Brookfield Property: This 6.6% Blue-Chip REIT Is A Strong Buy (NASDAQ:BPY-DEFUNCT-102181) (2024)

This article was co-produced with Dividend Sensei.

There are three things REIT investors should always focus on:

Quality assets. A safe dividend. A proven and skilled management team.

These are how you generate great total returns.

That’s why we’re impressed by Brookfield Property (BPY) (BPR) – double ticker symbols - we’ll explain shortly. It has those assets and abilities in spades, which is why I consider it to be one of the best high-yield REITs you can buy today. And with a level 9/11 quality score (taking into account dividend safety, the business model, and management quality), I consider it a definite Sleep Well At Night pick… a SWAN-quality stock capable of delivering safe and rising dividends even during a recession.

And that’s despite whether the share price takes a pounding. Which it probably will.

Better yet, despite an impressive 33% rally off December’s lows, Brookfield Property remains highly undervalued. It currently sports a 30% discount-to-book value, which in and of itself is likely underestimating its true intrinsic value by at least 5%.

That means that, over the long term, I’m confident that management won’t just deliver its targeted 12%-15% compound annual growth total returns – calculated by its yield plus 5%-8% dividend growth – but possibly even hit 15% or higher over the next five years if the economy doesn’t falter along the way.

Photo Source

Brookfield Property: The King of Global Real Estate Has a Strong Long-Term Growth Plan

First, it’s important to clarify the difference between Brookfield Property Partners and Brookfield Property REIT, the latter of which was created as part of the former’s $15 billion General Growth Properties acquisition last year. Because GGP’s shareholders were REIT investors, Brookfield created a REIT equivalent to fit everything in more smoothly.

As Brookfield itself explains, BPY and BPR are, economically speaking, the same security, with identical dividends/distributions and the same payout growth rate.

Brookfield Property REIT (NASDAQ: BPR) is a subsidiary of BPY, intended to offer investors economic equivalence to BPY units but in the form of a U.S. REIT security. Dividends on BPR shares are identical in amount and timing to distributions paid out for BPY units, and BPR shares are exchangeable on a 1:1 basis for BPY units or their cash equivalence (emphasis mine).

As evidenced in the two sets of images below, these are stunning commerce centers.

Source: BPY Website

(Source: earnings supplement)

On the retail side, Brookfield owns 8% of all Class A malls in America. These centers saw sales per square foot rise 3.7% to $765. For context, that’s higher than Simon Property (SPG). Brookfield’s policy is to limit redevelopments to 10% or less of assets in order to implement conservative risk management.

For example, on the retail side alone, Brookfield is currently working on $1.5 billion in redevelopments that are expected to deliver 6%-8% cash yields. That’s far below its 4.5% cost of capital. And in terms of core office properties, the REIT has about $4.5 billion in new developments planned through 2025 whose cash yields on capital are expected to be about 7%.

The other 20% of the assets are part of the LP (i.e., venture capital) investment portfolio, which is where Brookfield Property investors get to participate in six investment funds run by Brookfield Asset Management (BAM).

These funds are where Brookfield invests in deeply undervalued properties that generate stable cash flow. That’s a good start, but the corporation believes it can improve that real estate and then later sell them at a profit, realizing 15%-21% annualized returns for investors.

It’s also worth mentioning that these LP funds give Brookfield Property exposure to nearly every industry in this sector. And another impressive fact is how its first seven asset sales in the BSREP 1 fund have delivered more than 29% annualized returns for investors, 8% above management’s target.

(Source: earnings supplement)

Over the next five years, LPs are expected to generate $5 billion in cash flow and profits.

(Source: Investor presentation) - 2018 LP gains of $0.61 per unit/share However, while Brookfield’s track record on profitable real estate deals is the stuff of legend, making it literally the Buffett of global real estate, what investors ultimately should like most is the REIT’s track record of steadily growing its operating cash flow from its core property portfolio.

(Source: investor presentation)

While many investors have been disappointed in Brookfield Property’s price performance over the years, ultimately, management can only control its own operations and fundamentals. Its long-term goal has been to deliver 5%-8% long-term payout growth, backed by strong cash flow per share growth, and it has managed to accomplish that since its 2014 IPO.

