So BPO preferreds got hammered again today, with losses of about 10% of market value and will doubtless dominate the list of new 52-week lows reported in the Globe tomorrow, as they have done for the past two weeks.
So, what’s going on?
It seems to have started with a SEC filing by Brookfield DTLA Fund Office Trust Investor Inc.:
Subsidiaries of Brookfield DTLA Fund Office Trust Investor Inc. (the “Company”) have secured loans of $465.0 million on Gas Company Tower, comprised of a $350.0 million mortgage loan, a $65.0 million mezzanine loan and a $50.0 million junior mezzanine loan (collectively, the “Gas Company Tower Loans”). There is $465.0 million currently outstanding under the Gas Company Tower Loans. The initial maturity date of the Gas Company Tower Loans was February 9, 2023, with three one-year extension options. The Company did not exercise the option to extend the maturity of the loans and therefore, on February 9, 2023, the Gas Company Tower Loans matured, and an Event of Default (as defined in the underlying loan agreements) has occurred and is continuing. The lenders may exercise their remedies under the loans, including foreclosing on Gas Company Tower. As of the date of this filing, the lenders have not exercised any of their remedies under the Gas Company Tower Loans
Other Subsidiaries of the Company have secured loans of $318.6 million on 777 Tower, comprised of a $268.6 million mortgage loan and a $50.0 million mezzanine loan (collectively, the “777 Tower Loans”). There is $288.9 million currently outstanding under the 777 Tower Loans. The Company did not obtain an Interest Rate Protection Agreement (as defined in the underlying loan agreements) which constitutes an Event of Default (as defined in the underlying loan agreements). Wells Fargo Bank, National Association, as Administrative Agent for the lenders under the mortgage loan, has notified the relevant subsidiary of the Company that defaults and potential defaults have occurred under the loan and that the lenders have the right to exercise their remedies under the 777 Tower Loans, including, without limitation, declaring the debt to be immediately due and payable and foreclosing on 777 Tower. As a result of the default under the mortgage loan, an Event of Default (as defined in the underlying loan agreements) has occurred and is continuing under the mezzanine loan. As of the date of this filing, the lenders have not exercised any of their remedies under the 777 Tower Loans.
This was picked up by Business Insider in a 2023-3-30 story later syndicated to Yahoo:
Gas Company Tower was once a gleaming model of downtown America’s ascendancy. Located squarely in Los Angeles’ central business district, the 52-story skyscraper has a strong pedigree. It’s home to a collection of major corporate tenants, including the Southern California Gas Company, the white-shoe law firm Sidley Austin, and Deloitte, one of the Big Four accounting firms. Its owner, Brookfield, is an $800 billion investment firm known for its blue-chip portfolio of real-estate assets. The tower’s lobby even had a Hollywood cameo when it was featured in the opening shot of the 1994 film “Speed.”
More recently, though, the glassy office property has become an example of the alarming financial turmoil that is engulfing once-bedrock real-estate assets. Brookfield disclosed in a February filing that a subsidiary it controls had defaulted on $753.9 million worth of debt tied to the tower and another nearby office building — one of the largest since the great financial crisis. But as Brookfield grapples with its lenders, it’s also facing a potential exodus of the building’s most visible occupants.
The Southern California Gas Company, the Gas Company Tower’s namesake tenant, is in the market to relocate its 360,000 square feet at the property. Sidley Austin, which has about 136,000 square feet in the 1991-vintage building, is also prowling the market for new space, according to two people with knowledge of both tenants’ real-estate decision-making. Spokespeople for Sidley and Brookfield declined to comment. A spokesperson for the Southern California Gas Company did not reply to a request for comment.
This report was further fleshed out by RealDeal:
Brookfield has admitted one of its trophy office towers in Downtown L.A. has lost a quarter of its value, thanks to L.A.’s new transfer taxes.
The investment firm wrote down the value of its 45-story office tower at 355 South Grand Avenue — the South Tower of the Wells Fargo Center — by $111 million, according to an annual report released by Brookfield’s entity that owns six office buildings and one retail center in Downtown L.A.
The publicly traded fund, called Brookfield DTLA Fund Office Trust Investor, blamed the writedown on Measure ULA — the City of L.A.’s new transfer tax that will take 5.5 percent from all commercial and residential sales that trade for more than $10 million, according to its report.
The writedown marks the first time Brookfield has drastically cut the value of one of its Downtown L.A. holdings, which have been affected by the dual triggers of high vacancy rates and high interest rates.
