Brookfield Property REIT (BPYU) offers an 11.5% dividend yield that is hard to ignore. While clearly there are concerns given its exposure to malls and retail, we believe the backing of parent, Brookfield Asset Management (BAM) will help weather the storm. BAM’s decision to fund BPYU’s tender offer is a vote of confidence in the business, and it also signals to investors that the current valuation may be a bargain. If you have a higher tolerance for volatility and risk in your portfolio, you may want to consider adding shares. This article reviews the health of the business, valuation, risks, dividend safety, and concludes with our opinion about investing.
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Overview:
Brookfield Property REIT Inc. (BPYU) is a subsidiary of Brookfield Property Partners (BPY) which is one of the world’s largest commercial real estate companies, with approximately $88 billion in total assets. BPY’s portfolio includes office, retail, multifamily, logistics, hospitality, self-storage, triple net lease, manufactured housing and student housing. BPYU only owns a subset of BPY’s portfolio, namely its Core Retail portfolio. It consists of 122 retail properties located throughout the US comprising ~120 million sq. ft. of leasable area.
According to the company’s website:
“Brookfield Property REIT (BPYU) is a subsidiary of BPY, intended to offer investors economic equivalence to BPY units but in the form of a US REIT security. Dividends on BPYU shares are identical in amount and timing to distributions paid out for BPY units, and BPYU shares are exchangeable on a 1:1 basis for BPY units or their cash equivalence.”
These assets have a stable cash flow profile due to long-term leases in place. The company targets between a 10% and 12% total return on its portfolio. BPYU’s tenant base is highly diversified with no single tenant accounting for more than 3.8% of its annual rent. In fact, the top 10 tenants account for only 21% of the total annual rent.
Source: 10-q Filing
The company’s retail portfolio which includes 100 of the top 500 malls in the US is at the center of the COVID-19 storm. Most of its malls were closed for the majority of Q2 as mandated by the government. But now nearly 85% of its portfolio is open. Rent collections for its portfolio in Q2 were ~34%, with July collections trending significantly stronger. It is in negotiations with the vast majority of its tenants on lease modifications. BPYU expects these modifications may result in rent deferrals or abatements in some circumstances. Additionally, it is likely that more bankruptcies result from the shutdown which could lead to further down-time in the near and mid-term.
However, its Chief Executive Officer, Brian Kingston, explained during the Q2 earnings call: “we are cautiously optimistic that the worst of the economic shutdown is behind us and our business is well-positioned to withstand any lingering impacts.”
BPYU boasts of strong development and redevelopment initiatives totaling approximately $459.0 million under construction and $361.0 million in the pipeline. BPYU targets earning between 5% and 8% unlevered, pre-tax returns on construction costs for its development and redevelopment projects which should drive net operating income (NOI) growth. Its development track record reflects successful completions on time and on budget. We expect that this portion of the balance sheet will be meaningful to earnings growth throughout the next five to ten years as projects reach completion and begin to contribute rental revenue to earnings.
Vote of Confidence from Brookfield Asset Management
Brookfield Asset Management (BAM), the parent company of Brookfield Property Partners (BPY) announced that it would fund the purchase up to 74.1 million units of BPY and ~9.1 million units of BPYU from public unitholders for a price of $12.00 per unit, which amounts to a total value of ~$1 billion. This offer represented an opportunity for public shareholders to tender their units at a premium price to where they were valued in the market (as of July 2). The tender offer for BPYU units expired on August 12, 2020. Worth mentioning, it was oversubscribed, and as a result BPYU will accept for purchase on a pro-rata basis ~81.2% of the shares of Class A Stock tendered.
The decision by BAM to invest money during this challenging environment is a vote of confidence in the business. BAM is known for making opportunistic investments which means that they invest when the valuations are low. This suggests that Brookfield Asset Management views $12 per unit offering as a bargain and probably thinks the actual value of the business to be much higher. The near-term outlook for retail appears challenging but the investment by BAM is an indication that the long-term outlook for malls may be much better than what is being priced into the stock by investors.
Is the Dividend Sustainable?
