Brookfield Property Partners (BPY) Getting the Job Done with Good 1Q14 Results

Brookfield Property Partners (BPY) reported results [Source] for the first quarter 2014 with fully-diluted Funds from Operations (FFO) of $174 million or $0.31/unit compared to $155 million or $0.33/unit in 1Q13. The improvement in FFO was due the increased investments in General Growth Properties (GGP) and Brookfield Office Properties (BPO), same store sales growth in retail operations and offset with reduced office revenue during the quarter primarily from space under redevelopment. Per unit results were lower than 2013 as the impact of investments in GGP and BPO financed with the issuance of units are not yet fully reflected in FFO.

Consolidated Financial Results

[Source] BPY 1Q14 Earnings Release

Net income for 1Q14 attributable to unit holders was $372 million ($0.67 per unit) versus $293 million ($0.63 per unit) for the 1Q13. The increase in net income was primarily from significant fair value gains particularly from the Partnership’s investment in Canary Wharf Group plc.

“As we consolidate our global office properties under one platform, we welcome new investors to Brookfield Property Partners,” said Ric Clark, Chief Executive Officer of Brookfield Property Group. “With the strong organic growth of our high quality assets, we are very excited about our prospects going forward.”

Pro Forma BPO and GGP

We can share the excitement too; BPY’s management suggested in a recent March presentation [Source]  that it can offer investors the opportunity to earn a ~20% per annum return over the next five years. While these returns are outstanding, they are similar to the company’s long term return record where they continue to earn investor confidence and patience.

Getting the Job Done:

Formed in early 2013 Brookfield Property Partners is starting 2014 well positioned to deliver these total returns consistent with our investment thesis [Source].  The retail business is showing strong results and the office business is seeing strengthening and momentum in leasing with improving fundamentals.

A major accomplishment this quarter is the successful tender offer to privatize Brookfield Office Properties Inc. (BPO) with the purchase of 220 million shares of BPO during the quarter. BPY now owns approximately 93% of the company and will proceed with a second stage transaction to acquire the remaining shares of BPO in early June.

Although the transaction was slightly dilutive to BPY unit holders (our equity per unit decreased from $25.23/unit to $24.96/unit) in the short term more than offsetting benefits will be realized in the not too distant future. Following the tender offer, BPY is implementing plans to integrate BPO into BPYBPY’s office properties and business development will be consolidated into the BPO platform and streamlining the organization is underway to capitalize on efficiencies. The cash portion of the merger will be from a total of $1.7 billion of debt. BPY is targeting to raise about $2 billion from asset sales and joint ventures with institutional investors. Demand remains strong and BPY expects to achieve attractive valuations and fully repay the acquisition debt within the next 18 months.

The acquisition addresses concerns over BPY’s low trading volume which hinders institutional ownership and inclusion into the indexes. The three month average volume of BPY units increased from about 100,000 units per day before the transactions to about 700,000 units per day currently. The company also announced it will be added to the S&P/TSX Composite Index, the principal broad market measure for the Canadian equity markets; the S&P/TSX Composite Dividend Index; the S&P/TSX Capped Real Estate Index and the GPR 250 Index, a weighted index based on shares of 250 leading property companies in the world. The greater liquidity will lead to greater institutional sponsorship along with the inclusion in the indexes to help eliminate the current 20% unit price discount to net asset value.

BPY Collage

Management’s Operating Results Summary:

BPY 1Q14 Operating Results Summary

Office Operations:

During the quarter office operations generated $84 million FFO. The increase in vacancy at Brookfield Place New York was the largest contributor to the decline over the prior year. This was partially offset by increased ownership of BPO and a reduction in interest expense due to refinancing.

Office operations contributed $282 million of proportionate valuation gains for the quarter; $141 million attributable to the investment in Canary Wharf Group plc resulting from continued strengthening of the London office market as well as appreciation in Canary Wharf’s development pipeline. The valuation of assets increased due to further recovery of the downtown Los Angeles office market and continuing success of retail leasing at Brookfield Place New York.

