DTLA - DTLA Holdings

[SugarRE]

I am unfortunately holding the bag on this on...but eagerly watching Bulldog:

 

https://specialopportunitiesfundinc.com/wp-content/uploads/sites/40/2020/02/SOF-Annual-f.pdf

 

[BG2008]

Shamingfully raising my hand as another bag holder, luckily at a very small position

[petec]

Very tempted here...

[SugarRE]

In the lane of using other folks work, does anyone have insight into Bulldogs thoughts? 

 

Also, I'm pretty sire these are held in BPY, and therefor there is no selling pressure from a fund life standpoint.

[johnny]

In the lane of using other folks work, does anyone have insight into Bulldogs thoughts? 

 

Also, I'm pretty sire these are held in BPY, and therefor there is no selling pressure from a fund life standpoint.

 

Capital securities – fund subsidiaries includes $820 million (December 31, 2018 - $775 million) of equity interests in Brookfield DTLA Holdings LLC (“DTLA”) held by co-investors in the fund, which have been classified as a liability, rather than as non-controlling interest, as holders of these interests can cause DTLA to redeem their interests in the fund for cash equivalent to the fair value of the interests on October 15, 2023, and on every fifth anniversary thereafter.

 

https://www.sec.gov/Archives/edgar/data/1545772/000154577219000015/bpyex991q32019.htm

 

That said, most ways I try looking at this security make it feel pretty bad.

 

Redemption is now over $45/share, accumulating $1.90/year. That doesn't quite make it the -cheapest- source of capital on the balance sheet, but the longer it stays there, the better it gets.

 

If I could take out capital with an interest rate starting at 4.2%, with the option to PIK the interest, and with the interest rate on the new principle being 0%, I'd max that card out and bend over backwards to avoid accidentally triggering paying for the rest of my life.

 

Why should it be any different here? Surely the big brains at Brookfield could figure out a way to achieve Value Realization for their actual clients/partners in 2023 without actually losing half a billion dollars to a couple of dipshits who have been wasting their time every year asking to scrutinize the receipts on the lobby enhancements to the Wells Fargo building. No?

[COBFInfinity]

If I could take out capital with an interest rate starting at 4.2%, with the option to PIK the interest, and with the interest rate on the new principle being 0%, I'd max that card out and bend over backwards to avoid accidentally triggering paying for the rest of my life.

 

Why should it be any different here? Surely the big brains at Brookfield could figure out a way to achieve Value Realization for their actual clients/partners in 2023 without actually losing half a billion dollars to a couple of dipshits who have been wasting their time every year asking to scrutinize the receipts on the lobby enhancements to the Wells Fargo building. No?

 

Your question is why will DTLA preferred get any better treatment than MPG preferred got in 2013? Are preferred shareholders stuck indefinitely with a non-compounding security that gets worse the longer it is outstanding? Bulldog's pressure doesn't hurt, but I doubt it really matters. After all, there were MPG preferred holders on that board and it didn't get a good deal for preferred stock in the buyout.

 

Due to the capital structure, however, I have voted with my money that DTLA preferreds will be paid at some point (unfortunately, I have voted with my money mostly in prior years at $20-21/share.)

 

A hypothetical liquidation analysis (most likely thanks to Bulldog!) was provided two years ago, see page 23 here (https://www.dtlaofficefund.com/~/media/Files/B/BrookField-DTLA/reports-and-filings/DTLA%20Pref%20Investor%20Day_May%202018%20FINAL.pdf)

 

Following this liquidation analysis, what might it look like today? I have no specialty in commercial property and don't have an idea how much impact the pandemic has had on values, so for demonstration purposes I will assume that the gross real estate value is unchanged for the DTLA properties relative to the 12/31/17 estimates. In reality, I bet they are down, but I just don't know any better at this point. It's all guesswork until some actual large transactions start occurring post-pandemic, but feel free to opine if you have a better sense. Like I said, this is just for demonstration.

 

So here's my hypothetical right now with the rest of the liability values as of 3/31/2020.

