Brookfield Property Partners L.P.
Q4 2016 Earnings Call Transcript

Published: 3 Feb 2017

[Operator:]

Good day, ladies and gentlemen. Welcome to the Brookfield Property Partners' 2016 Fourth Quarter and Full Year Financial Results Conference call. As a reminder, today's call is being recorded. It is now my pleasure to turn the call over to Mr. Matt Cherry, Vice President of Investor Relations and Communications. Please go ahead, sir.

[Matt Cherry:]

Thank you, and good morning, everyone. Before we begin our presentation, let me caution you that our discussion will include forward-looking statements. These statements that relate to future results and events are based on our current expectations. Our actual results and future periods may differ materially from those currently expected because of a number of risks, uncertainties, and assumptions. The risks, uncertainties, and assumptions that we believe are material are outlined in our press release issued this morning. With that, I'll turn the call over to Chief Executive Officer, Brian Kingston.

[Brian Kingston:]

Thank you, Matt, and good morning, everyone. Thank you for joining the call today. With me on the phone are Ric Clark, the Chairman of BPY; and Bryan Davis, our CFO. In my prepared remarks, I'll recap our activities and accomplishments over the course of 2016 and provide some observations on real estate fundamentals and the investment environment that we're currently seeing around the world. Bryan will then go through the details of our quarterly and annual financial results. And I will close the call with a list of our priorities to focus for 2017. Following those comments, we would be happy to take questions from analysts and investors on the call today. As you would have seen in our disclosures this morning, we reported solid quarterly and annual financial results for 2016. Specifically our company FFO increased by 15% over 2015. This growth was fueled by strong performance in our core office and retail segments as well as new investments made in our opportunistic investment strategy. Given this increase in cash flow, our board of directors has approved a 5.4% distribution increase for 2017 which is in line with our targeted annual distribution growth of 5% to 8%. Importantly, with our payout ratio now in line with our long-term target of 80%, going forward, we should be able to grow our distributions at the higher end of that targeted range consistent with the strong growth in cash flows we foresee over the next several years. Just recapping some of our 2016 strategic priorities, one of our first goals was to enhance the flexibility of our balance sheet. And early in the year, we secured a BBB corporate credit rating from S&P which allowed us to refinance our corporate credit facility increasing its size by $500 million to a total of $2.5 billion, extending its terms to 2019, and lowering its cost by 55 basis points which will save us about $14 million a year in annual interest cost. We also issued $200 million of perpetual preferred shares into the Canadian market using those proceeds to repay $200 million of capital securities which were due on demand. In total, we reduced our corporate debt by over $1 billion in 2016 further improving our access to liquidity. Our second priority was to continue to actively recycle capital out of some of our stable and more mature assets taking advantage of strong investor appetite for these types of assets. Over the course of the year, we successfully raised approximately $3 billion of net equity from core office and retail sales. The majority of these transactions in places like New York City, London, Sydney, Las Vegas, Washington DC, and Vancouver was executed at cap rates in the 3% to 5% range. Proceeds were redeployed into various initiatives including debt repayments, new investments, funding our development pipeline, and unit buybacks. Our third priority was to increase the occupancy in our core office and retail business. Over the course of 2016, we completed over 8 million square feet of office leasing and 13 million square feet of retail leasing. Importantly, new leases signed during 2016 were rents that were on average 14% and 20% higher than expiring leases respectively for our office and retail. Our final priority was to increase the resources associated with our share buyback program. Repurchasing our units offered to compelling investment opportunity in 2016 and we bought back approximately 2.8 million units at an average price of $21.35 per unit U.S. We were particularly active late in the year buying back approximately 1.6 million units in the fourth quarter alone as we gained greater certainly around our various capital recycling initiatives and volatility and equity capital markets following the U.S. election negatively impacted real estate share prices. We believe acquiring our own units at a 30% discount to NAB will provide very high returns on the capital we have invested. In addition to delivering strong operating results, we continue to investigate other potential paths to get our units trading closer to the underlying value of our business. Late last year at our Annual Investor Conference we mentioned that we are actively considering conversion of BPY structure to U.S. REIT. And while work continues in this regard, the uncertainty with respect to potential future changes in U.S. tax law under the new administration has led us to take a more cautious approach to this decision until we have greater clarity. We will continue to provide you with updates on this topic as they became available. So with that as an introduction I will turn the call over to Bryan Davis with the detailed financial report. Bryan?

