Flatt and his team are still well-regarded but questions are now swirling about the value of Brookfield’s commercial real estate holdings.
Brookfield and its real estate subsidiaries, Brookfield Property Partners (TSX:BPY.U;NASDAQ:BPY) and Brookfield Property REIT (BPYU), the second-largest mall operators in the U.S., have shown to be especially exposed during the pandemic.
The arrangement could bring BAM’s stake in BPY to 63 per cent from 55 per cent.
Nonetheless, Veritas Investment Research put out an “accounting alert flash” in mid-August questioning how BPY reported its second-quarter results.
Veritas wondered how it was that if BPY’s net operating income declined 7.7 per cent year over year, following a 3.4 per cent drop in the first quarter that “net operating income (NOI) did not decline more given that BPY collected just 34 per cent of its rents during the quarter?”
You’ll recall from our interview with Veritas CEO Anthony Scilipoti that his firm relies on forensic, accounting-based research and notices these kinds of things.
Another research group that follows the Brookfield real estate entities closely is Dalrymple Finance, which released a 12-page report detailing why it thinks that Brookfield Property Partners is essentially insolvent.
BPY has a market capitalization of about $14.2 billion, as of this writing, and its units trade at $15.08 (Canadian).
Here is an abbreviated version of a longer report by Dalrymple Finance that outlines its thesis on Brookfield Property Partners and Brookfield Property REIT:
A Note on Structure:
Brookfield Property Partners is ~64% owned and externally managed by Brookfield Asset Management. Brookfield Property REIT is ~95% owned by Brookfield Property Partners and is externally managed by Brookfield Asset Management.
In addition to retail, BPY owns office, hospitality, student housing, multifamily and logistics assets.
Embedded incentives in the structure facilitate overleverage and cash extraction through fees and overpayment of distributions by the external manager, Brookfield Asset Management.
Historical cash deficits at BPY have been filled largely by adding leverage to the properties. The strategy has become unstable in the current environment. We believe BPY and BPYU will cut their distributions.
- Overpayment of distributions – We estimate that BPY had annual cash flow deficits after distributions of approximately ($1 billion) before Covid that will grow in 2020.
- Cash cow no more – BPYU was the largest source of cash for BPY. In 2019, we estimate that $790 million of cash upstreamed from BPYU amounted to 67% of BPY’s distributions paid. BPYU’s cash distributions to BPY declined to $0 in the first half of 2020.
- Overstated NOI and operating metrics – BPYU’s steady revenue and soaring accounts receivable in the face of collapsing cash flows suggests reported NOI and earnings before interest, taxes, depreciation and amortization (EBITDA) are overstated. We use reported figures, but adjusted operating metrics are likely 20 per cent lower at BPYU and 10-15 per cent lower at BPY.
- Insurmountable debt – BPY and BPYU both have extremely high levels of debt. Debt/EBITDA of 15.4x and 14.3x, respectively, are twice the peer group average of 7.4x. Interest expense is 61 per cent and 182 cent of adjusted cash flow for BPY and BPYU, respectively, compared to 30 per cent for high-quality peers.
- Debt defaults and consequences – BPYU is in default on $1.2 billion of mortgage debt across 12 properties and has approximately $4.9 billion coming due by the end of 2021. We believe continued debt defaults may lead to a collapsing of the corporate holding structure, putting assets across BPY at risk.
- Distribution cuts are coming – All mall REITs (except BPYU) and 36 per cent of all REITs have cut or suspended dividends. BPY’s excessive leverage, high exposure to retail, poor cash generation and costly external management make distributions unsustainable. The distribution will have to be scaled down.
- Bailouts for now – BAM has engineered bailout programs through various strategies for the organizations, including funding tenants, direct cash infusions and stock buy-backs, using both corporate cash and private equity funds, in what we view as deeply conflicted transactions. BAM committed nearly $2.4 billion to the entities in the fiesta half of 2020.
- Watchful investors and lenders – Will BAM’s private equity clients watch while their cash is used to bailout BAM’s failing public entities? Will lenders accept ring-fenced, asset specific, defaults where partial and/or implied guarantees exist while the parent, BPY, continues to upstream ~$800 million annually in fees and distributions to BAM?
- The units are worthless – Using EV/EBITDA metrics from the peer group indicates that BPY’s units have negative equity.
The Endgame: Insolvency is Here
- Historical substandard cash flows exacerbated by Covid-19.
- BPY’s largest source of cash disintegrates.
- Revenue recognition policy appears to overstate operating metrics.
- Excessive leverage and debt defaults.
Brookfield Property Partners is not a viable entity as it does not generate enough cash to sustain the enterprise. Further, it has negative real equity after years of asset stripping through a conflict-ridden incentive system by BAM.
Bankruptcy could be imminent given the defaults of $1.2 billion of property debt.
Cash flow deficits have plagued BPY since its inception. We are now at the point in the cycle where declining cash flows and asset values are bringing financial mismanagement to the fore.
In our analysis, BPY is teetering on the edge of insolvency.
Related stories: Brookfield: Inside the $500 Billion Secretive Investment Firm (Financial Times subscription)