Real Estate Value  $3,623,000

Mortgage Debt      -$2,288,865

Senior B Pfd            -$186,090

Series A Pfd              -$433,117

Series A-1 Pfd          -$422,332

Remaining Cash          $292,606

 

So this is the obviously bad news - the common equity value has most likely dropped at least 50% from 2 years ago. (Just as a sensitivity analysis, if the Real Estate Value has actually fallen 10%, the common equity is $0.) No surprise that the preferred stock has also dropped 50% then.

 

But here's where the twist comes in on the now less valuable capital structure. Brookfield DTLA Holdings owns 100% of the Senior B Pfd (which is pretty secure unless the real estate value really collapses), a small portion of the publicly traded Series A Pfd (whatever they tendered for in 2013, maybe 5%?), 100% of the Series A-1 Pfd, and 100% of the common equity.

 

So assuming that the common equity has dropped a lot (seems like a safe assumption) or possibly is just a call option at this point, it would sure seem that Brookfield's incentives will shift towards maximizing the value of the A-1 preferred, and not the common equity value.

 

So what is this Series A-1 preferred? It is a non-public pari passu issue with the publicly traded Series A preferred! It is in exactly the same boat as we are in - dividends are being deferred and the longer this happens before dividend payments resume, the lower the IRR to the owner. Clearly, Brookfield has some internal calculus that weighs their desire to improve the IRR on both the Series A-1 preferred and the common equity, and there is potential tension here because maximizing the Series A-1 preferred return with an earlier payoff may be detrimental to the common value. But my logic says that today, with the Series A-1 value likely much higher than the common, Brookfield's incentive should be to capture the value on the A-1 as soon as they reasonably can. And the key point for all of us is that if they do that, all of us in the publicly traded preferred HAVE to be along for the same ride since the issues are pari passu.

 

So this incentive structure is why I'm sticking with this holding at about 25% of liquidation value. There are some real practical questions as to how and when they will be able to execute this and I don't have great insight about that. But let's consider the hypothetical concern we'd all have is that the DTLA preferred gets "MPG'ed" by having the entire portfolio sold to some other entity in the years to come. In such a case, it seems implausible that Brookfield would let their own A-1 preferred shares get stranded in a non-paying security subject to the whims of the new owner. They will want to get cashed out. And if they do, we have to get cashed out on the same terms.

[Philbert77]

COBFInfinity - thanks for the well written post. I think you made some strong points. There are a number of investors far smarter than me that are convinced that this will pay out eventually (Bulldog, East 72 Holdings).  I don't think the opportunity would be here ($10 on a $40 redeemed value) if there was no/little risk.  I will continue to hold and hope to cash out someday.

[COBFInfinity]

There certainly are risks. What if property values are really -20%? That would only leave $20/share for the preferreds before accounting for operating expenses and liquidation costs. It will take some time to see how prices for large office buildings like these shake out.

[Scunny Bunny]

The two crucial words in COBFInfinity's analysis are pari passu (side by side). However, the biggest risk is Brookfield putting more $$$ in via senior debt, which is possible.  Obviously, one would have to ask why they would put more $$$ in ahead of their existing preferred stock.  Clearly COVID has changed the math, but to what extent, we don't really know.  Maybe some residential conversions in DTLA might work......

[COBFInfinity]

The two crucial words in COBFInfinity's analysis are pari passu (side by side). However, the biggest risk is Brookfield putting more $$$ in via senior debt, which is possible.  Obviously, one would have to ask why they would put more $$$ in ahead of their existing preferred stock.  Clearly COVID has changed the math, but to what extent, we don't really know.  Maybe some residential conversions in DTLA might work......

 

There's certainly a chance that they play games to get around the pari passu issue. But I simplify it to two cases: a) there is common equity and b) there is no common equity.

 

If there is common equity, sticking more high yielding senior debt in the capital structure will eat away at common value first, and only if the subsidiary becomes insolvent does Brookfield "win" by impairing the preferred stock. Keep in mind that Brookfield owns 47% of this, while co-investors own 53%, so I think it would be quite a challenge to execute this. Are these investors, all together, going to want to commit another $500 million to $1 billion of new money on what has become an even riskier investment, that will kill the IRR on their previously committed capital, just to screw us little guys? Is that the best use of their capital in the next few years? If Brookfield alone wanted to fully fund this senior debt without the co-investors, it would be screwing it's co-investors before us, and that is something they probably do care about.

 

If there is no common equity, then consider new senior debt a DIP-style loan. Preferreds would be impaired, but that's to be expected at that point. That's why it would be really nice to know just what these properties are worth now and what the post-COVID 19 office space world looks like. It seems likely that these DTLA properties will be down much more than the national average, so are we already at a point where the common equity is gone? And if so, what would Brookfield and it's partners want to do in such a scenario: liquidate and get whatever they can out or keep it going for another 5-10 years hoping for the call option to get back into the money?

[petec]

A few thoughts and questions.

 

Haven't Brookfield been investing in upgrading these properties/building new ones onsite? Capex has been high so I assume so. If so, and given lower rates, is there a chance that GAV has held or risen despite Covid?

 

How does this senior bond idea work? If the bond does not come from the existing owners, their investment is destroyed. BAM won't do this because a) it is one of the existing owners and b) it will never screw over its co-investment partners or its entire business model goes up in smoke. So the bond must come from the existing owners. Why would they put more cash in? Effectively they would be assuming the mortgages on their own properties (every other use of proceeds simply increases the value of the trapped equity). I do not see how this increases their IRR or accelerates their net cash flows, which are the two outcomes they might seek. What am I missing?

 

As I see it the risk is the entire capital structure, bar the traded prefs, is sold to another investor - who then faces the same dilemma.

 

I was not interested here when the potential return was 2x.

 

But 4x... Hmmm.

 

 

[bizaro86]

One possibility would be they put in some sort of mezz debt at say 14%. That is a great investment for the common owners and transfers value to the new mezz debt from the equity. If they did enough they could transfer all the value from the prefs to new debt.

[COBFInfinity]

One possibility would be they put in some sort of mezz debt at say 14%. That is a great investment for the common owners and transfers value to the new mezz debt from the equity. If they did enough they could transfer all the value from the prefs to new debt.

 

I think I addressed that 2 posts up. If the mezz debt owners are the same as the equity owners, what would be the point?

[petec]

One possibility would be they put in some sort of mezz debt at say 14%. That is a great investment for the common owners and transfers value to the new mezz debt from the equity. If they did enough they could transfer all the value from the prefs to new debt.

 

I think I addressed that 2 posts up. If the mezz debt owners are the same as the equity owners, what would be the point?

 

Exactly. The IRR on the total investment, including both the original and the new, would be poor.

[bizaro86]

One possibility would be they put in some sort of mezz debt at say 14%. That is a great investment for the common owners and transfers value to the new mezz debt from the equity. If they did enough they could transfer all the value from the prefs to new debt.

 

I think I addressed that 2 posts up. If the mezz debt owners are the same as the equity owners, what would be the point?

 

Exactly. The IRR on the total investment, including both the original and the new, would be poor.

 

I think the only way it works is if the mezz owners are the same as the common owners. Otherwise Brookfield is too conflicted. The point would be to transfer money from the public pref owners to the owners of the common/mezz debt.

 

The common would take the first losses, but if you did it in size you could wipe out the common and prefs. So the former owners of the common would now have all the value of the capital structure.

 

Basically, you could put in debt where $1 in spits out $1.50 in NPV. It's a zero sum game so that money is coming from the equity holders. The original common is a sunk cost here, so transferring value from prefs to common holders is in the best interest of the holders of the common.

 

Probably it depends on their view of value in the structure. If they think the common is already meaningfully impaired then using this opportunity to impair the prefs makes sense. If they think the common is still well in the money it probably doesn't make sense.

[realassetsvalue]

The Downtown LA office market has majorly lagged West LA this cycle (and arguably every cycle), which plus the complications around the preferred interests and waterfall, made me put this in the "not worth figuring out the complicated part" pile at 50% of redemption value like many others. At 25% of redemption value, took another look.

 

I quickly put together a terribly formatted basic excel sheet, which is attached, if anyone is interested.

 

In summary, I think it goes back to the not worth exploring pile for me unless someone has a view that the DTLA market will be very different and better over the next 5 years than it has for the last 5 years.

 

What Brookfield has achieved since 2014

Annualized rent was $145m in 2014 and is at $166.2m at Q1 2020. I calculate NOI at $148.2m in 2014 and $154.6m in Q1 2020. The 2020 figure is on a straight-line basis, strip out c. $10m of straight line rents a year gets to ~$145m of annualized NOI at Q1 2020.

 

Effectively NOI has been flat / less than 1% CAGR over the last 6.5 years.

 

Mortgage debt up marginally from $2.1 billion to $2.2 billion over the period but I was too lazy to figure out (A) How much cumulative CAPEX has been spent on the project and (B) what the increase in Series B preferred outstanding has been to figure out how much capital beyond cash flow has been required.

 

Valuation

The current Series A price of about $11.15 a share implies an Enterprise Value of c. $2.6 bn, which is a GAV PSF of $342 PSF and cap rate of 5.6%. This is conservative in at least one sense as I haven't ascribed any value to the minority interest in the 755 S Figueroa residential project, which is a JV with the mother ship (Brookfield). I didn't easily see what DTLA's interest in the project is or any indication of what value to ascribe - I have been lazy and assume it won't move the needle compared to their wholly owned office properties

 

Annual funds from operations is about $40m, which would almost cover my estimate of normalized recurring CAPEX of 30% of cash NOI (just a rule of thumb for offices). However, in the Q1 2020 10-Q they state that they expect to spend ~$390m on CAPEX / leasing costs over the next 5 years or ~$78m a year - about twice both their current FFO and "normalized CAPEX".

 

Since they'll need more CAPEX capital beyond operating cash flows, if we assume they full draw down the ~$110m of future funding they have in their mortgages and at their option on the Series B, this results in a "fully drawn" enterprise value of $2.7bn, which increases GAV PSF to $357 PSF and the implied cap rate moves down to 5.3%. Furthermore they'll still need to raise at least another $80m of capital from somewhere ($390m CAPEX - $200m of cash flow (5 years @ $40m a year) - $110 of future funding available).

 

Comparable

I'd compare this to Douglas Emmett (DEI), which owns office and multifamily in West LA (the good part) and Honolulu. At $30 per share, I calculate that this trades at a 5.9% cap rate and generates $1.90 per share in cash flow after recurring CAPEX that's available for dividends / acquisitions / redevelopment projects, etc. Arguably, COVID-19 recession pain is not baked into DEI's numbers yet but the same can be said for DTLA.

 

In addition, DTLA's net debt to cash EBITDA is somewhere around 15x. This is very high. DEI's net debt to EBITDA is ~5.7x

 

The 4x upside on the preferred seemed to indicate a potential mis-pricing of the assets but I just don't see it at these numbers. What am I missing?

 

The other piece of info that I haven't seen highlighted here from 10-Q is that DTLA repurchased c. $7m of the Series B in Q1 2020. What could possible rationales be behind this move? It would seem to me to indicate that Brookfield is not trying to impair the Series A / A-1 but perhaps there are other elements at play?

DTLA_BasicValuationWorking.pdf

[COBFInfinity]

Thanks for the response, Realassetsvalue. I'm not going to debate your numbers, because as I said I don't have a good idea what the current cap rate should be. However, based on your analysis, it sounds like this entire venture was already a colossal failure by Brookfield even before the coronavirus hit if not even the preferreds are in the money. Is that your take?

[realassetsvalue]

Thanks for the response, Realassetsvalue. I'm not going to debate your numbers, because as I said I don't have a good idea what the current cap rate should be. However, based on your analysis, it sounds like this entire venture was already a colossal failure by Brookfield even before the coronavirus hit if not even the preferreds are in the money. Is that your take?

 

I wouldn't pretend to fully understand the original deal and what Brookfield's / its institutional JV partners' cost basis is as I haven't done the work so I wouldn't go as far as colossal failure but they definitely haven't managed to meaningfully increase occupancy and NOI over the last 6 years. They've done a lot of work and spent a lot of dollars to add value but haven't been able to really outperform the DTLA market much. I think its a case of a great operator taking a non-consensus view on a poor office market and the poor office market winning out.

 

The preferreds may be in the money - its not impossible someone would come along and pay a 5% or 4.75% cap for the portfolio. But I struggle to pencil out a valuation for the real estate that makes sense that fully redeems the A / A-1s - would have to either be a c. 4.25% cap (you can buy Santa Monica office properties for this) or a lot of value from the minority interest in the residential JV along with a sub 5% cap rate.

 

I think it felt like an interest situation but there is higher quality real estate out there in public markets at a cheaper price and without the risk of Brookfield finding a way to avoid paying you... But I'd love to hear alternative views.

 

 

[sundin]

A Refinance that was done this month.

 

"The 10-year non-recourse loan has a fixed rate of 2.44 percent and requires monthly interest-only payments"

 

"L.A.’s downtown office submarket — the city’s largest, holding just under 19 percent of total office inventory — registered an average vacancy rate of 14.1 percent and an average rent of $43.50 per square foot in the fourth quarter of last year, Fitch wrote, citing data from research firm Reis. With that, City National Plaza’s current vacancy rate comes in just above the submarket average while its average gross rent rate per square foot of $47.07 is in line with existing Class A and Class B product comps in the area. "

 

https://commercialobserver.com/2020/05/massive-downtown-la-office-complex-gets-550m-cmbs-refinance/

 

DTLA can defease about ~ $400 million without prepayment penalty, their current weighted interest rate is 3.65%. This should add value.

 

Not sure what the typical prepayment penalty is but maybe its worthwhile trying to refi everything at this point if capital is available.

 

 

 

 

 

 

[realassetsvalue]

That's a good comp, sundin, thanks for sharing it. Below is a link to the KBRA pre-sale report for that deal which I found for anyone who wants to dig further into the numbers of this building / CMBS deal and draw out the market data.

 

https://www.krollbondratings.com/documents/report/33457/cmbs-msc-2020-cnp-pre-sale-report

 

I personally can't imagine that anyone would pay the price of the appraisal $1.3bn ($530 PSF), which is a ~4% cap on 2019 NOI of $52.2m. Based on the debt in place, that price would result in a 5.15% property-level leveraged cash flow yield before CAPEX (NOI less debt service) on the $750m of equity.

 

The existing owners bought it for $858m ($340 PSF) in 2013 and invested $193m in CAPEX since then ($77 PSF) according to the doc, putting their total cost basis at $1.05 bn ($417 PSF), a ~5% cap. Their property-level leveraged yield on cost before CAPEX would be ~7.7% on $500m of equity. That doesn't seem like a terrible return

 

However, given they've had to historically invest ~$27.5m of CAPEX a year, which appears to be close to all the cash flow the building has produced, and have also seen NOI and occupancy basically flat over the last 5 years, I am guessing it has not been a great IRR for them.

[sundin]

Thanks for sharing that report. It seems that issuer placed a 4.69% cap rate on the deal which is in line with what you're saying however KBRA is valuing it at 7.75% cap rate. A bit of a disconnect here.

 

I'm not sure that the appraisal will change for DTLA either from the lenders point of view. Institutions that have strong access to capital are generally trusted with their forecasted rent and plan to increase cash flow.

 

The DTLA transaction was valued at $2.1 billion in 2013 with a total of 7,580,957 sq feet. This current debt issue values the City National Plaza at $1.3 billion for 2,519,787 sq feet.

 

Any one have asset specific detail?

[sundin]

....Stock is up ~35% on odd 6% of total shares traded in 2 days last week.

[petec]

....Stock is up ~35% on odd 6% of total shares traded in 2 days last week.

 

Total speculation, but I was wondering last week if this might be one of the subsidiary debt instruments BPY commented they might buy back if they got cheap enough...

[COBFInfinity]

Total speculation, but I was wondering last week if this might be one of the subsidiary debt instruments BPY commented they might buy back if they got cheap enough...

 

Can you point to a transcript on that? Technically not debt either way, but they've also got preferreds BPYPN, BPYPO, BPYPP, BPYUP still trading at healthy discounts to par.

[SugarRE]

Has anyone gained insight from Bulldog?  From credible market sources I've heard that B is not going to pay .