[Bryan Davis:]

Thank you, Brian. During the fourth quarter we earned company FFO of $268 million compared with $242 million for the same period in 2015. On a per unit basis, company FFO for the quarter was $0.38 per unit compared with $0.34 per unit in the prior year, an increase of 12%. A solid operating performance across most business units more than offset the impact of the conversion of foreign income into our U.S. dollar reported results. BPY recorded a net loss attributable to unitholders for the quarter of $62 million or $0.09 per unit compared with net income of $863 million or $1.21 per unit in the prior year. The decrease this quarter relates to fair value losses in our core businesses as uncertainty related to the recovery of energy markets and the political environment in the UK and U.S. led us to reduce our future cash flow expectations in our discounted cash flow models compared with the prior period. Offsetting this in part we saw compression of spreads over the risk free rate, improved investment market, and a reduction in property level risk due to leasing which accounted for a slight decrease in our average discount rates. During the quarter, we had 84 assets across our portfolio externally apprised either to support a transaction, financing, or our reporting process. The aggregated price value of these assets came to $22.2 billion or 10 basis points within our IFRS values. BPY executed on a number of asset sale transactions in the quarter at values in line with our prior period IFRS and resulted in a realized gain of $208 million or $0.29 per unit. The transactions included the sale of interest in 13 core office assets located in the U.S., UK, and Australia, at an average cap rate of 4.3% and realized gains of $195 million. Eight industrial assets in Italy and Spain at an average cap rate of 4.9% and realized gains of over $15 million, seven multifamily assets at cap rates in the low 5%, The Ritz-Carlton in San Francisco added 4.4% cap rate in addition to a number of suburban office assets and retail malls. These realized gains combined with our FFO this quarter provided strong support for our quarterly distribution of $0.28 per unit that was paid at the end of December. In reviewing our Q4 Company FFO in a little more detail the main drivers that contributed to the $26 million year-over-year growth were

[Brian Kingston:]

