DJ Hot Property, Cool Price -- Barrons.com

By Andrew Bary

Brookfield Property Partners is one of the world's largest property owners with a high-octane strategy and lofty yield, and it comes at a depressed price.

The company controls $86 billion in assets on five continents with a focus on office buildings and malls, including Hudson Yards and Brookfield Place -- formerly the World Financial Center -- in Manhattan, Canary Wharf in London, and the Fashion Show mall in Las Vegas.

Its partnership units (ticker: BPY) look attractive. They trade around $18, down 17% in the past year, and yield 6.9%.

With a market value of $18 billion, Brookfield Property is the flagship real estate vehicle for Toronto-based Brookfield Asset Management (BAM), one of the largest alternative-asset managers in the world. Brookfield Asset Management rivals the industry leader Blackstone Group (BX) with private real estate funds. BAM recently closed on its largest fund totaling $15 billion.

Brookfield Property was spun off by Brookfield Asset Management in 2013 and has executed a series of transactions like its 2018 deal for mall owner GGP to consolidate its real estate operations and simplify its corporate structure.

BAM owns 53% of Brookfield Property, which has about 42% of its assets in malls and other retail properties, 41% in office buildings, and 17% in private real estate funds run by BAM. Brookfield Property invests alongside institutional investors in the private funds.

Those private funds have a strong track record, with 20%-plus annual historical net returns and an emphasis on buying what they see as undervalued assets. Brookfield funds last year took control of the overleveraged 666 Fifth Ave. office tower in Manhattan controlled by the family of Jared Kushner, President Donald Trump's adviser and son-in-law.

"Brookfield has a superhigh-quality real estate portfolio and allows holders to invest alongside a talented management team at a significant discount to net asset value," says Sheila McGrath, an analyst with Evercore ISI. She has an Outperform rating and a $20.75 price target.

Still, Brookfield Asset Management is frustrated -- and should be embarrassed -- by the performance of the units. Since BAM formed Brookfield Property in 2013, the units are down 17% and the annual total return has been just 1.7%, behind Vanguard Real Estate (VNQ), a broad-based exchange-traded fund that has returned 7.6% annually over the same span.

Major U.S. REITs like Simon Property Group (SPG), the largest mall U.S. owner, and office specialist Boston Properties (BXP) have all generated considerably better total returns.

Unlike U.S. REITs, Brookfield Property provides a quarterly estimate of its net asset value based on international accounting standards using appraisals and cash-flow analysis. The NAV was more than $28 a share on Sept. 30.

There is also a companion REIT aimed at U.S. investors: Brookfield Property REIT (BPR), which was created in 2018, when the company bought the 66% of GGP that it didn't already control.

The two securities trade around the same price, pay the same dividend, and are economically equivalent. Brookfield Property REIT offers U.S. investors a 1099 tax form, while units of Brookfield Property Partners generate K-1 tax forms, which many investors dislike. The Brookfield Property REIT also has a preferred stock issue yielding 7%.

Executives of Brookfield Property Partners declined to comment ahead of the company's fourth-quarter results on Feb. 7. The company soon is expected to increase its distribution (the partnership dividend equivalent) by about 5%, to $1.32 per unit, which would mean a 7.3% yield.

In BAM's third-quarter shareholder letter, CEO Bruce Flatt valued Brookfield Property "in the range of $30 per share." He wrote that it has regularly sold properties for more than their carrying values. BAM started buying Brookfield Property units in late 2018 and purchased $274 million at an average price of $19.71 per unit. In November, when the units traded around $20, the company outlined a scenario of 15% yearly returns through 2022.

So why does Brookfield Property trade so far below its estimated net asset value? Debt, complexity, and an expensive external management structure.

It also doesn't help that the company is exposed to malls, which are the most unloved real estate sector. And with Brookfield Property trading at an average discount to NAV of more than 20% since it went public, the NAV calculation may be inflated. The current discount is about 35%.

Given Flatt's view, Brookfield Property ought to consider a large asset sale whose proceeds could be used for debt reduction and stock buybacks.

McGrath calls Brookfield Property a "publicly traded private real estate play." Brookfield is more active in buying, selling, and redeveloping properties than large U.S. REITs. It's spending $1.7 billion, for instance, on mall-related redevelopment that includes building hotels and apartments.

Reflecting the private-equity mind-set at Brookfield Property, the company has much higher leverage than comparable U.S. REITs. The company's debt totaled about $46 billion on Sept. 30 against equity of $28 billion. Brookfield's ratio of debt to annual cash flow is now about 12 times, double the average of major U.S. REITs.

That leverage, which magnifies returns and increases risk, has lately been a negative for the company as investors focus on the health of corporate balance sheets.

Brookfield Property argues that its debt is almost entirely backed by individual properties, limiting the risk to the company.

Another issue is complexity, given the company's global scope, diverse asset base, and dense financial reports. Brookfield Property is managed by BAM, which takes annual management fees that result in higher overall expenses than large U.S. REITs. It also has a higher dividend payout ratio of its funds from operations -- an important real estate cash-flow measure -- than do major U.S. REITs, which yield an average of 4%. The company is valued at about 11 times projected 2019 funds from operations, or FFO, of $1.59 per unit, a discount to U.S. REITs.

Brookfield Property aims to generate annual growth of 7% to 9% in FFO over the next five years and increase the distribution at a 5% to 8% rate. It also aims to realize $500 million in annual gains from its investments in BAM-run real estate funds.

These are ambitious goals, but little of that is reflected in the unit price.

Brookfield Asset Management has a reputation as one of the shrewdest global real estate investors. Now, it's time for the company to deliver for Brookfield Property holders.

Write to Andrew Bary at andrew.bary@barrons.com

(END) Dow Jones Newswires

February 01, 2019 19:59 ET (00:59 GMT)

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