The TSX-listed reset preferred shares of Brookfield Office Properties (BPO) are relatively attractive.
Key points about the securities:
BPO was privatized by Brookfield Property Partners (BPY) in 2016 and its preferred shares became backed by a “full and unconditional guarantee” from BPY. BPY is not guaranteed by Brookfield Corporation (BN).
Current yields range from 12.6% (BPO.PR.C) to 16.6% (BPO.PR.G) with average of 14.8%
Future yields will reset at varying premiums on various dates to the Government Of Canada 5 year bond and at its current level (3.198%) the reset preferred yields will average 18.7% with one series as high as 22.3% (BPO.PR.R)
BPO preferred shares are significantly cheaper than BPY’s four NASDAQ-listed fixed rate preferreds that have an average yield of 12.1%. Both offer a large yield premium over BPY bonds and securities of real estate peers SL Green and Vornado.
BPO preferred shares were heavily impacted by selling pressure in October and December. Recovery is likely in January as happened in November. The NYSE listed preferred series (BPYPP BPYPO BPYPY BPYPN) were much less affected, likely due to a different investor base. Peers VNO-O and SLG-I dipped in October, but rallied in December due to enthusiasm for the Fed pivot and falling interest rates.
BPY is complex and risky:
SEC Filings show high leverage with $130Bn of assets supported by $48Bn of equity and minority interests. 9M23 FFO was negative. DBRS calculates that Debt/EBITDA was 17X and DSCR was 1.1X. Over 90% of the company’s debt was secured and Brookfield is taking advantage of opportunities to strategically default (payment on 3% of debt has been suspended).
BN’s Investor Day (Real Estate Update from page 97 and Transcript) emphasized BPY’s Core properties: “10 Trophy Commercial Complexes + 19 Irreplaceable Shopping Centers”. The balance of the portfolio which includes 180 buildings is defined as transitional or opportunistic (“Buy-Fix-Sell”). BN mentioned the potential for its Reinsurance business to acquire property assets from BPY (some office buildings and preferred shares already purchased in 9M23). BN has $23Bn of equity in BPY and investor perceptions of BN are influenced by the highly visible core property assets.
S&P Rating commentary released 12/21/23. BPY Preferred shares are rated B (“vulnerable and has significant speculative characteristics”)
DBRS Rating commentary released 05/15/23. BPY Preferred shares are rated Pfd-3 (low)
The Brookfield Property REIT Corp (BPY) notes due Apr27 are illiquid, but have rallied from a peak yield of 11.13% on 10/06 to a most recent trade at 7.91% on 12/28. The history of the Bid-Offer yield spread from Interactive Brokers shows the credit risks explained in the 12/21 S&P ratings downgrade were well-understood by the market and had no new price impact.
The performance of BPY’s fixed-rate preferreds and notes show that there are no market or corporate developments to justify the recent price declines in the reset preferred series.
Details of the TSX-listed Reset Preferred series are summarized by Brookfield here. Looking at two series as examples:
BPO.PR.T paid an annual dividend of $1.344 for the past 5 years, but that resets to $1.6975 from 1/1/24. The 12/28 closing price of $10.50 implies a generous 16.3% yield, a huge premium over the average 12.13% yield of the 4 fixed rate preferred series. If BPO.PR.T were to trade at the same yield then its price would rise 34%.
BPO.PR.A pays an annual dividend of $1.1773 for the 5 years ending 12/31/24 after which it will reset to the GOC 5yr + 3.15%. If bond prices are unchanged then the dividend would reset to $1.587 from 1/1/25. That would provide a very generous 19.35% yield, a huge premium over the average 12.13% yield of the 4 fixed rate preferred series. If BPO.PR.A were to trade at the same yield then its price would rise 60%.
The reset exposes holders to interest rate risk. If rates decline, as implied by the Canadian govt bond yield curve, then the benchmark for future repricing would be below today’s quote, however lower rates could ease the huge credit risk premium currently reflected in BPY securities. Refinancing of maturing debt would be easier and an economic soft landing would facilitate execution of the value-add strategies to recover capital from the transition properties.
This article has focused on the valuation of the BPO preferreds relative to other BPY securities which is likely to lead to an attractive return over the next year. The long-term outlook for BPY is beyond the scope of this article. If BPY is successful in execution of its business plan then over time the credit risk premium in its securities will decrease and the BPO preferred could appreciate from their current prices of $7-10 up to their $25 par value. However, if challenges increase then the experience of the Brookfield DTLA Office Trust shows that BN is willing to let non-guaranteed subsidiaries fail. DTLA was formed in 2013 and held seven downtown LA office towers following a merger with MPG Office. BPY owns 47% of DTLA equity and the balance is held by third party institutions. The trust has defaulted on all its debt, ceased SEC reporting, and its preferred shares (DTLAP) are quoted at $0.10.
Disclosures & Notes
A the time of publication the author held several series of Brookfield Office Properties Preferred shares (BPO.PR.A BPO.PR.N BPO.PR.P BPO.PR.R BPO.PR.T). The author does not make any recommendation regarding any investment in any company or security mentioned in this article. Investors are encouraged to check all of the key facts cited here from SEC filings and other sources prior to making any investment decisions. The author believes all information in the article is accurate as of the date of publication. Any factual errors in the article will be correctly as promptly as possible.
The high yield on the BPO preferred shares clearly demonstrates that they are high risk investments. The low prices demonstrate that nearly everybody who has ever bought them has lost money so that might happen to you if you buy them.
On looking I see on quantumonline that BPYPP is rated BB, while BPO.PR.A, etc. apparently are rated just B. That makes a big difference, doesn't it? Perhaps being guaranteed by BPY in some way is not quite as strong support as actually having been issued by BPY?
I like the article and I am digging deeper into these securities... Thanks!
Also, it looks like the cumulative default rates over time, even for B rated securities, comes out to an annual expected default rate of 1%-2%, which strikes me as quite low given the spreads on these that are much much higher vs CAD govt bonds. So, apart from the short-term price drop of which one might wish to take advantage, just owning a diversified portfolio of such assets would be expected to produce quite generous returns even with defaults quite above expected. Am I missing something on that front? Even single B credit risk shouldn't result in a spread of something like 1000 bps, no? - more like 300-500 is the usual spread in the market I would think but I am far from an expert on that...
Great article.