Thank you, Bryan, and turning to our operating segments, occupancy in the core office portfolio increased 90 basis points in the quarter to 92.3% which is consistent with the end of the prior year. As I mentioned earlier we had a strong volume with execution of over 8.2 million square foot of total leasing in 2016 at rents that were on average 14% higher than the expiring rents. We also made meaningful advancements in the lease up of our active development projects bringing our 7.3 million square foot pipeline to 60% committed. Important lease signed during the fourth quarter was the National Hockey League at One Manhattan West in New York. NHL signed for 176,000 square feet bringing that project to 37% pre-let ahead of delivery in late 2019. Behind that we are in various stages of discussions with tenants representing in aggregate six million square feet of total requirements. Our two near-term deliveries in London are 85% and 71% committed respectively and we are close to signing a third lease at our largest London development 100 Bishopsgate which would bring that 940,000 square foot building to approximately 65% pre-let ahead of its late 2018 delivery. Real estate fundamentals in the majority of our key office markets remain positive. While the London market slowed following the unexpected Brexit outcome in June, it stabilized quickly, and demand for premier quality office products has remained healthy. The outliers to this strength are energy driven markets which remain challenged due to the impact of the price of oil and other commodities. Despite this, we completed over 300,000 square feet of leasing in our Calgary portfolio during 2016, demonstrating why owning the best assets in a market provides great downside protection during challenging markets. As you may have seen last month we submitted a proposal to acquire the minority interest in our Canadian REIT subsidiary Brookfield Office Properties Canada for CAD30.10 per unit. If successful this transaction will allow us to fully integrate our North American operations under BPY further simplifying our structure following on the previous privatizations of Brookfield Office Properties and Canary Wharf. The proposal is currently being considered by a special committee of the Box Board of Trustees and so we are somewhat limited in the comments we can make with respect to this process. We do however believe the all cash offer at a 15% premium to where the units had been trading is an attractive one for Box unitholders and hope to have a successful transaction completed in the first half of the year. Moving on to retail, leasing activity comprised 13.3 million square feet of leasing at average rent spreads 20% over the leases that were expiring. Same-store NOI growth was 5.3% in 2016 and tenant sales were up about 1% to $20.5 billion on a trailing 12-months basis. Same-store occupancy finished the quarter at 96.5%. Although there has been much written about the challenges currently being faced by retailers generally and department stores in particular, we continue to see very high demand from tenants for space in our premier U.S. malls. There is a noticeable difference in investor appetite and operating performance between the best located destination shopping centers and lower quality or poorly located retail locations. In the 125 retail centers owned by GGP are among the top 400 in the entire country. We are anticipating same-store NOI growth that is consistent with 2016 in this business this year. In addition there is capacity for us to invest meaningfully in development and redevelopment initiatives within the portfolio, the strategy that in the past have proven to produce 8% to 10% yields on our cost. As you would have seen in our press release we were active late in 2016 acquiring department store boxes through GGP as well as forming a strategic partnership with Macy's to redevelop a high quality portfolio of their owned stores. Our contrarian investment approach is particularly well suited to finding opportunities in this sector at the moment. Within our opportunistic investments as we have mentioned over the past 12 months we have been allocating an increasing percentage of our capital to these strategies. In April of 2016, Brookfield held a final close of $9 billion for its second global opportunistic fund double the size of its predecessor fund. BPY's commitment to this fund is $2.3 billion and to-date the fund is invested or committed to invest approximately 75% of that capital, and we anticipate having the fund fully invested over the course of 2017. Through our participation in Brookfield sponsored fund strategies we have expanded into new higher growth generating real estate sectors including self-storage, student housing, and manufactured housing. We have also expanded our global investment and operating footprint, accreting to acquire premier large scale projects in Seoul, South Korea, and Mumbai, India. Looking ahead to 2017, I will just give a brief update on our strategic priorities for the year and building on our success in 2016 the goals for this year remain largely the same. We will continue to seek opportunities to enhance the flexibility of our balance sheet by extending the maturity profile of our debt, reducing our floating rate exposure, and seeking avenues to reduce the overall cost of capital. We plan to recycle a further $1 billion to $2 billion of net equity from mature asset sales this year to fund new investments and continue the build out of our development pipeline. We will remain focused on bringing our core office and retail portfolios to stabilized levels of occupancy taking advantage of strong leasing conditions in our key markets. And finally, should our units continue to trade at a significant discount to NAB we will then dedicate increasing resources to buying back our own units. So to recap the year we achieved meaningful earnings growth, improved the balance sheet, and made some strategic investments in new sectors and markets. We are well positioned to further this growth in 2017 and this was reflected in the board's approval of our annual distribution increase. We remain committed first and foremost to delivering 12% to 15% long-term total returns for our unitholders. So with those remarks I'm now happy to open up the line to questions for any analysts and investors. Operator?

[Operator:]

[Operator Instructions]. And our first question comes from the line of Sheila McGrath with Evercore. Your line is now open.

[Sheila McGrath:]

Yes, good morning. I was wondering if you could give us some insights on the investment market perhaps in New York and London in terms of investor demand and pricing for office assets? And then also give us an update on interest level at 245 Park.

