. And I guess lower your stake which obviously, now you're going to use the Toronto, the Canadian subsidiary that equity in there to be able to provide this. I guess, as you sit back, what do you want to do when you grow up in terms of Brookfield Properties? What, how do you envision the ownership of assets and in the relatively geography, what relative do you want to own?

Ric Clark

Just, looking back to the last decade, we've not at all been a static organization. The company, although it's been around since the early, or late 20s, I think, in its current form since probably the late '90s, or mid-90s has gone. The amalgamation of 7 portfolio acquisitions and we're constantly kind of rethinking the strategy and the direction. At the moment, what we envision is owning the or one of the highest qualities collection of office assets and most important developed countries in the world and those been Canada, U.S. , Australia and ultimately United Kingdom, but not in every market, not the ELP [ph] strategy where you want to be all things to all people, but focused on the best, most dynamic and resilient markets within those countries and it would be, again. I think that’s basically it.

Michael Bilerman – Citi

And then just the last one, just in terms of this mezz debt purchase. You, obviously within the fund have other partners, other capital partner that you have but there’s also Blackstone. How does – when you talk about the $570 million, is this the $570 million converting to effective equity so that you are putting all those capital, you are able to get at some discount, effectively the 570 converse to equity in which your ownership stake is going out? And how does it also affect your other partners, both your partners in the fund but also Blackstone’s involvement?

Ric Clark

As far as how it will affect the other partners, I suppose all the details with that have not yet been worked out. But it won’t really be meaningful from an economic standpoint to Brookfield Properties I think it’s an important point to make. And I think works could add.

Bryan Davis

Michael, we are looking it as an ultimately conversion and deleveraging of the U.S. fund, it’s often and the $4.1 billion of existing debt, sub against that fund.

Michael Bilerman – Citi

So you are viewing it is all equities, you’re putting in. So you’re effectively paining something in its name, some discounts for the 600s, so you’re putting another 600. When we think about sources and leases, you have another use of capital somewhere up to $570 million of equity that you are injecting into the fund that you have to raise somewhere else.

Ric Clark

I don’t think we are saying that Michael.

Michael Bilerman – Citi

Well, the debt was brought at a discount by Sam.

Ric Clark

Right.

Michael Bilerman – Citi

Right. And now they are transferring that debt and you are paying them for that debt but who’s getting the equity. Someone has to become, someone has to be taking some ownerships stake in the portfolio if someone’s buying debt and I’m just wondering who that is, is that property taking a bigger stake in the fund by converting debt equity or is BAM taking a stake in the fund as an equity?

Ric Clark

No. I would view it as property. Its properties pro rata share of deleveraging in the fund.

Michael Bilerman – Citi

The U.S. fund.

Ric Clark

Yeah. So there is an incremental and some of the details still need to be worked out, but I would just look at this if there’s no incremental retching up and equity interest in the fund, it’s just simply a – And it’s possible we’ve over funded and we won’t really know unit we finish our work on refinancing which is underway now but it’s possible that we will get money back, once the refinancing is done.

Michael Bilerman – Citi

So you are coming out of pocket for money? This is when it all comes down to this.

Ric Clark

Yes. Yeah. That is towards equity in the deleverage.

Bryan Davis

The other important point is if that’s not – we’ve already included that in a $1.3 billion of liquidity that we’ve been referencing, as it relates to the liquidity position of Brookfield Properties going forward.

Michael Bilerman – Citi

Okay. Thank you.

Operator

Your next question comes from line of Ross Nussbaum with UBS.

Ross Nussbaum – UBS

Hi. My answer is also been answered. Thank you.

Operator

Your next question is from the line of Mario Saric with Scotia Capital.

Mario Saric – Scotia Capital

Last question on top liquidity. First all of the transactions – a majority of liquidity that you build up over the past 12 months would have been absorbed at point in time. How do you look at – I guess your liquidity on a pro forma basis as well as your leverage at this point in time in the cycle? Are you comfortable with it or what are the thoughts there?

