GGP Final Analysis: Fire Sale of Prime Properties

Summary

As of late, credit markets have become dysfunctional, or put more accurately, “functional” in the prudent pricing of risk in the wake of losses incurred by financial institutions and lenders owing to the OPM (other people’s money) methodology of writing loans destined for sale through market securitization. The resultant problem of ‘shrinking liquidity’ is aggravating the operations, to say the least, of many real asset and related financial concerns. In particular, this has considerably impacted the ability of commercial real estate companies including General Growth Properties (GGP), which has huge debt obligations payable in next few years, to refinance its loans and capital expenditure [capex] requirements.

In the event of GGP not being able to meet the requisite financing/refinancing needs as we have forecast, it is likely to find itself faced with either of the following two options – 'foreclose some of their existing loans’ or “sell few of their unencumbered properties”. Last Friday we had discussed the impact of foreclosure and sale of some of its properties on GGP’s valuation. We are now presenting our analysis on its valuation in case GGP elects to only sell some of its unencumbered properties – the ‘sale of properties’ scenario.

GGP’s Valuation Summary

In our base case scenario (without assuming sale or foreclosure), we arrived at GGP’s valuation of approximately $6.9 bn or $28.4 per share (under the CFAT approach – please refer table below). Our underlying assumption in the above valuation was that GGP would be able to arrange the requisite financing for its loan repayment and capex requirements.

However, considering the tight liquidity condition in the current capital market scenario, GGP might have to sell some of its prime and unencumbered properties. Accordingly, we have assumed that GGP would sell its properties to arrange for $1.2 bn and $1.5 bn, respectively, in 2008 and 2009, representing approximately 30% of its total refinancing needs in these years. We expect GGP to sell these properties at a significant discount to their current valuation (arrived at using net present value approach) due to subdued demand for commercial real estate amid a liquidity crunch in the credit market.

Additionally, we expect GGP to postpone its re-development and new development plans, which would put a strain on the GGP’s future revenue streams. Incorporating the above assumptions, we expect GGP’s valuation under ‘sale of properties’ scenario of $6.0 bn, translating into a per share value of $24.5. This represents a downside risk of 38.7% from the current market price of $40 (as of February 1, 2008).

GGP’s valuation comparison under ‘base case’ and ‘sale of properties’

Under our ‘foreclosure and sale’ scenario, we expect GGP to foreclose approximately 6% of its property portfolio which would reduce GGP’s re-payment obligations by nearly 20% each in 2008 and 2009, to $2.0 bn and $2.6 bn, respectively. In addition, we expect GGP to sell some of its unencumbered properties and curtail capital improvement requirements. Consequently, the assumed foreclosure and sale of properties together with estimated curtailment in capital expenditure would bring down GGP’s total financing needs by 50% and 42% in 2008 and 2009, respectively, to $2.7 bn and $2.4 bn.

However as a result of foreclosure, GGP’s credit standing would take a severe beating. Consequentially, increased penalties in the form of increased cost of financing and additional difficulty in raising finance for future projects would restrain GGP from foreclosing its mortgaged properties. Also, since re-financing and maintaining credit standing is one of the prime business drivers for REIT’s, unless the situation aggravates steeply from here, GGP may opt not to go the foreclosure route.

Since both the scenarios - ‘base case scenario’ (without assuming sale or foreclosure) with entire debt re-financed through additional loans and ‘foreclosure and sale’ – may seem extreme (the first being too optimistic and the other being too pessimistic), we believe that GGP might alternatively sell a few of its unencumbered properties to partly meet its re-financing requirements. We expect GGP to re-finance approx. 30% of its re-financing needs each in 2008 and 2009 through sale proceeds of $1.2 bn and $1.5 bn from properties.

In addition, we expect GGP to reduce its capital expenditure towards re-developments and new developments by 50% and 70% to $0.8 bn and $0.20 bn in 2008 and 2009, respectively. As a result of sale and reduction in capital expenditure, we expect GGP to reduce its financing requirements by 36% and 34% in 2008 and 2009, respectively to $3.5 bn and $3.7 bn.

We have identified the following properties which would enable the company to meet the above re-financing needs.

click to enlarge

We expect GGP to realize approximately $2.7 bn from the sale of above mentioned properties (in 2008 and 2009), having a book value of $2.0 bn. As a result of the above sale, GGP is expected to record profit of $0.7 bn over the next couple of years. Although GGP would be able to record gain on sale for the above transaction, it would actually drag down the company’s valuation as the current valuation (arrived at using net present value approach) of these properties is noticeably higher than the sale proceeds (see table above). This assumption is based on the hypothesis that GGP would be able to sell these properties only at a discount (15% assumed by us), due to fewer buyers for commercial real estate properties in a down trending market with diminishing liquidity – basically, the typical buyer’s market. In addition, we have assumed 8% cost on sale of transaction.

click to enlarge

Valuation Based on Various Earnings Measurement

GGP’s portfolio analysis

Based on our estimates of property values and rental growth, approximately 19% of GGP’s properties have cap rates greater than 10%, while more than 51% of the its portfolio has cap rates below 4.5% (in nearly 25% cases the cap rates are even less than the current U.S treasury rate). Most of these properties with low cap rates were purchased during 2003-2007 when the property prices were high and credit to finance these purchases easily available.

As property values have declined significantly since then, many of these properties are currently sporting negative equity with their LTVs rising above 100%. We believe that these are the properties that are most vulnerable to foreclosure in case GGP is not able to meet its re-financing requirements in 2008 and 2009 (a distinct and likely possibility).

click to enlarge

GGP’s properties purchased over the last 3-4 years have lower cap rates (3-4%) owing to higher purchased price. In addition, these properties were purchased with a significant amount of debt. As a result of recent decline in rentals and property prices, properties purchased with high leverage have negative equity which continues to drive down company’s overall valuation. As seen from the table above, around 45% and 26% of properties (these properties were acquired in 2007 and 2004) have negative equity as against only 2-5% properties acquired during 1990’s and early 2000.

GGP’s financing options

As of September 30, 2007, GGP had a total mortgage debt of around $24 bn. GGP’s net investment in real estate on its books (at gross value after adding back depreciation) on that day stood at $26.6 bn, while its shareholder’s equity was $1.5 bn. GGP is one of the most highly leveraged REITs in U.S with debt-to-assets of 84.4%.

Besides being highly leveraged, GGP has a significant portion of its debt due for maturity over the next few years. Nearly $5.9 bn or 24.7% of GGP’s total debt is due for maturity over 2007-2009, while by 2011, a significant 74% of the company’s outstanding debt is due for maturity. By the end of 2007, GGP was able to refinance only 6.1% (or $359 mn) of debt due to mature over 2008-2009.

However, as the company approaches the period of its next debt maturity date, the task of refinancing could only be expected to get more difficult in context of continually tightening credit market conditions. The threat of monoline failures, combined with significant asset write downs by banks and real estate companies aggravated by sharp declines in housing demand and prices, together with an increase in defaults and foreclosures, have created one of the tightest lending environments in the recent history. An environment that will be even tighter for those considerably above average risk, as we see GGP!

Faced with tough times of arranging refinancing and amid high expectations of further deterioration in the credit and capital market conditions, at least in the near term, we believe GGP, though reluctantly, might have to opt to foreclose some of its highly leveraged properties to meet its debt obligations in order to preserve its other income-generating properties.

click to enlarge

As a result of the assumed foreclosure of $4.8 bn worth of loans in 2008 and the assumed sale of $2.7 bn worth of properties in 2008 and 2009, we believe that GGP would be left with approximately $2.7 bn and $2.4 bn of financing needs in 2008 and 2009, respectively, out of which $1.9 bn and $2.2 bn is related to re-financing debt repayments while $0.8 bn and $0.20 bn in 2008 and 2009, respectively, is related to capital improvements.

Comments

[300mph:]

Very thorough analysis.

2008 Feb 07 05:56 PM

[granger:]

Great analysis. Truly good stuff, thank you. i have holding a Long Ddr Short Ggp position.

2008 Feb 07 06:05 PM

[tazman:]

reggie,

I can't wait for GGP to prove you wrong and make you eat your words. Do you have a short position in GGP or long positions with other REITS? You seem to have made it your personal mission to try and malign GGP. They have never defaulted on a loan, nor have they ever had to sell properties to meet their financial obligationsm, and I don't think they ever will even with the current market conditions. They will be announcing their 4th quarter results next week which I think will start the process of showing just how little you know. Maybe I will send you some ketchup to help you eat those words.

2008 Feb 08 10:52 AM

[tazman:]

Reggie, Let's see... 5.1% comp NOI growth, double digit core FFO growth, record occupancy, sales PSF growth, strong leasing results already in 2008.... sure seems the kiss of death to me, and a company that is going to implode? I think I will send that ketchup to you now.

2008 Feb 13 10:22 AM