During the quarter 1.5 million square feet of office space was leased at average net rents more than 6% higher than expiring rents. Leasing activity was very active in downtown New York, where momentum has increased over the last six months. Of the top 10 leases during the quarter, five were in downtown New York, totaling 424,000 square feet. Overall occupancy of the portfolio closed the quarter at 88%, flat with year end. However, on a same store basis, occupancy increased by 30 basis points over the prior quarter.

On the business development front, BPY purchased an additional 23.6% interest in Five Manhattan West (formerly known as 450 West 33rd Street) in New York for $50.1 million in January, increasing ownership to 98.6%. A $200 million redevelopment of this property was announced that includes an exterior recladding and interior renovation program. At the Manhattan West development site construction proceeds with completion expected in November 2014.

In the quarter dispositions of office properties yielded net proceeds of $127 million, including the sale of a 90% interest in Heritage Plaza in Houston. BPY bought this asset in 2010 in the aftermath of the financial crisis with 16% of vacancy. Over the past three years occupancy was increased to 98% with a compounded annual rate of return on the investment of 33.5%.

Retail Operations:

During the first quarter, the retail platform posted strong results, reporting $125 million FFO, compared to $75 million in the prior year. Over the course of the last 12 months ownership interest in GGP increased from 23% to 33% on a fully-diluted basis, which accounted for the majority of the increase. The balance was attributable to same-store NOI growth of 5.7% compared to the prior year, driven by an increase in same-store occupancy from 95.8% to 96.2% in the current year and a 10.8% increase in suite-to-suite spreads. A proportionate gain on the extinguishment of $19 million of debt was also realized.

GGP has continued to maintain strong leasing momentum. In the first quarter it has signed or approved a substantial amount of this year’s leasing budget, and has increased its permanent occupancy. Although tenant retail sales per square foot have returned to prerecession peak levels and continue to rise, the overall growth rate has begun to moderate. Since the beginning of the year, affiliates have made significant progress on a number of our major redevelopment projects. GGP’s largest redevelopment, the Ala Moana Center in Honolulu, remains on schedule and leasing activity has been strong. At quarter end, approximately $400 million of  redevelopment projects are under construction in the retail platform, with over $200 million of projects in the pipeline.

BPY closed a $157 million investment in China Xintiandi marking the first investment in China. Xintiandi owns a portfolio of mixed use properties in Shanghai split between premium retail and office assets, including the iconic lifestyle center which bears its name. BPY’s investment with a number of institutional partners is structured as a U.S. dollar denominated preferred stock, with significant governance rights, that is convertible into common shares of Xintiandi. As part of the investment, BPY also received warrants in Shui On Land, its parent company.

Multifamily, Industrial and Hospitality Operations:

The multifamily, industrial and hospitality operations reported $19 million FFO in 1Q14 compared to $15 million in 1Q13. Acquisition activity was the largest contributor to the increase. The Atlantis hotel had a strong first quarter due to seasonality and an increase of 16% in group bookings of compared to the prior year.

Multifamily occupancy remains stable at 94.9% and rents were increased an average of 3% versus the prior quarter. Industrial occupancy ended the quarter at 76.6% versus 77.8% over year-end. The decline was a result of opportunistic acquisitions of properties with high vacancy levels. The hotel properties had a 2.4% increase in occupancy, outperforming the prior year.

Balance Sheet and Liquidity:

During the quarter Brookfield Property Partners borrowed $1.5 billion under its credit facility to fund the BPO acquisition and an additional draw down of $260 million will be used for the second phase of the acquisition. The credit facility is a two-year, $2.5 billion facility, comprised of a $1.0 billion revolver and a $1.5 billion term loan. Pay down of the term loan to less than $500 million can extend $1.5 billion of the facility for an additional year. At the asset level, 13 financings were executed totaling $500 million, on a proportionate basis.

