Brookfield Property Partners (BPY) is a unique real estate investment in many ways. However, it has material exposure to malls, one of the hardest-hit segments of the market right now in the wake of efforts to slow the spread of the coronavirus pandemic. The headwinds facing this real estate niche have been material for years, and then COVID-19 pushed the industry-wide stress even higher.
With its limited partnership units trading down nearly 42% this year, is this trading entity that provides dividend yields around 15% worth the risk? Here are five considerations you need to account for when deciding if this is the right investment to add to your portfolio.
1. A complex real estate entity
Brookfield Property Partners is a master limited partnership (MLP) that owns real estate and is run by Brookfield Asset Management (BN 2.35%). The first thing to note is that the partnership structure is not the normal one investors are used to in the publicly traded real estate space. There are tax considerations to this corporate form, including having to deal with a K1 at tax time, among others.
That said, there is a real estate investment trust (REIT) version of ownership via Brookfield Property REIT (BPYU). It's effectively the same investment but structured as a REIT to avoid the tax complications of an MLP.
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Obviously, both entities are run by Brookfield Asset Management. It's more common for a REIT to be internally managed, which limits concerns over things such as conflict of interest and the manner in which compensation is structured.
Canada-based Brookfield Asset Management has an over 100-year history of investing in infrastructure assets and runs a number of publicly traded partnerships, so it's well-versed in what it does. Those other partnerships, meanwhile, are largely focused on other niches, so overlap with Brookfield Property Partners is minimal.
There's little reason to be concerned about this set-up, but investors should recognize it exists. There are potential risks, even though they appear minimal.
2. A widely diversified asset list
Brookfield Property, which we'll use as the designation from here on out since you can buy the MLP or the REIT, made a splash a few years ago when it bought the portion of mall owner General Growth Properties it didn't already own. This was a classic Brookfield Asset Management move, jumping into an out-of-favor sector to take advantage of low prices.
The problem is that the situation in the mall space hasn't gotten better, with increasing pressure from store closures and bankruptcies as retailers navigate the consumer shift toward online shopping. Known as the "retail apocalypse," there are very real issues for malls to deal with, even if the eventual demise of brick-and-mortar stores is being vastly overestimated. And that was before COVID-19, which we'll get into below.
However, there's more to get a handle on than just retail assets. Brookfield Property owns 134 office properties in addition to the 122 enclosed malls it owns. The two segments are roughly of similar size, although the mall portfolio generates a bit more in funds from operations (FFO), a real estate metric that's similar to earnings for an industrial concern. Together, these owned properties make up the biggest portion of the portfolio, but there's still more.
Brookfield Property also invests in private limited partnerships sponsored by Brookfield Asset Management that invest in things such as apartments and hotels. The goal of this segment is to buy on the cheap and then sell when prices appreciate. It's far more active than the office and mall portfolios, which look to buy and hold assets.
As if that weren't enough, Brookfield Property's portfolio, while largely focused on North America, reaches beyond this region largely via the partnerships in which it invests. Brookfield Asset Management has a global reach, so there's no reason to be overly concerned that Brookfield Property is investing in regions it doesn't know well. Still, this exposure changes the dynamics of the entity.
In short, Brookfield Property isn't your run-of-the-mill property owner, and investors need to do some homework before buying this very unique entity in either of its two forms.
3. COVID-19 changes things
We've already considered the coronavirus as it relates to malls; however, it needs a deeper dive. The big picture is that governments the world over have effectively hit the pause button on economic activity, asking people to social distance and closing non-essential businesses. That's been devastating to mall owners, as enclosed malls are hardly essential. So roughly half of Brookfield Property's owned portfolio is now shut down, and there are very real concerns that tenants will stop paying rent, decide to close stores more aggressively because of COVID-19, or simply go out of business altogether. It's a material headwind.
The office portfolio, meanwhile, is facing its own COVID-19 headwinds. Anyone who can work from home has been asked to do so. That means offices are largely empty, just like malls, so there could be problems collecting rent on this side of the business, too. There could also be a long-term impact if businesses decide that using remote employees is more desirable than making people come to a central office every day. This would be a headwind to occupancy levels and, in turn, rental rates.
With regard to the LPs, which are more aggressive buyers and sellers of assets, COVID-19 could upend investment plans. The best outcome would be that holding periods lengthen. The worst is that investments are repriced in the markets they serve, and the profits expected don't materialize. Buying and selling institutional-level properties is a lumpy business, so the full impact may not be clear for a long time.
At this point, there's no way to tell how any of this shakes out. With uncertainty high, investors have been selling Brookfield Property. That's not unreasonable.
4. A parent company to help, if needed
With that as a background, Brookfield Property has something most other real estate companies don't -- a parent that's large and well-financed. So, while Brookfield Property has warned investors of the risks it faces, it was also able to highlight its unique strengths. That includes an undrawn $6 billion line of credit and, perhaps more important, the ability of parent Brookfield Asset Management to step in if needed.
It also noted that the investments beyond its core office and retail assets are limited to the money already put into the LPs, so there's no operating risk to Brookfield Property. Further, those partnerships have "dry powder," so Brookfield Asset Management expects they will be able to weather the hit from COVID-19.
In fact, in true Brookfield Asset Management fashion, Brookfield Property has been buying back its own units during the sell-off. Over the three-week span prior to its unitholder update letter, it bought roughly six million units. Clearly, Brookfield Property thinks the market is selling its units too cheaply today.
5. Will it keep paying distributions and dividends?
The one thing Brookfield Property didn't address in its update letter was the distribution (or dividend, in the case of the REIT). The big statement was that it believes it can weather the hit and muddle through, and that's likely to be the case. However, getting through this period without reducing the amount of cash it passes down to its investors is another question altogether.
For example, it had a payout ratio of roughly 85% in 2019. That's not troublingly high, but it isn't low, either. However, there's more to the story, as you might expect from such a complex entity. Asset sales at the LPs added $0.18 per share to FFO last year. Pull that out, and the core portfolio payout ratio was 95%. Worse, core portfolio FFO fell 6% year over year. And with COVID-19, it looks like it will fall even further in 2020.
Since LP asset sales are inherently lumpy, and property markets are in a state of flux, it's likely Brookfield Property will have a very hard time covering its distribution this year. That doesn't mean it will be cut, since companies can cover temporary FFO shortfalls with debt for short periods of time. But the longer COVID-19 issues linger, the more likely a disbursement cut becomes.
A tough real estate investment to recommend
Brookfield Property is actually very well run, overall. That's the norm for anything associated with Brookfield Asset Management. However it's also very complex and facing extraordinary times. The disbursement, meanwhile, could easily be cut in an effort to preserve liquidity if things continue to get worse.
Aggressive dividend investors willing to live through a cut -- with the expectation that disbursement growth will resume when times are back to normal -- might find Brookfield Property interesting. After all, the roughly 50% drop in value appears to be pricing in a cut. However, most other investors should probably err on the side of simplicity and consider other ways of getting exposure to malls and offices -- or just sit on the sidelines a little longer to get a better handle on the big-picture impact of COVID-19.