The connection is explained by another helpful SEC filing:
This information statement (“Information Statement”) is being furnished by Brookfield DTLA Fund Office Trust Investor Inc., a Maryland corporation (the “Company”, “we”, “our” or “us”), in connection with the Annual Meeting
…
As of the Record Date, Brookfield DTLA Holdings LLC, a Delaware limited liability company (“DTLA Holdings”, and together with its affiliates excluding the Company and its subsidiaries, the “Manager”), was the holder of all of the issued and outstanding shares of Common Stock.
DTLA Holdings is an indirect partially- owned subsidiary of Brookfield Property Partners L.P. (“BPY”), one of the world’s premier real estate companies and a subsidiary of Brookfield Asset Management Inc. (“Brookfield Asset Management” or “BAM”), a leading global alternative asset manager with approximately $750 billion in assets under management. DTLA Holdings is entitled to vote on the election of five directors, the ratification of the selection of Deloitte & Touche LLP as the Company’s independent registered public accounting firm and on each other matter properly presented at the Annual Meeting. As of the Record Date, there were 1,000 shares of Common Stock outstanding.
DTLA has a balance sheet that is … interesting. Negative equity for the common shareholder, just barely outweighed by the ‘mezzanine equity’ of the preferred shares issued by the company, and 2.3-billion in debt secured by assets with a stated value of 2.5-billion. Succinctly:
Brookfield DTLA’s business requires continued access to adequate cash to fund its liquidity needs. The amount of cash Brookfield DTLA currently generates from its operations is not sufficient to cover its investing and financing activities, including upcoming debt obligations, leasing costs and capital expenditures, without issuing additional debt or equity, resulting in “negative cash burn,” and there can be no assurance that the amount of Brookfield DTLA’s negative cash burn will decrease. If Brookfield DTLA’s operating cash flows and capital are not sufficient to cover its operating costs or to repay its indebtedness as it comes due, we may issue additional debt and/or equity, including to affiliates of Brookfield DTLA, which issuances could further adversely impact the amount of funds available to Brookfield DTLA for any purpose, including for dividends or other distributions to holders of its capital stock, including the Series A preferred stock. Given the uncertainty in the economy, current office leasing volume and volatile financial markets created by the continued rise in interest rates and the Company’s upcoming debt maturities, management believes that access to liquidity will be challenging and is planning accordingly. We are also working to proactively address challenges to our long-term liquidity position. However, if uncertainty in the economy and financial and leasing markets do not improve, or the Company is not able to find additional sources of liquidity, the property-owning subsidiary debt obligors may not be able to successfully refinance the debt obligations when they fall due, which could result in foreclosure on the encumbered properties.
A mess, and now the company has announced:
Brookfield DTLA Fund Office Trust Investor Inc. (the “Company”) announced today that its board of directors (the “Board”) has approved the voluntary delisting of the Company’s 7.625% Series A Cumulative Redeemable Preferred Stock, $0.01 par value per share (the “Preferred Shares”) from the New York Stock Exchange (the “NYSE”). The Board believes that its decision to delist and deregister the Preferred Shares will better enable the Company to maximize value for all stakeholders, including the holders of the Preferred Shares. The Company also gave notice to the NYSE of its intent to voluntarily delist the Preferred Shares and to withdraw the registration of the Preferred Shares with the Securities and Exchange Commission (the “SEC”). The Preferred Shares are currently listed on the NYSE under the symbol “DTLA-P.”
…
The delisting and deregistration of the Preferred Shares will not have any impact on the terms or conditions of the Preferred Shares, including the dividends payable on the Preferred Shares and the rights granted to holders of the Preferred Shares to appoint two directors to the Board under certain circumstances. After the delisting and deregistration of the Preferred Shares, the Company intends to continue to make unaudited annual and quarterly financial statements available to investors. The Company also will seek to have the Preferred Shares quoted on the Pink Sheets Electronic Quotation Service (the “Pink Sheets”) in the OTC Pink Limited Information marketplace, although it cannot provide any assurance that any broker-dealer will make a market in the Preferred Shares, which is a requirement for Pink Sheet quotation.
So it’s a mess, but misery loves company and there’s a lot of love in the air:
The humdrum business of renting out offices and stores is suddenly in the spotlight as property experts and economists warn that growing problems in U.S. commercial real estate could trigger a new financial crisis.