[Brian Kingston:]

Sure, so as I mentioned earlier certainly starting with London I guess certainly around the time the Brexit results came out, it was a real slowdown in activity in the market as people started to digest what it means but really just lasted through the summer and coming into September, October we've seen a real pickup in activity. I think a lot of people are looking at London thinking this will be a great buying opportunity. So it's not a unique idea and as a result of that, the transactions that have actually been happening over there have been at very strong cap rates. We actually sold one of our office buildings in the city late in the year that was at a price that was at or a little bit above what we had been expecting to sell it for pre-Brexit. So that's anecdotal with one asset, but the investment market there is very strong. I think in our discussions with various LPs around the world there is a tremendous amount of interest in buying at what people think is may be a favorable time to do that. And so as a result we really haven't seen a noticeable change in activity in London. New York remains I would say probably the most popular destination for capital amongst foreign investors looking to invest, not only in the U.S. but internationally. We are seeing a tremendous amount of demand there. You mentioned 245 Park which is one asset that we're currently in the market for right now, it's a little early to speculate exactly where pricing will come out, but I can tell you that interest has been very high and from a lot of different places around obviously Asia and the Middle East, but there has been a great domestic interest in it, as well.

[Sheila McGrath:]

Okay. And then, Brian, could you give us an update on One Manhattan West, just leasing outlook and what you are seeing on the leasing side?

[Brian Kingston:]

Sure. I will let Ric handle that.

[Ric Clark:]

Yes, hi Sheila.

[Sheila McGrath:]

Hi, Ric.

[Ric Clark:]

Interestingly last year I would say actually slowed down a little bit leading up to the election but once the election was determined activities picked up and we've just seen robust space showings and activity both at Manhattan West and the rest of our portfolio in New York City. We are under discussion with close to 6 million square feet of tenants in most of that targeted at Manhattan West. Clearly we don't have much space, so they're all going to result in leases but activity is strong. So we expect to have more announcements on new leases as the year progresses.

[Sheila McGrath:]

Okay, great. One last quick question. You mentioned in the letter about the payout ratio. And I was just wondering if you could help us with that calculation, the 80%. It's FFO plus gains on sales or where can we figure out that calculation?

[Bryan Davis:]

Sheila, it's just our distributions divided by our FFO that's what our target is on and we just calculated on an annualized basis.

[Sheila McGrath:]

On FFO, okay got it. Okay thanks.

[Brian Kingston:]

Okay, thanks, Sheila.

[Operator:]

And our next question comes from the line of Mark Rothschild with Canaccord. Your line is now open.

[Mark Rothschild:]

Thanks. Maybe just starting with your comments on buyback, Brian, you mentioned that if the units remain well below NAV you'd have -- you'd allocate increasing amounts of capital towards the buyback. Is that, would that be consistent with what you did in the past quarter or should we expect something more significant if this discount to NAV persists?

[Brian Kingston:]

No, look I do think as mentioned over the course of the year as we got more certainty around some of the asset sales et cetera that we were working on, it allowed us to do more in the fourth quarter than we had in the previous years. And I think it's the same for 2017, where we obviously think where the shares are trading right now relative to the value that each of these individual assets has worked, it's a very meaningful discount and certainly a much bigger discount than we can buy new assets at. So we do think it's a good use of that capital. So I would say that, I don't want to predict it quarterly how much we would dedicate toward it, but I do think if the shares stay where they are, we will buy back more shares in 2017 than we did in 2016.

[Mark Rothschild:]

Good, thanks. And you made a comment about converting to a REIT that it's not something that you guys would be able to do right now just because there's uncertainty about some things regarding taxes. Can we infer from that that if there is some resolution or something that changes that makes it work or may be that nothing changes and you see some stability in that regard that it is something you are likely to pursue?

[Brian Kingston:]

You know I think it's little early to comment one way or the other. I do think there will be greater clarity or we are expecting there to be greater clarity over at least the direction of where some of these tax changes are heading fairly early in 2017, it's clearly one of the priorities of the new government. And really I guess the point was it at where we are right now but we don't have that direction and so it would be premature to make a decision based on where the current rules are if they may possibly change over the course of this year. So I think once we get a better sense for the direction that they're heading, we will be in a best position to make an informed decision around that.