(Source: Investor presentation)

More importantly, management – which has so far lived up to its promises dividend wise – expects to deliver growth of about 8% long-term operating cash flow per share over the next four years.

(Source: Investor presentation)

For context, that’s the second-largest liquidity war chest in all of REIT-dom, behind only Simon Property Group’s $7 billion. It’s basically enough to fund Brookfield Property’s development backlog all on its own.

(Source: Investor presentation)

Should the discount to NAV shrink from here, then up to 25% annual returns are possible over the coming years. For the record, this is literally Buffett-like returns from this blue-chip REIT.

In other words, Brookfield Property has many avenues to continue generating not just generous, safe, and growing dividends over time, but potentially 15% or more long-term total returns as well.

Valuation/Total Return Potential: Still One of the Best High-Yield SWANs You Can Buy

Yield: 6.6% (vs. 5% five-year average) TTM FFO Payout Ratio: 91% (vs. an 81% REIT sector average and 90% safe limit) Dividend Safety Rating: 4/5 Payout Ratio, Including Property Gains: 66% Debt/Annualized EBITDA:10.2 (vs. a sector average of 5.8) Corporate Debt/EBITDA: 0.3 Interest Coverage Ratio: 1.7 (vs. a sector average of 3.4) Corporate Interest Coverage Ratio: 55.8 Credit Rating: BBB Average Interest Cost: 4.5% Dividend Growth Guidance: 5%-8% (backed by 7%-9% cash flow growth) Expected Total Return (No Valuation Change): 11.6%-14.6% Management Long-Term Total Return Target: 12%-15% Valuation Adjusted Total Return Potential: 14.3%-20.3%

The first thing I look at when analyzing a dividend stock is the dividend safety. After all, the last thing I want to own or recommend is a yield trap that will have to cut its payout during a recession and send the share price crashing to boot.

At first glance, BPR’s payout ratio seems dangerously high and, indeed, I will need to see that come down over time or this REIT will get a safety downgrade. However, the reason for that temporarily high ratio is the large amount of shares Brookfield needed to issue when it bought GGP. And, for the record, this was the final major purchase management plans to make using its undervalued equity, which is why Brookfield is now buying back stock at extremely accretive prices.

What’s more, the payout ratio factoring in profitable asset sales is just 66%, well below levels that would have me concerned about a potential dividend cut.

Now, one of the scariest things about Brookfield Property, at least at first glance, is the $45.8 billion in total debt. That results in a very high leverage ratio that’s far above the REIT sector average of 5.8. Similarly, the interest coverage ratio initially looks like it’s at 1.7, which is beneath the safe limit for REITs of 2 or higher.

However, 97% of Brookfield Property’s debt is non-recourse, self-amortizing property level debt, with just $1.2 billion being at the corporate level, what shareholders are responsible for. In other words, Brookfield’s approach to debt is to use the commercial equivalent of mortgages to finance its acquisitions and investments.

In the event that something goes wrong so that a property can’t finance its own debt service costs, Brookfield hands over the keys and borrowers can’t go after the REIT’s overall cash flow. This creates a firewall around the overall funds from operations, or FFO, and makes the dividend far safer than the payout ratio and balance sheet might make it seem initially.

(Source: investor presentation)

What’s more, management plans to eventually reduce that debt to $40 billion, achieving an industry standard debt/capital ratio of 50% and a lower leverage ratio, the latter of which ahead of schedule.

Does that mean there are no risks associated with that much debt? No, as I’ll explain in the risk section, $44 billion in mostly non-recourse debt has its own risks, which is why most REITs choose to use lower leverage levels. But the point is that I consider Brookfield Property’s dividend safety to be a 4/5. As mentioned before, this means I’m granting it a level 9 SWAN quality rating courtesy of a 2/3 business model and 3/3 management quality.

Another thing I’m always focused on is valuation, and Brookfield Property remains one of the most mispriced blue-chips in the sector, likely due to fears about its debt.

