Pedestrians and office workers walk past the Bay St. entrance to Brookfield Place in Toronto’s Financial District on July 12, 2022.Fred Lum/the Globe and Mail
Real estate companies with exposure to office buildings are struggling amid high vacancy rates and an uncertain future as many people continue to work from home.
If buying the beaten-up units of real estate investment trusts at the depths of despair sounds too risky, here’s another approach: Take a look at the preferred shares of Brookfield Property Partners, which can yield more than 10 per cent right now – signaling risk, but a compelling opportunity too.
Preferred shares are fixed-income securities that are issued at a par price, generally $25, and pay a set quarterly distribution in the case of fixed-rate shares.
Yes, they still reflect uncertainty in the office market. And full disclosure: I own a particular issue that has been pummelled over the past year.
In July, 2021, Brookfield Asset Management Inc. BAM-T privatized Brookfield Property Partners, its real estate arm with top-quality office towers in a number of cities, including New York and London.
The units, which I owned, were delisted. In exchange, investors were given the option of receiving common shares in the Brookfield parent – now called Brookfield Corp. – cash, newly issued preferred shares of the delisted REIT, or a combination of all three.
I took the combo deal, but soon after bought more of the preferred shares, which yielded 6.25 per cent.
Not a bad deal, I thought: In 2021, the economy was doing fine, inflation wasn’t an issue and this working from home routine was getting very old. The office beckoned.
Since then, inflation has surged and higher interest rates have crushed many fixed-income investments, including preferred shares. Worse, many office towers remain sparsely inhabited, raising concerns that companies won’t renew leases.
“Security prices for real estate companies have come under pressure since the beginning of the rate-hike period. Real estate is capital intensive and interest-rate sensitive,” Ana Lai, real estate senior director at S&P Global Ratings, said in an interview.
A recession won’t help matters. And preferred shareholders rank well behind bondholders if a company fails and its assets are carved up, leaving those shareholders vulnerable when companies run into financial troubles.
Brookfield Property’s preferred shares (BPYPM on Nasdaq and BPYP.PR.A in Toronto) are signalling investor discomfort: They traded as low as US$14.09 on Nasdaq earlier this month, or nearly 44 per cent below the issue price of US$25.
The original 6.25-per-cent yield – an annualized distribution of US$1.5625 a share – is now 10.3 per cent, as of Thursday.
Fund managers who run some of the largest preferred share funds did not want to comment about specific issues. However, the company’s first-quarter conference call last week emphasized its real estate business, with a consistent message: We’re fine.
“In contrast to what you may be reading in the headlines, our real estate business continues to demonstrate its quality and resilience,” Bruce Flatt, Brookfield’s chief executive officer, said during the call with analysts.
Brian Kingston, chief executive officer of Brookfield’s real estate business, offered a few details to support his view that high-quality office buildings in desirable cities – Brookfield’s focus – stood apart from more commoditized buildings elsewhere.
For example, Brookfield has completed one million square feet of leasing over the past 12 months at its soon-to-be completed two-million-square-foot tower at 2 Manhattan West in New York. Rents there were 35 per cent higher, he said, than at 1 Manhattan West, which was leased before the start of the pandemic.
“Today, companies are seeking offices that foster collaboration, creativity and community among their workers. And to that end, modern office buildings have never been in higher demand,” Mr. Kingston said.
The preferred shares haven’t recovered much since these assuring words last week.
Brookfield’s real estate arm has a lot of debt at a time when borrowing costs are rising, which is a point S&P has made in its credit rating reports on the company.
As well, Brookfield has defaulted on several properties in Los Angeles and Washington, possibly raising concerns among investors about the rest of the real estate portfolio.
Mr. Kingston referred to the failed investments as isolated errors, and noted that Brookfield finances each of its buildings individually. That means problems with one property won’t affect the others or the parent company.
Still, the defaults show what’s at stake in the office property market, and wading in might not be to everyone’s taste.
So why consider it?
Betting on the survival of a unit within Brookfield Corp., which is valued at more than US$50-billion, doesn’t seem outlandish. S&P believes that the real estate arm’s relationship to the parent company reduces credit risk.
A recovery in the office building sector could send preferred share prices higher. In the meantime, the shares’ quarterly distributions will continue to flow.
Yes, a recovery could take some time. But investors are being paid – a lot – to wait.