On the face of it, this is a tough time to be a commercial property company.
But it is a great time to shuffle these assets using IFRS accounting, as distinct from GAAP accounting used by most US companies. Consider for example the case of Brookfield Asset Management’s (and funds it manages) $5.9bn buyout of the minority holders in Brookfield Property Partners (BPY), one of America’s biggest mall operators.
That would appear to be a high price for BAM to pay for the prospect of losing about $150m in annual management fees and incentive distributions, along with $760m in regular distributions that would have been coming to its previous share of the units.
And the $16.50 per unit price BAM and its private partners are paying for BPY was pushed far above the $11 and change where the units were trading in July last year, before BAM started, in effect, bidding against itself for what became a takeover.
If, as Bruce Flatt, BAM’s chief executive, told the Financial Times recently, “It’s the right thing to take it [BPY] private”, why did he and the board not do so back in July for a price far below $16.50? Canaccord Genuity has put the net asset value of BPY at about $11.89, almost 30 per cent below BAM’s offer.
Ah, but thanks to the miracle of IFRS accounting, which Brookfield prefers over the more prescriptive US GAAP, BAM will be able to mark up the value of the bought-in BPY units on its own balance sheet to its own $27 mark to model valuation. Better than mean old mark-to-market.
Also, it will be far easier for BAM to restructure BPY’s pile of debt out of public view. While the pandemic has made it harder to attract office renters and shopping centre customers, it has become easier, in many cases, to implore creditors for debt restructuring.
BPY’s quoted equity has handily outperformed “comparables” such as Simon Property and Boston Properties, thanks in large part to BAM’s own purchases. BPY is up 75 per cent since the end of June, while Simon has risen 39 per cent and Boston Properties by just 3.5 per cent.
But BPY’s interest expense is about 66.5 per cent of its net operating income, compared with 27.6 per cent at Simon and 26.3 per cent at Boston Properties. In a weak property market, maintaining high income distributions (not to mention related-party management fees) as BPY was doing would seem to be increasingly difficult.
I asked Brookfield about issues it might have in maintaining relatively high leverage. In particular, how many BPY properties have been returned to lenders over the past year, and how much debt was eliminated through such processes. Brookfield’s response: “We have not commented on this publicly.”
I asked how much debt service on BPY properties is in suspension, and BAM’s assessment of the value of the properties covered by debt service suspension. Again, “We have not commented on this publicly.”
Now, on page 37 of BPY’s third-quarter report, in small type under “liquidity & capital resources” of the management discussion and analysis, we are told that “approximately 4 per cent of our debt obligations represent non-recourse mortgages where we have suspended contractual payment, and are currently engaging in modification or restructuring discussions with the respective creditors”. But this response does not, in my view, provide enough specific detail to adequately assess how much of BPY is in distress.
What could be a reasonable motive for BAM’s directors and management to pay a succession of higher prices to take BPY private? Apart perhaps from the possibility of using a favourable revaluation to increase the size of BAM’s assets under management and, therefore, appear more dynamic from the point of view of raising new funds? Why not just cut all the distributions, management fees and incentive fees and let the market do its own price discovery?
Well, an independent BPY could come into visible distress due to harsh markets and over-leverage, as well as having paid more distributions than could be covered by simple operating earnings, as distinct from non-recurring asset sales and asset-level borrowing. Then investors might come to question the Brookfield group model for other public partnerships.
Better to put off trouble for another day.