Following the close of the BPO acquisition BPY will have access to its liquidity, which includes approximately $350 million of unrestricted cash and $620 million of availability under its $1.0 billion corporate credit facilities to finish the quarter with $1.7 billion of liquidity at the corporate level.

And a Positive Outlook:

Looking forward, we are excited about the organic growth prospects of BPY. Over the next five years we believe that we can significantly enhance our cash flow by increasing occupancy, capturing rent uplifts and commissioning development projects within our existing operations. This upside combined with our 5% current yield should lead to very attractive risk-adjusted returns for our unit holders.

Summarized from Managements Letter to Unit Holders:

  • Occupancy is currently 88% in office properties primarily due to a temporary increase in vacancy at Brookfield Place New York.
  • 2014 started with roughly two million square feet to lease in the Lower Manhattan office portfolio.
  • Leasing momentum has accelerated in the past few months with the overall vacancy rate for the submarket declining by 100 basis points to 11.2% and direct asking rents surpassing $50 per square foot for the first time in over five years.
  • For the year meaningful progress is expected in leasing this portfolio and occupancy rate is expected to increase to the mid-90% level, consistent with historical averages.

 

  • On average, in-place office and retail rents are 15% and 6% below market prices, respectively. As 40% of the combined lease portfolio expires over the next five years, we expect to mark to market the majority of these leases, significantly increasing revenue.
  • The office and retail leases typically have escalators, which increase rent by a fixed amount, also adding to revenue.

 

  • Opportunities to invest capital to upgrade or expand assets such as Brookfield Place New York and GGP’s Ala Moana Center in Hawaii are identified.
  • Due to the high-quality, irreplaceable nature of these assets, premium returns on capital are anticipated.
  • New development projects, such as Manhattan West and Bay Adelaide Centre in Toronto, are selected once a minimum threshold of pre-letting in order to manage the risk profile.
  • In total $5 billion of projects are underway, which are expected to earn a pretax, unlevered return of 8% – 10% upon stabilization.

 

  • BPY is constantly on the lookout for new investments as a value investor.
  • Pursuing a target returns through a combination of add-on acquisitions and multi-faceted investments that leverage structuring capability.
  • The scale and scope of the global operating platforms position BPY to originate new investments that are accretive to unit price.

 

  • The past quarter shows signs that the North American economy is continuing a steady recovery. In Europe, capital inflows have increased significantly, perhaps outpacing economic fundamentals.
  • Capital is showing signs of returning in developing markets, such as China, India and Brazil as they rebalance in order to try to support another phase of economic growth.
  • BPY will remain disciplined and capitalize on opportunities to earn premium risk-adjusted returns that these markets provide.

Ordinary Course Unit Buy-Back Program:

Brookfield Property Partners intends to initiate a normal course issuer bid. The Partnership believes that its units trade in price ranges that do not fully reflect their value. As a result, from time to time, acquiring its units represents an attractive and a desirable use of available funds.

Distribution Declaration:

The Board of Directors has declared a quarterly distribution of US$0.25 per unit payable on June 30, 2014 to unit holders of record at the close of business on May 30, 2014. Unit holders resident in the United States will receive payment in U.S. dollars and unit holders resident in Canada will receive their distributions in Canadian dollars at the exchange rate on the record date, unless they elect otherwise. The distribution represents an annualized distribution of US$1.00 per unit.

Buying Opportunity:

Mr. Market continues to provide an attractive opportunity as BPY management deliver results and faces a positive outlook for opportunities.  Management seems confident they can deliver total returns approaching ~20% per year over the next five years. Based on BPY’s managements demonstrated performance, with BPY selling at a discount to current net asset value and well below our estimate of intrinsic value [Source] of about $50/unit in 3-5 years and they seem well underway.

Disclosures: Long BPY, BAM, BIP, BEP

References:

  • BPY 1Q14 Earnings Release [Source]
  • BPY 1Q14 Letter to Unit holders [Source]
  • BPY 1Q14 Supplemental Information [Source]

 

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