There are multiple indications that Brookfield can maintain its current dividend and eventually increase it. For starters, the tender offer is a vote of confidence and support from Brookfield Asset Management.
Second, Brookfield just raised $2.2 billion in new capital, another indication that the marketplace also has confidence in the business. And while the company’s high debt level may be concerning to some (~$27.4 billion as of Q220 comprising $16.8 billion of own debt and its share of $10.6 billion of affiliates debt), keep in mind the high level of debt reflects the private-equity mindset of BPYU which it has inherited from its parent and manager BAM. While it increases returns, the risks in the eyes of investors also rises making them cautious. But the important thing to note is that nearly 75% debt is non-recourse i.e. backed by individual properties which limits the risk to the company. If a project goes bad, the lender will recover money by selling the property thereby not impacting operations of the company.
Furthermore, the recently completed tender offer is not only an indication that BAM likely views the shares as undervalued, but it also reduces the total dividend payments the company must pay out going forward (i.e. there are now less shares outstanding upon which the company must pay dividends). As we will see in the next section, Wall Street analysts are expecting future funds from operations (“FFO”) to exceed the dividend payout (a good thing). They also expect the dividend to be maintained going forward (and eventually increased).
(source: Company Data)
Valuation:
Considering rent collections for Q2 were only ~34%, Brookfield’s funds from operations (FFO) metric was down sharply during the quarter, as you can see in the following table from FactSet.
However, rent collection has been on an uptick since then, and analysts are forecasting further improvement. As you can see in the following table, price-to-FFO stood at just 5.7x at the end of Q1 and 7.7x at the end of Q2, considerably lower than BPYU’s historical level (a reflections of challenges, fear and higher debt). However, the 6 Wall Street analysts reporting to FactSet expect continuing FFO and price-to-FFO improvements going forward.
In fact, these analysts have a price target of $13.71 per share, representing 18% price appreciation upside. And worth noting, their aggregate expectation is for the current dividend per share to be maintained in 2020 and 2021, and increased in 2022.
Obviously, there are a lot of a assumptions here, but the marketplace is indicating confidence in Brookfield (as evidenced by the firm’s recent $2.2 billion capital raise), and the idea of dividend strength and share price gains is not absurd.
Preferred Shares (BPYUP):
Worth mentioning, Brookfield Property REIT also has preferred shares outstanding (BPYUP). They trade at a discounted price of ~$18.98 and offer a dividend yield of 8.4% (i.e. the preferreds also pay high income and offer price appreciation potential). The preferred dividend is cumulative, and you can read more about it here. We believe the preferred shares are also worth considering, particularly if you are an income-focused investor, and considering preferreds are higher in the capital structure than common.
Risks:
Tenant bankruptcy: BPYU earnings continue to be impacted by bankruptcies that have taken place since the beginning of 2018. BPYU is well diversified with no significant tenant concentration. However, should one or more of these tenants face financial trouble it could lead to future cash flow interruption.
Interest rate risk: The US Federal Reserve has cut interest rates to zero and even though we expect interest rates to remain relatively tame, dramatically rising rates could create challenges. As REITs are often seen as an alternative to bonds, higher interest rates could mean decreased demand for REITs, thereby causing a decline in the share price. Also, higher interest rates put downward pressure on earnings as interest costs rise.
Lower consumer spending: With projections from renowned institutions such as the IMF pointing to a global recession, we think consumer spending and confidence will be hit and in general will be negative for retail-focused REITs. Although, the company is seeing signs of spending picking up but a global recession is likely to cause a negative impact on earnings.
Conclusion:
The high yield of ~11.5% offered by BPYU is hard to ignore. Though the company has been hit hard by COVID-19 pandemic, there are some signs of turnaround. Nearly 85% of its portfolio is now open and rent collections have been improving. Additionally, the decision by BAM to invest money to fund BPYU’s tender offer is a statement of confidence in the business. It also suggests that the current market price of $11.60 may be a bargain. We believe the shares offer attractive long-term price appreciation potential along with a high-dividend yield, although we caution that volatility will likely remain high as uncertainty due to COVID-19 will linger on. Investors with some risk appetite may want to consider Brookfield Property REIT for a spot in their long-term income-focused portfolio.