Among the people raising alarms is Scott Rechler, chief executive officer of RXR Realty, a large property manager in New York, and a director of the Federal Reserve Bank of New York.
In a Twitter thread last week, Mr. Rechler warned that US$1.5-trillion in commercial real estate debt will mature over the next three years. Most of it was taken out when interest rates were near zero.
…
Somewhat similarly Neil Shearing, group chief economist at Capital Economics, warned that a “doom loop” could emerge in which falling commercial real estate values feed back into the U.S. banking system, choking off lending and creating further declines in commercial property prices.
…
Still, it’s far from certain that the worst case will materialize.
For one thing, the commercial real estate sector is made up of several distinct subsectors. While office and retail landlords are struggling, some other areas, such as industrial properties, have held up just fine, while still others, such as hotel properties, are actually seeing conditions improve as the economy reopens and travel resumes.
Taken as a whole, the commercial real estate sector doesn’t look so bad. Delinquent mortgages – that is, those on which payments have been overdue for at least 30 days – are rising in number, but the statistics are still a long way from panic levels.
In February, 3.12 per cent of U.S. commercial mortgages were delinquent, according to data tracker Trepp Inc. That is slightly higher than the 2.98 per cent recorded six months earlier but far below the record 10.34 per cent recorded in July, 2012.
OK, so the owners are keeping their mortgages current – for now – but some of them will be struggling to do so. And meanwhile:
Slate Office REIT is slashing its monthly distribution by 70 per cent, making it Canada’s second publicly traded office building owner to cut its payout in the span of three weeks as vacancies rise and higher interest rates bite.
Slate, which owns office properties in Canada and the United States but derives half of its operating income from the Greater Toronto Area and Atlantic Canada, slashed its distribution to 1 cent per unit monthly from 3.3 cents after a strategic review. Slate’s units, which trade on the Toronto Stock Exchange, dropped 25 per cent Wednesday and are down 43 per cent this year.
True North Commercial, which owns office properties across Canada but focuses on Ontario, slashed its own distribution by 50 per cent in mid-March. The REIT is run by Daniel Drimmer, one of Canada’s largest property owners through a mix of private and publicly traded businesses. Like Slate, True North’s unit price also tanked after the decision and its units are now down 45 per cent this year.
Higher interest rates have weighed on most real estate investment trusts because they carry mortgages often amounting to between 50 per cent and 60 per cent of their property values. Like homeowners, REITs usually only face higher rates when their mortgages come up for renewal. But some, such as Slate, had sizable exposure to variable-rate mortgages.
Me, I blame millennials:
Canada’s downtown office vacancy rate reached 19 per cent in March, with Toronto and Vancouver driving the trend as the shift to hybrid work pushes more businesses to give up office space.
The level of vacancies was nearly double the 10.8 per cent in downtown markets before the start of the pandemic, according to new data from commercial real estate firm Altus Group. The 19-per-cent vacancy rate was a record high since 2003 when Altus started collecting data. It surpasses other tumultuous periods in the office market, including the oil price crash in 2014 when energy companies cut jobs and slashed their corporate offices.
…
Three years after governments required workers to stay at home to stop COVID-19 from spreading, employees have embraced remote work and are shunning workweeks of five days in the office. That is particularly the case for tech workers who generally have had more freedom to work from home.
“Less people are coming in and less space is needed,” said Colin Scarlett, executive vice-president with commercial real estate firm Colliers in Vancouver. “Employees don’t believe they need to be in the office. As a result, the employer has been delicate on the return to the office.”
So am I pushing the panic button here? First of all, take a look at the most recent affirmation of BPO’s & BPY’s rating by DBRS:
The ratings continue to be supported by (1) the Partnership’s robust access to liquidity of $4.7 billion, consisting of $2.0 billion in cash and cash equivalents and $2.7 billion available on credit facilities at December 31, 2021; (2) financial flexibility afforded by nonrecourse mortgage debt and no unsecured maturities until July 2023 when the CAD 500 million Series 1 Senior Unsecured Notes come due; (3) DBRS Morningstar’s view of implicit support from BAM; (4) BPY’s market position as a preeminent global real estate company; and (5) high-quality assets, particularly its Core Office segment, with long-term leases in place and large, recognizable investment-grade-rated tenants. The ratings continue to be constrained by BPY’s weak financial risk assessment as reflected by both its highly leveraged balance sheet and low EBITDA interest coverage (1.28x at the last 12 months ended December 31, 2021); a riskier retail leasing profile in terms of lease maturities and counterparty risk relative to BPY’s Core Office segment; a higher-risk opportunistic Limited Partnership Investments segment composed primarily of hotel, office, retail, and alternative assets; and DBRS Morningstar’s assessment of the unmitigated structural subordination of the Senior Unsecured Debt at the BPP level relative to a material amount of debt at its operating subsidiaries.
