A Real Estate Gem Lost in the Rubble

Real estate was one of the hardest-hit sectors of the market during the financial crisis, and for good reason. After all, the real estate market caused all of this mess in the first place.

According to the Case-Shiller Home Price Index, residential home prices have fallen about -30% from their peak in 2006. Commercial real estate, the hardest hit sector, has seen prices fall more than -40% since the 2007 peak according to the Moody’s/REAL Commercial Property Price Index.

Although prices have fallen off a cliff, the declines appear have leveled off since late last year. While prices could still make new lows, it’s safe to say the worst is over, making it a good time in the cycle to pick up bargains in the right stocks.

Brookfield Properties Corp. (NYSE: BPO) is one of the largest owners of commercial real estate in North America. This Toronto-based company operates several landmark properties in high-profile markets in the United States and Canada. The stock has come a long way from under $5 a share during the peak of the financial crisis, but it’s still a long way from pre-crisis levels. And here’s thing: Although the stock price has been hurt, the company’s business and cash flow really hasn’t. The market should eventually realize this aberration.

And while commercial real estate overall may continue to experience problems, Brookfield seems to avoid the most common pitfalls.

For example, many properties are struggling with lower occupancy rates as business failures and contractions have lessened commercial space demand. However, Brookfield currently (at the end of the first quarter) had an occupancy rate of 94.8%, virtually unchanged from 95% in the year ago period and one of the highest in the industry.

Also, lease renewal rates for many properties in the industry have tended to be lower. Brookfield, however, maintains leases that are on average -11% below current market prices. When leases come up for renewal, Brookfield can actually raise the rent. In fact, new leases rolled over in the first quarter were at prices +25% higher than the old leases.

The company operates properties in some of the most prominent and coveted locations on the continent. The one-of-a-kind and high status nature of Brookfield’s properties tend to attract some of the best and most financially sound companies in their industries, including companies like Royal Bank of Canada (NYSE: RY), Goldman Sachs (NYSE: GS) and Chevron (NYSE: CVX). These top notch clients create stable demand and leads to steady cash flow for Brookfield.

First quarter results were not those of a company in a struggling industry. Net operating income rose +26% from the year ago quarter to $392 million, and funds from operations (FFO) rose +30% to $136 million in the same period. FFO from commercial property operations were up +22% from last year’s quarter because of same store sales growth (more rent revenue from the same property) of +6.2%. Residential development revenue soared +120% as the Canadian residential market rebounded over the same period as well.

Looking forward, management said fundamentals in Brookfield’s markets are improving and that the company has turned the corner from the financial crisis. In addition, the company has $1.7 billion available in cash and available credit lines to deploy toward acquisitions. Although there are +29% more shares outstanding than a year ago because of new share issuances in 2009, the purchase of properties at rock bottom prices should have a positive effect on earnings in the near and long term.

Action to Take –> Brookfield has a recession-resistant income steam and is in a position to significantly boost it in the future by picking up dirt cheap assets in the worst real estate market since the Great Depression. As well, the company’s assets and inflation adjusted leases serve as an excellent hedge against possible inflation going forward.

Brookfield has paid quarterly dividends of $0.14 a share since 2007. The stock yields a solid 3.8% based on recent prices. The stock is well off its high of $30 hit in 2007 and should have a lot of room to run in an improving real estate market.