Brookfield Property Partners: Pay For Office And LP Investments, Get Retail For Free (NASDAQ:BPY)

Despite the seemingly intensified post-COVID-19 headwinds, I think Brookfield Property Partners (BPY) warrants investors’ attention. While the BPY portfolio is high-quality and thus, should prove less sensitive to the current backdrop, the market is currently pricing in an overly punitive discount to NAV. Plus, there’s additional downside protection from the ~$1bn commitment by BAM and partners, as well as the optionality from BPY’s rich development pipeline. At current prices, BPY investors pay for the core office portfolio and LP investments, and get the core retail assets for free.

High-Quality Concentration

To be clear, long-term concerns on the state of physical retail remain very valid. But quality counts as well, and BPY did a good job of highlighting the quality of its underlying assets and its higher tenant profitability at the recent investor day event. Case in point – BPY currently holds a 19% share in high-quality retail real estate in the US, with its footprint typically located in close proximity to peoples’ homes.

Source: Investor Presentation

Within the retail portfolio, 25 high-performing malls account for $10bn of the $13bn in equity allocated on the balance sheet. Within BPY’s core office portfolio, on the other hand, 15 of its top office/mixed-use complexes account for $10bn of the $13.5bn equity allocated on the balance sheet. Both core office and core retail have 94% and 97% occupancy, respectively. This implies that the majority of the value in both core portfolios is concentrated in a relatively small mix of very high-quality assets, which should prove less sensitive to industry-wide headwinds.

Source: Investor Presentation

High Distribution vs. Low Unit Price

BPY also addressed its distribution policy at the event, noting the structural target 70% payout ratio has, on average, been achieved since inception. On a quarterly basis, BPY pays a cash distribution per unit of $0.3325, equivalent to $1.33 annualized. This implies 2020 and 2021 AFFO payout ratios (including realized gains) of >100% in both years, and relative to a unit price of $13, equates to a ~10% yield.

That seems high, but I think CFO Bryan Davis’ response as to why BPY maintains the high yield was telling – “we don’t think our yield is too high. We actually think our share price is too low.” FY20/FY21 payout ratios aside, I tend to agree with his view, given the >$7bn in projected liquidity generation through FY25, of which ~$3.0bn will come from net gains.

Thus, I see the elevated payout ratios gradually declining over the coming years, but more a function of AFFO recovering and asset sales bolstering NAV than distribution cuts. That said, I also think a pause or a slower distribution growth scenario (relative to the historical pace) is likely in the upcoming years.

Addressing Balance Sheet Concerns

As of 2Q20, BPY’s liquidity position is a healthy ~$6bn – $1.5bn cash on hand and $4.5bn from credit and construction facilities. This likely moves higher in the coming years as asset sales within the LP Investment segment are set to provide cash inflow of >$7bn over the medium term.

Source: Investor 2Q20 Supplemental

While the debt load is elevated, I think there’s upside from refinancing as well – during 2Q20, BPY refinanced ~$2.1bn of office, retail and multi-family properties at sub-4% interest rates. Given the decline in financing rates over the course of this year and a likely “lower for longer” scenario continuing into the near future, BPY should benefit from significant savings from refinanced debt, in my view.

Further, a significant portion (~$7bn) of the debt is concentrated within the LP Investment segment (vs. Core Office and Core Retail), given the relatively higher development activity. The issue, though, is that LP debt creates an inflated view of group-level leverage metrics as the full present values of these developments are not recorded as corresponding assets on the balance sheet.

Source: Investor 2Q20 Supplemental

Downside Support from BAM’s $1bn Commitment

Over the last two months, Brookfield Asset Management (BAM) and its partners have invested ~$0.5bn for 43m units (implied $12/unit – a premium at the time of purchase). The purchases were structured via concurrent substantial issuer bids (SIB), but given BAM’s equity commitment of $1bn, the $524m called upon under the SIB ($436m in BPY units and $88m in BPYU shares) implies $476m in remaining equity commitment.

The good news, in my view, is that the sizable remaining commitment provides investors some buffer against further volatility in BPY’s unit price and sentiment towards retail properties. Given current valuations remain depressed, I think an additional SIB could well be announced later this or next year, likely at a higher price.

Pay for Office and LP Investments, Get Retail for Free

The market seems to be assigning an overly punitive discount to BPY units at current levels, offering investors an opportunity to invest alongside Brookfield at fire-sale prices. Essentially, investors in BPY today are paying for the office and LP investments while getting a portfolio of high-quality retail assets for free (see NAV breakout below).

Source: Investor Presentation

Not only does this fail to recognize BPY’s existing balance sheet value, but it also assigns little credit to the optionality from BPY’s rich development pipeline, repositioning efforts, and the upcoming realizations from its LP Investments. Net, BPY offers patient, longer-term investors an asymmetric risk/reward opportunity at these levels.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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