[Mark Rothschild:]

Well would it be fair to say that you wouldn't be mentioning this repeatedly you have been asked at the Investor Day as well if this is not something that you are strongly leaning for?

[Brian Kingston:]

I did something that we are actively working on. We don't have a preconceived view one way or the other as to whether we definitely want to do it. It's obviously there are pluses and minuses too, which we've talked about in the past, the index inclusion et cetera we think it would be a net benefit in terms of increasing investor interest in the shares or in units. But there are also limitations on how we operate the business and we really just need that to sort of take all that into account.

[Mark Rothschild:]

Okay. Great.

[Brian Kingston:]

I wouldn't read too much into that we mentioned it twice though.

[Operator:]

[Operator Instructions]. And our next question comes from the line of Mario Saric with Scotiabank. Your line is now open.

[Mario Saric:]

Hi, good morning. Maybe at the risk of beating a dead horse here, just going back to the REIT conversion, Brian, if we put aside the administration's kind of proposed changes to tax, just kind of given the work that the Company has done in the past four months with respect to converting to a REIT, would the odds that you initially placed on a successful conversion being 50/50 have changed significantly based on what you've done in the past four months?

[Brian Kingston:]

No, you are pinning me down to a specific number but I don't think the -- look I don't think anything has changed in our thinking over the past four months that would lead that percentage to change dramatically. I think the issues were well known. There is a -- as far as the structural process to converting, we believe there is a logical path there but it's really some of the other final points that probably drive that decision.

[Mario Saric:]

Okay. And one other potential policy change is just the elimination of the 1031 rollover. Can you talk about how significant or insignificant that may be for your operations in the U.S.? In terms of how about capital recycling and things along those lines?

[Brian Kingston:]

Yes, depending on how long you have we could talk a lot about the implications of some of these. I think 1031 on its own -- the decision to eliminate 1031 on its own is not a standalone decision. There is numerous other changes that come with it, including deductibility of interest and being able to expense acquisitions in the year that they're made. And so I think really the elimination of 1031 really only happens with those other changes and it's logical because those other changes sort of get rid of the requirement to have a 1031. So I would say that in general if some of these changes are made, it is likely going to we think lead to increased transaction activity in the U.S. I'm not sure that that necessarily impacts value one way or the other. But we do think some of the things could lead to greater transaction activity. But I think most importantly are the things we're watching the most closely is obviously the REIT structure is tax beneficial under the current set of rules and with the changes, some of the changes that are being contemplated that may be less true in the future. That's really the certainty we're trying to get more clarity on before we make decisions around some of these things.

[Mario Saric:]

Okay, thank you for the color. That's great. Just may be shifting focus to fundamentals and specifically looking at the office portfolio, if I look at the occupancy it increased quarter-over-quarter in six of your markets and it was flattish in only two. I think as you mentioned your overall occupancy was up 90 basis points quarter-over-quarter. So I'm just wondering if you can may be talk about the level of conviction that you have internally with respect to hitting your previous targeted occupancy of the mid-90s on the office side by the end of 2017, 2018 acknowledging that the portfolio may not be a static one over time?

[Ric Clark:]

Hi, so this is Ric. I would say our confidence level is actually pretty high given the level of activity. As I mentioned just few minutes ago actually it was down for some reason going into the election I guess just political uncertainty, but across the board we've seen a pickup in activity and we've got a lot of discussions going on within our development portfolio as well. So I think there is a good chance of hitting our numbers and of course we will update you quarter-by-quarter as the year goes on.

[Mario Saric:]

Okay. And then I think I heard the discussion pipeline was 6 million square feet. Is that for your entire development pipeline, or is that specifically for One Manhattan West?

[Brian Kingston:]

Yes so that's for New York in general and I would say probably two-thirds of that is geared towards Manhattan West overall. So some of that would be targeted towards One Manhattan West, some potentially the Second Tower and some Five Manhattan West, our existing building that we redeveloped.