P/Annualized FFO: 13.2 (vs. a 16.4 REIT average) P/NAV: 0.7 (book value $28.95) P/Morningstar Fair Value (DCF Model): 0.83

While there are many ways to value a REIT, anyway you slice it, Brookfield Property is trading at a very attractive valuation. Morningstar’s conservative discount cash flow model estimates it's 17% undervalued, and that’s the least undervalued fair value estimate I’ve seen.

To err on the side of caution I estimate Brookfield is anywhere from 17%-30% undervalued right now, which makes it a very strong buy under my blue-chip valuation scale. Of course, that’s only for those comfortable with its risk profile and high share price volatility.

Risks to Consider

As I alluded to earlier, there are definitely risks to keep in mind before investing in Brookfield Property.

(Source: earnings supplement)

First and foremost is the debt, which, while not dangerous from a dividend perspective, still has negatives to consider. Normally, Brookfield’s policy is to use long-term fixed-rate bonds in local currency to minimize interest currency fluctuations and minimize interest rate risk to its business model.

However, due to the use of floating rate debt to finance the GGP acquisition, 35% of the debt is at a currently floating rate, potentially opening Brookfield Property to interest rate risk should short-term rates (according to the London Interbank Offered Rate, or LIBOR) rise significantly in the future.

The good news is that, in today’s global economic environment, where central banks are not raising rates, there isn’t much risk of that. However, over the long term, investors will want to make sure that management converts that floating rate short-term debt into long-term debt. Fortunately, that’s the plan.

In Q1, BPR issued $1 billion in seven-year fixed rate bonds that will be used to repay some of the floating rate debt used to fund the GGP acquisition. So management is well on its way to reducing floating rate risk.

What about the 65% of Brookfield’s debt that is set at a fixed rate? Well, here too, there are interest rate risks.

(Source: Ycharts)

While the Fed may not be raising rates, corporate bond yields are set by the market and BBB-rated debt interest rates can be extremely volatile. The late 2018 correction saw a massive surge in yields due to financial market fears. That wasn’t surprising considering how investors often get nervous when stocks crash.

Thankfully, recession fears are easing for the time being due to continued strong economic growth. This has caused BBB yields to return to much lower levels, below BPR’s effective average interest rate. Funding growth with non-recourse debt shouldn’t be an issue during normal economic conditions. But should recession fears rise again (say, due to the U.S./China trade talks failing), corporate bond markets could tighten, making it much harder for Brookfield to execute on its growth model.

How big of a macro risk does Brookfield face right now? Well, that depends on how the trade talks go. The note that Goldman Sachs released earlier this week estimated a 60% chance of a deal being struck by Friday, resulting in no increase in tariffs by the U.S. or retaliation from China.

However, should that estimate prove wrong, Barclays estimates that China’s GDP growth could be impacted by 0.5% from the initial tariff hike on its $200 billion in imports and the full 25% tariffs on all Chinese imports would slow annual growth by 1%.

U.S. economic growth would not fare any better, according to Moody’s Analytics. Moody’s model estimates that 25% tariffs on all Chinese imports – for which Goldman estimates a 10% probability of this occurring – would knock U.S. economic growth down by 1.8% due to large-scale Chinese retaliation plus massive supply chain disruption in the U.S. economy.

(Source: Cleveland Federal Reserve)

A few weeks ago, the Cleveland Fed’s recession/GDP growth model estimated a 31% probability of a recession beginning by April 2020. It also predicted 2.3% economic growth this year. That’s based on the 10-year, three-month yield curve, a leading economic indicator and the most accurate recession forecasting tool yet discovered.

But the trade war fears this week have caused the curve to once more invert to -0.5 bp as I write this.

(Source: CNBC)

In the last seven recessions, if the curve stayed negative for 10 consecutive trading days, then a recession occurred on average within about 10 months. This means that the recession confirmation clock could be ticking, though that’s purely due to trade fears. It will likely return to positive territory. Canceling the recession clock should a deal be reached soon.

(Source: NY Federal Reserve)

The reason I bring up recession risk and the yield curve at all is that, before the trade war freak-out, the risk of recession already was at a 10-year high, and close to the levels that previously preceded the last three economic downturns.