Bryan Davis

Ric, maybe I can address it. I think, we’re very comfortable with our leverage levels as we sit today. You know, a good share of the liquidities that we raised, has been deployed, either through our investment in Bishopsgate, what we have been talking about with respect to the debt in the fund and with respect to the transaction but we still have liquidity, we still have our un – full on drawn bank lines, we also have the ability to refinance the number of assets that are coming due over the balance of this year and into next year that are at loan-to-value level in and around the 30% range.

So I think we feel very good about our balance sheet in our liquidity position going forward as well as the leverage level that we currently sit at, taking into accounts that the big thing that influences our leverage is, of course, the U.S. office fund and we’re expecting as we talked about that this will represent the develeraging of debt until the U.S. office fund went ultimately met that roads in 2011.

Mario Saric – Scotia Capital

And everything we started within U.S. office, does that impact your ability to sell office from that fund versus, let say four months ago?

Ric Clark

In terms of the deferred of the mezzanine list, is that.

Mario Saric – Scotia Capital

Yeah. Just purchases higher than that as well as any restructuring that you’ve potentially done?

Ric Clark

Some of the restructuring will help asset sales but I think generally in the office with anything, we’re just – our view on asset sales would be some in the right assets for the right part.

Mario Saric – Scotia Capital

Okay. Thank you.

Operator

Your next question comes from the line of Neil Downey with RBC Capital Markets.

Neil Downey – RBC Capital Markets

Brilliant transaction, Bryan, does that put 3.4 billion of assets and 2 billion of debt on your balance sheet or is it a one-line item given to let say total return swap?

Bryan Davis

It is 3.4 billion of assets and 2 billion of debt as we expect. You, in part, you know it’s control over assets which is the measured test under IFRS. You know, we have management and economics which effectively equal control.

So having said that and as you would have noticed, we did put out the proportionate set of financial statements so even if it was one-line time, we would have definitely showed you what our financial statements would look like on a proportionate basis?

Neil Downey – RBC Capital Markets

Okay. Thank you.

Operator

Our next question comes from the line of Sam Damiani with TD Newcrest.

Sam Damiani – TD Newcrest

Thank you. Just want to clarify the yield there, the city square property in parts of the development assets earning, no yield today. I guess, it totals 6.7 cap and 6% FFO yield that strips out, that investment, I believe, is 3.4 billion. Is that right?

Ric Clark

Correct. But it assumes that the equity that we have invested in city squares resulted in this transaction. We got the ability to capitalize interest associated with that.

Sam Damiani – TD Newcrest

I see. Okay. And so that’s another $100 million asset. I think you’ve mentioned earlier. Is that money been spent? Are you buying it at fully completed cost?

Ric Clark

It is in the process of being spent. The equity has been fully committed. There is a construction facility in place that will fund the balance of the construction cost until completion, I think in 2011 or thereabout.

Sam Damiani – TD Newcrest

So how much debt does that bring you out from starting – when you’re starting with 2 billion, how much more will be on balance sheet when that building is completed?

Ric Clark

So 500 million

Sam Damiani – TD Newcrest

500 million is the total cost and this is really $3.9 million.

Ric Clark

Hold on. Let me get back to you on that. I have to check to make sure we didn’t perform the full debt level into the 2 billion. We may have done that. So let me get back to you on that.

Sam Damiani – TD Newcrest

Okay. That will be great. And then just the yield on that development, I mean through 900 buck plus foot, I guess, is what I’m seeing here and the market rent seem to be under $45 dollar range based on your disclosure. So that is just the stabilized yield to be around 5%.

Ric Clark

I think that has been higher than that.

Bryan Davis

Yeah.

Ric Clark

This would be – this property would be the newest and probably, likely one of the best, if not the best asset in the portfolio. So the yield is going to be a bit lower than the yields in the rest of the properties but I think it’s a little higher than that.