DBRS Morningstar would consider a negative rating action should BPY’s operating environment fail to improve as expected such that total debt-to-EBITDA remains above 16.0x, on a sustained basis, all else equal, or if DBRS Morningstar changes its views on the level and strength of implicit support provided by BAM. On the other hand, DBRS Morningstar would consider a positive rating action should DBRS Morningstar’s outlook for BPY’s total debt-to-EBITDA improve to 13.0x or better.
Trouble is, that affirmation is just over a year old now, and much has changed in the interest rate world since then. On a better note, S&P performed an Annual Review For Brookfield Property Partners L.P. dated 2023-2-1 and took no action.
Meanwhile BPY’s balance sheet still looks reasonable, with limited partners supplying about 8.1-billion in equity; total equity, including preferred shares and non-controlling interests, is 41.7-billion supporting 112-billion in assets. The limited partners actually recorded a small loss in 2022, as the available net income was scooped up by the non-controlling interests, but in 2022 there were substantial net sales of assets, net payments of debt and an increase in cash.
So, I’m concerned but I’m not panicking. One of Brookfield’s great strengths is actually being shown off by the DTLA problem: a lot of the debt is secured by the properties with no recourse to the company and – as may be shown by the DTLA situation – they are not averse to cutting their losses on a given investment and sending jingle-mail to the mortgage holders.
Affected issues are BPO.PR.A, BPO.PR.C, BPO.PR.E, BPO.PR.G, BPO.PR.I, BPO.PR.N, BPO.PR.P, BPO.PR.R, BPO.PR.T, BPO.PR.W, BPO.PR.X and BPO.PR.Y.
Updatd, 2023-4-6: Those fortunate enough to have a copy of the August, 2022, PrefLetter on hand will have noted that as of 2022-7-29, CPD had a weight of about 3.8% in BPO preferreds. It’s actually more than that, since my analysis ignored the “Brookfield Property Preferred Pref”, BPYP.PR.A, with a portfolio weight of 1.50% (massive!), since it is a US-Pay issue and shouldn’t be in the TXPR index at all, according to me. As of 2023-4-5, this issue had a portfolio weight of 1.44%, so the total BPO weight in CPD is over 5% (before recent markdowns, anyway!). I consider this level of holding to be imprudent for an issuer of this credit quality, but then I consider the total level of Pfd-3 holdings in CPD to be imprudent. It’s not their fault, they’re reflecting the market, just like they’re supposed to do … but the market remains distorted by the issuance boom of ten-odd years ago, when a lot of companies that should not have been able to come to market … did.
The September, 2020, edition of PrefLetter reveals that ZPR held a weight of about 2.8% in BPO – also imprudently high, according to me, but better. ZPR does not hold BPYP.PR.A.
An Assiduous Reader writes in and says, in part:
but sometimes have to do a deeper dive into financials
– to have discovered that BPO had so much variable AND lumpy maturities within this dreaded “window” of high short rates (curve likely rightly assuming rates will settle back into 3s a year out) was a total shock
– how could they have been so stupid with all the warning signs of an imminent big move up in rates?
– especially when parent, BN, maintains a debt/cap of only 17% and its ALL termed out to 13 year average?
– why would BN have been so well prepared but left BPO in such a vulnerable spot
20 years of brainwashing participants into believing the “sub 2” environment would persist in perpetuity really got the better of a lot of people!
Fair enough, but as I am very fond of pointing out, it takes two to make a market. I’m not sure if a substantially longer term would be possible for commercial mortgages, or just how a hedging programme might work, or how such hedging might be viewed by investors in BPY/BPO. It’s not my field.
Some digging has indicated that American commercial mortgages generally have a much shorter term than the 30-year standard for residential mortgages, with terms greater than ten years being relatively hard to find, but I have been unable to locate any solid data. If anybody can find such data, let me know!
Update #2, 2023-4-5: Oddly, the BPYP.PR.A US-Pay issue mentioned above has done considerably better than BPO.PR.N – to take an example – in the year-to-date:
