Investment Thesis
Investors of Brookfield Property Partners L.P. (NASDAQ:BPY) and Brookfield Property REIT Inc. (BPR) have seen shares slide over the last 12 months, pushing down prices and increasing the company's distribution yield. Since hitting a low of ~USD$15 in December 2018, units have rebounded over 20%. With a current yield of just under 7%, the current entry point still looks very attractive. The distribution is not only safe and well covered, but expected to grow by 5-8% annually. Concerns over debt levels and geopolitical exposure such as the impact of Brexit are overdone. While the stock has rebounded, it remains undervalued, currently trading at a 37% discount to NAV. Medium-term investors can still anticipate a strong total return and enjoy a growing distribution while they wait.
Company Profile
Brookfield Property Partners is the property investment arm of its parent Brookfield Asset Management (BAM), which, as the majority shareholder, owns 53% of BPY. Brookfield Property Partners owns, operates, and develops: office, retail, multifamily and alternative real estate assets. BPY owns a high quality diversified asset mix, which includes 42% retail, 41% office and 17% limited partnerships in a variety of assets, including storage units, multifamily, student housing, and hospitality properties. Brookfield's properties are geographically diversified with assets in North America, South America, Europe, Asia, Middle East and Australia. Since its launch in 2013, the firm's total assets have almost tripled to USD$90B.
Source: Brookfield Investor Day Presentation
Corporate Structure - BPY & BPR
The Brookfield family of companies is famous for having a complicated corporate structure. Not only are its firms domiciled in different countries, it utilizes limited partnerships and subsidiaries throughout its organization. Brookfield Asset Management is the top level investment entity where management maintains high ownership. Under this umbrella, Brookfield has a partial ownership in a number of publicly traded limited partnerships with focuses in infrastructure, Brookfield Infrastructure Partners (BIP); renewable power, Brookfield Renewable Partners (BEP); real estate, Brookfield Property Partners; and private equity, Brookfield Business Partners (BBU).
Source: Brookfield Asset Management
Brookfield Property Partners, Brookfield's real estate division, trades on the NASDAQ, and under BPY.UN on the TSX. As BPY is domiciled in Bermuda for tax purposes, the units do not come with voting rights. In order to remedy the investor concerns about the drawbacks of the limited partnership structure and to allow for this business to be included in equity indexes that typically exclude LPs, Brookfield created Brookfield Property REIT Inc. (BPR), a Real Estate Investment Trust domiciled in Delaware. For all intents and purposes, the vehicles are equivalent, with shares of BPR exchangeable for units of BPY at a one for one ratio. BPY owns ~75% of BPR shares, and investors in both receive identical distributions. While this structure was designed to allow retail investors the opportunity to participate in the same class of investment opportunity as Brookfield's institutional investors, the complexity of the structure has no doubt been a contributing factor to the current discount to NAV where BPY trades.
Source: Brookfield Property Partners Corporate Profile
High Quality Assets
Across all of Brookfield's business segments, the company focuses on high-quality assets, Brookfield's real estate holdings are no exception. The company has focused on developing and acquiring high quality office and retail properties in the world's most important economic centres. According to Forbes, Brookfield "quietly owns entire skylines in places like Toronto and Sydney". In Europe, BPY owns two of the largest and most iconic assets on the continent; Potsdamer Platz in Berlin and Canary Wharf in London. Brookfield Property Partners owns some of the best real estate assets in New York and is the largest office landlord in London and Los Angeles.
Source: Brookfield Investor Presentation
Brookfield places an emphasis on acquiring assets where it thinks it can improve value by adding its expertise in management or improvement. This theme is especially important in Brookfield's retail business, where it has been buying high quality but underperforming mall assets to redevelop and densifying. These high quality assets are in good locations and have valuable land that often presents other development opportunities. One example of this is the Ala Moana Centre mall, where Brookfield realized 9.6% and 6.9% yield on cost in successive redevelopment phases. These underperforming assets can sometimes be picked up for below their fair value, enabling BPY to earn a healthy internal rate of return on redevelopment and densification projects.