Sam Damiani – TD Newcrest

Like how much, Ric, is it sub-six asset or up 5.5 stellar?

Ric Clark

No. I don’t think it is. I think it’s – give me a second.

Brian

And while Ric is looking, Sam, I confirm that the debt number that we provided on page five pro forma is in the full debt that will be answer these questions.

Sam Damiani – TD Newcrest

And so that money has been spent or you got to start with the lower debt amount and that’s going to creep up to that level.

Ric Clark

Yes. It creeps up, yes. Sam, you know, unfortunately I thought I had it but I don’t.

Sam Damiani – TD Newcrest

No risk.

Ric Clark

So I have to get back to you on it.

Sam Damiani – TD Newcrest

Great. Thank you.

Operator

The next question comes from the line of Jimmy Shan with National Bank Financial.

Jimmy Shan – National Bank Financial

Just a couple of quick clarification. In terms of the liquidity position, after all these transaction are affected including the sales of the resi business, I mean, you still going to have about a billion dollars of to be deployed. Is that a fair estimate?

Ric Clark

Yeah. You know, as we sort of look out into 2011 and build in the various different capital initiatives that we are focused on whether it’s refinancing of under levered properties that are coming due in the next little while. When you take that into account with the existing capacities that we have within our bank lines, that’s probably a fair number.

Jimmy Shan – National Bank Financial

Okay. And other than 1.3 billion of liquidity you referenced on slide five, you mentioned 300 million of that is from credit facility. Is that in some form of cash for full-term investment?

Ric Clark

No, no. So of the 1.3 billion round up to about 800 million that relates to credit and the balance is cash, sort of, liquid cash whether it’s deposit or cash, just cash on our balance sheet.

Jimmy Shan – National Bank Financial

Okay. And then last question, I think, Ric, you made reference to BAMS may be worsened. So should we assume that the transaction is sort of out of the question, given through the management structure of that business?

Ric Clark

I wouldn’t make that assumption. Not necessarily, other question, just, I think given our overall liquidity in (inaudible) Mountain in Australia and I think the opportunity. This was the logical thing to do now, now, whether or not we do something with them or the U.K. I think it just requires further thought and it seems we need to think about it.

Jimmy Shan – National Bank Financial

Thanks.

Operator

The next question comes from the line of Suzanne Kim with Credit Suisse.

Suzanne Kim – Credit Suisse

Hi. I apologize if you’ve already addressed this question earlier but I’m just wondering how all of the shuffling is going to impact your guidance? Assuming what you do to spin off the residential portfolio?

Bryan Davis

You know, I think, one of the things that we had alluded to is transaction as it relates to the residential portfolio, likely won’t be effective until towards the end of the year, not early next year. So and we haven’t come out with 2011 guidance just yet. So as it relates to 2010 guidance, depending on sort of the close of this transaction. It’s not going to have that meaningful impact.

Suzanne Kim – Credit Suisse

Okay. But in terms of all the other transactions, you’re maintaining your guidance for the year then through your first guidance.

Bryan Davis

Yes, yes. I mean, you know, the one big reconciling item is it our IFRS guidance didn’t include the 53 million or $0.10 gain that we were able to earn on the investment in the debt underlying the Washington portfolio. So whether you stripped that out or you keep that in, you have to just bear that in mind.

Suzanne Kim – Credit Suisse

Great. Thanks.

Operator

And at this time, there are no further questions.

Ric Clark

Thank you, operator. I just would wrap up by responding to Sam’s question earlier, in the initial year, the yield on the city square transaction is in the six or so, probably mid sixes and have your prime authority on that. So anybody who wants it later, we obviously ran over our 12 o’clock hard stop, that given the level of questions, we felt that it’s appropriate and if anybody has any additional questions that they like, press the follow-up line, we’d be please to do that. So thanks for your participation today.

Operator

This concludes today's conference. You may now disconnect.

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Source: Brookfield Properties Corporation Q2 2010 Earnings Call Transcript
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