While I don’t fear a dividend cut from Brookfield Property during a recession, as I previously explained, management’s ability to deliver the 7%-9% long-term cash flow per share growth needed to keep the dividend safely rising, while simultaneously lowering the payout ratio, and further deleveraging might be far more difficult. That’s because it requires about $1.5 billion in annual capital recycling, which won’t be possible should a recession cause global commercial real estate prices to significantly fall.

There's one other major risk for BPR that investors need to keep in mind, and it’s also tied to the company’s highly leveraged balance sheet. As my SA colleague, Michael Boyd, recently explained, Brookfield Property’s net asset value might take a major hit during a recession: a 40% decline should average cap rates rise by 90 basis points.

He says:

Like it or not, REIT market valuations tend to follow NAV - even if the cash flows are not fundamentally impacted. By being long on one of the most levered REITs in the market today, investors in Brookfield are accepting greater sensitivity to trends in asset prices. For those who are more risk averse, I would personally view owning REITs with similar real estate quality and lower leverage profiles, even if that meant foregoing some of that juicy current NAV discount (emphasis mine).

It’s important to remember that my own SWAN rating on Brookfield Property is 100% when it comes to whether or not I’m confident that the dividend will be maintained during a recession. It has zero to do with how stable a share price might be.

Brookfield’s highly leveraged balance sheet means that NAV could indeed take a pounding depending on how severe a future recession will be.

Will the global nature of the portfolio help insulate it a bit since the global economy isn’t likely to contract? Sure. But investors need to be prepared for BPR/BPY to fall hard and fast during any future economic downturn and subsequent bear market. (And, to be sure, no recession has ever not resulted in a bear market since WWII.)

This is why I keep pounding the table about good risk management and asset allocation. I can’t repeat it enough: No dividend stock is a bond alternative.

While blue-chip REITs tend to fall less, BPY/BPR’s leverage means it might not fare the same way.

If you need stable or appreciating assets to sell during a recession to fund expenses, such as with retirees’ working off of the 4% rule, you need to own enough cash/bonds to avoid selling stocks that are very likely to be down significantly.

Brookfield Property, as we saw during December’s 19.8% correction, can and likely will end up trading at an outrageously undervalued level considering how its discount to NAV hit 50% on Dec. 24 and its yield hit 8.8%.

Here are the risk management rules of thumb that I recommend for most investors. Those are based on decades of market studies, as well as the personal experience I and mutual fund managers have had.

Bottom Line: High-Yield Investors With Strong Volatility Tolerance Should Consider Buying Brookfield Property Today

When it comes to undervalued, high-quality REITs, there are few better choices right now for volatility-tolerant investors than Brookfield Property. The REIT’s world-class assets, industry-leading management quality, and strong growth runway, plus the cheap growth capital to back it up, make this level 9 quality SWAN stock one of the best values on Wall Street today.

Just keep in mind that with rising recession risk, it’s critical to remember that no dividend stock is a bond alternative and almost all equities fall during corrections and bear markets. Whether or not the current trade freak-out actually results in a recession, no one can know.

Which is why it’s important to focus on quality REITs that will be able to sustain dividends throughout the entire economic cycle and as part of a well-crafted portfolio whose asset allocation is right for your individual risk profile.

Am I confident in BPR/BPY’s dividend safety? Yes, I am. Do I love the current valuation, its 30% discount to NAV, and 15% or more long-term return potential? You bet.

But while I’m happy to recommend this undervalued, high-quality REIT today, I can’t stress enough that the biggest risk is the high leverage, which is baked into Brookfield’s core business model. Anyone who isn’t comfortable with the kind of asset value/share price volatility such leverage can create should avoid this REIT in favor of other quality REIT SWANs like Simon Property Group.

Note: We recently upgraded BPY to a Strong Buy after a recent 6% pullback. Marketplace readers were notified of the change first.

Author's note: Brad Thomas is a Wall Street writer, and that means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free, and the sole purpose for writing it is to assist with research, while also providing a forum for second-level thinking.