Source: Brookfield Investor Presentation
Performance Record
Since its launch in 2013, Brookfield Property Partners has grown cash flow from operations (CFFO) at a compound annual rate of 9%. In the first three quarters of 2018, FFO increased from $731M to $763M, a 4.4% increase over the same period in 2017. While FFO in the LP and retail segments grew, performance in the core office division declined slightly. Brookfield has achieved positive results in its office property segment where committed occupancy in office properties grew to 92.9% in Q3 2018, up 1.1% over the same period in the previous year. On the retail side, with the full integration of GGP properties achieved in 2018, Brookfield posted occupancy of 95.6% in its retail division for Q3 2018. In the same period, BPY grew its weighted lease revenue per sq. ft. by 5% over the previous year. Overall operating performance across BPY's core businesses continue to be healthy, suggesting that pressure on the unit price in 2018 was the result of debt concerns or external risk and not operating performance.
Source: Brookfield Investor Presentation
Growth Opportunities
Brookfield Property Partners has an exciting project development pipeline, with major assets under development in: London, Dubai, Manhattan, Washington D.C. and Los Angeles. These projects represent 3,500 apartment units and an additional 5.6 million sq. ft. of premier office space. In the next few years, same property growth is forecasted to be 2-3%, while other growth will be achieved through development. Over the next 4 years, Brookfield expects to grow cash flow to the point where it can redirect $1.1B annually into maintenance and development. While BPY expects that core office property to contribute a greater share of growth than retail or multifamily, Brookfield's LPs are expected to contribute an average of USD$500M annually.
Source: Brookfield Property Partners Corporate Profile
In addition to its project development pipeline of retail and office properties, Brookfield Property Partners is well positioned to benefit from a number of secular tailwinds, including population and consumer trends in the multifamily segment. Increasing urbanization and the densification of major cities where BPY owns assets are positive for rents and demand. Likewise, a decrease in home ownership rates in the United States and increased economic pressure to rent versus own, supporting pricing power for BPY's growing residential and multi-family L.P.'s. In the U.S., high rates of people under 25 years of age living with parents/family and carrying record student debt burdens has ensured that 100% of new apartment unit inventory that has hit the market in the last 7 years has been absorbed. These are positive trends for BPY's current portfolio of ~35,000 multifamily units and its current development pipeline of 14,000 units. Brookfield's strategy is to build in supply constrained housing markets that have high barriers to entry. With these tailwinds and a high quality development pipeline, the multifamily segment will continue to grow in importance as a portion of revenue for Brookfield Property Partners.
Compelling Valuation
In its recent investor day presentation, Brookfield Property Partners CEO, Brian Kingston talked about the firm's current price being near a 30% discount to NAV based on consensus estimates. Given that BPY is part of the sprawling conglomerate that is the Brookfield family of companies, it likely warrants some conglomerate discount. The rate of discount that should apply to a conglomerate is up for debate, but few would argue that it should be as deep as it currently is. Rob Lauzon, deputy chief investment officer at Middlefield Capital suggests that the discount to NAV should be approximately 10%. With a NAV of ~USD$29, a 10% discount would imply a fair value of ~USD$26.10. With Brookfield's current price of ~USD$18.60, using a fair value price of USD$26.10 would suggest that units of BPY are trading at a discount of almost 40%.
In addition to quantitative measures, consensus on the unit price is positive. Morningstar assigns BPY a 4 star rating and maintains that it is undervalued. Reuters lists the analyst consensus as a buy and Yahoo Finance shows a one-year analyst price target of USD$22.06, suggesting a ~19% upside. Although BPY has ample upside, its price will likely be capped by NAV. Due to Brookfield Property Partners' structure, complexity and leverage, I don't see units of BPY trading at a multiple that would see the unit price exceed NAV.
Source: Reuters
Source: Yahoo Finance
Another indication that BPY is currently undervalued is that parent company Brookfield Asset Management has been buying shares of BPY on the open market. In 2018, BAM purchased USD$200M in BPY at what the parent company sees as a $10 discount per unit. When compared to BPYs 5-year average, its current valuation is a 14% discount to its long-term book value and a 59% discount to its price/cash flow.