[Mario Saric:]

Okay. And then given your commentary on the outlook, is it a fair assumption that the kind of mark-to-market, the strong mark-to-market that we've seen in terms of lease rolls this year, is it a fair assumption to expect a similar mark-to-market next year given your bigger lease expiries at least in the U.S. are in New York as well as Houston?

[Ric Clark:]

Yes, I think that's right, yes. There is no reason to expect it to change much.

[Mario Saric:]

Okay. Then just maybe for Bryan Davis, I just wanted to clarify whether there was any incremental income coming in from Brookfield Place New York that wasn't in the Q4 run rate?

[Bryan Davis:]

Nothing material, Mario, I think as of the end of Q3 we were pretty much at full run rate.

[Operator:]

And our next question comes from Sheila McGrath with Evercore. Your line is now open.

[Sheila McGrath:]

Yes, I wanted to ask you about leverage targets for the year and if kind of -- if that will restrict the amount of shares you buyback?

[Bryan Davis:]

So our leverage target we've talked about on a number of occasions is the 50% range which is just debt to total assets which is effectively what we target at a very high level and is really focused on the fact that we pursue property level financing strategy. We are pretty close to those levels now. We did pay down a fair amount of corporate level debt during 2016 and into the early part of 2017 whether it be subsidiary credit facilities or corporate credit facilities or facilities associated with our fund activities. In addition we repaid our one series of senior unsecured notes in early January. So I think we feel in pretty good position with respect to leverage levels. I don't think that will restrict our ability to pursue things on an opportunistic basis if we find the ability to transact for value we will do that, and our main focus is ensuring that we have the liquidity available to allow us to do that.

[Sheila McGrath:]

Okay. And then on two questions in Europe. London, it looks like that you have three condo projects at Canary Wharf. Just wondering about your confidence level just with the uncertainty in London with those projects. Then also on if you could give us an update on the Berlin property.

[Ric Clark:]

So, Sheila on London we do have a few condo projects going on both at Canary Wharf and at Shell Centre and at Principal Place. And sales have been good, may be they have slowed down a little bit post-Brexit but honestly the product that we have I think is right in the sweet spot of those looking for condos. So we're not expecting any material changes or issues. As far as Berlin goes, progress on the repositioning of that project has also been tremendous, if you recall we bought the project with half the office space empty. I think as of now we're close to 90 with a pretty robust pipeline and in discussions with a number of tenants. So I think this year we will get all the office completely leased, we are in the process of renovating the apartment and re-leasing those. The prior owner had a different strategy of emptying them out, their plan was to sell them as condos. We've reversed course. So I think by the end of the year we will make great progress leasing those apartments backup again. The only thing really left to do there is to finish our planning for the redevelopment of the retail part of the project and that's underway. So we should have a plan in the next few months.

[Sheila McGrath:]

Did you do any major changes to get the office occupancy up so more than the previous owner?

[Ric Clark:]

Honestly we didn't. I think two things we had going for us. One is just our relationships with tenants around the world, I think really helpful. There were a couple of tenants in the project that were in the process of leaving that we convinced because of our relationships with them only to stay but to expand. So that was good and I think just being completely honest the market sort of changed right as we entered the market, so we have a lot of good strong wind at our back which was helpful as well.

[Operator:]

And our next question comes from the line of Mario Saric, Scotiabank. Your line is now open.

[Mario Saric:]

Hi, thank you. Sorry, just one follow-up question on the quarter for Bryan Davis maybe, the Hurricane Matthew, can you quantify what kind of an impact that may have had on an FFO basis on a year-over-year basis in terms of lost revenue and increased cost during the quarter?

[Bryan Davis:]

It was $4 million in aggregate, about $1 million at our share, but there was downtime associated with it as well that's not quantified in that number.

[Operator:]

And I'm showing no further questions at this time. I would like to take the call back over to Mr. Brian Kingston.

[Brian Kingston:]

Thank you everyone for joining the call again this quarter and we look forward to updating you again in future. Have a good day.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.