Data Source: Morningstar, Table Source: Author
Growing Distribution
With a current yield of ~6.8%, Brookfield Property Partners' distribution is currently 26% higher than its average yield over the last 5 years; another indicator that the company is currently undervalued. Over the last 5 years, Brookfield Property Partners has grown its distribution at a compound annual rate of 6% while reducing its payout ratio from 90% of CFFO to its target of 80%. Brookfield Property Partners has a stated target of growing its distribution between 5% and 8% annually. Brookfield maintains a CFFO growth forecast of between 7% and 9% annually to cover its distribution and to provide funds for reinvestment and development. Since the launch of BPY in 2013, the company has achieved 9% CAGR in CFFO, topping out its goal of 7-9% annual growth. Greg Newman, Director & Portfolio Manager at Scotia Wealth Management forecasts 9% AFFO Growth in 2019 providing ample coverage for BPY's growing distribution.
The Impact of Brexit is Overdone
One common risk cited for BPY is the potential negative impact of Brexit on the firm's London real estate portfolio. The fear is that with the UK's future uncertain, global companies may not be willing to enter into long term leases in Brookfield's London real estate. London is one of Brookfield's most important markets, accounting for 15.9% of revenue in Q3 2018. It is my opinion that Brexit fears are largely overdone. London will continue to be a financial capital regardless of Brexit. As an English language capital with a central geographic location, London will continue to be a key commerce hub.
While Brookfield has taken measures to mitigate the risk of Brexit such as a hedging strategy and currency sales dating back to 2016, London real estate seems to be doing fine. Real estate prices in London for major high-quality office properties are at least 30% higher than pre-Brexit. Although revenue from Brookfield's London portfolio is flat year over year, occupancy has actually increased; up 40bp from its 5 quarter average to 96.5%. For Brookfield Property Partners' London properties, the average remaining lease term is over 10 years, among the highest in Brookfield's portfolio. Strong occupancy and long leases attract quality tenants to Brookfield's quality properties.
Brexit Opportunities
Ever the contrarians, Brookfield has approached Brexit with an eye for opportunities in the real estate market. Although the Brexit concerns for BPY center on Brookfield's assets in London's financial district, BPY owns other properties that may actually stand to gain in the event of a hard Brexit. The Financial Post reports that properties in Brookfield's U.K. portfolio, such as Center Parcs U.K. Group Ltd., a family resort, and Brookfield's student housing assets could benefit from the UK's exit from the EU. With the British pound being the most important casualty of Brexit thus far, the lower currency may attract more foreign visitors and help diversify these businesses from their primarily domestic orientation.
Source: Brookfield
On Dec. 10, 2018, the BBC reported that the pound had dropped to its lowest level in 20 months. Earlier in 2018 amid a declining UK currency, Brookfield announced they had acquired a portfolio of 15 student housing properties in the UK for US$ 752M. Knight Frank, a global real estate consultancy reports that the majority of growth in university student applications in the UK comes from international students outside of the UK, making the student housing industry well positioned to benefit from a lower pound.
Source: Macrotrends
Debt Concerns
At its recent investor day, BPY reported plans to reduce its debt to a target ratio of 50% debt to capital. Its current debt burden represents a pro forma debt to EBITDA ratio of 12.6X, well above its target of 10.5X. In order to achieve this target, BPY will need to focus on increasing capitalization more so than reducing debt. This capitalization will be achieved by converting capital securities into units of BPY, paying down debt and completing its current pipeline of development projects. There is no doubt that higher-than-desired debt levels have weighed on the unit price of BPY. One compounding issue of this low unit price is that it does not allow BPY to raise capital in the equity markets at a reasonable price. In its Q3 2018 earnings call, Brian Kingston, CEO of Brookfield Property Partners Limited, maintains that new equity is not required for the firm to achieve their current business plan, but it is an area that the company intends to focus on.
Investor Takeaways
Brookfield Property Partners is a great opportunity for investors seeking high current yield, with both predictable distribution growth and capital appreciation upside. Brookfield Property Partners is a relatively low risk investment that is backstopped by Brookfield Asset Management as its majority shareholder. With its cheap current valuation and high quality assets, Brookfield Property Partners offers a substantial margin of safety for investors. While I expect reasonable growth from BPY, I maintain that parent company, Brookfield Asset Management, will offer a better long-term growth rate for investors opting for capital appreciation over yield.
