Financial disclosures for BAM-managed funds supplied by BPY show financial distress; yet, the projected returns for the funds are robust. What accounts for this apparent contradiction?
The strategy of the BSREP funds is to invest in turnarounds (distressed assets). So one would expect that NOI of the properties they acquire would be low or zero at the time of acquisition. That could account for the high interest cost relative to NOI in your table. Current NOI may not be reflective of asset value. The fact that NOI has dropped below interest costs may not be relevant given the above.
In Q2 2021 earnings materials, BAM disclosed that BSREP 4 (flagship real estate fund) has raised $9bn so far and should eclipse BSREP 3's $15bn fundraise. We know from prior BAM disclosures that the re-up rate from LPs is quite high (i.e., likely that if you invested in fund 3 you'll invest in fund 4), so I think a fair number of the BSREP 4 LPs are also BSREP 3 investors and have made their latest investments with full understanding of BSREP 3's returns thus far. In this post you wrote, "I think it is likely that the funds are currently deeply distressed." Does this new info change your mind, and if not, why?
Hi, As I said on Twitter. The BSREP 3 and even BSREP II are late vintage funds. Whatever returns they are posting now may or may not be representative of fully realized returns at the end of fund life. Further, I have no clue how fully BSREP investors understand their returns. I don 't know if they look at a tearsheet from a consultant or spend their days scrutinizing the audits and questioning valuations. Nor do I know if their investors either know or care how returns are generated. For example, are the IRRs driven by savvy purchase, fix, occupy collect higher rents, or are they driven by the financial engineering of buying, large cash out refil to return cash early to drive IRR. And if they do look at this level, do they care. I have no clue.
So, no. None of that changes my mind. Rather than speculate on how much investors may or may not know about their portfolios, I relied on the numbers Brookfield published in BPY's financial statements. They were a disaster.
Of course, given BPY is often the largest investor in BAM funds, they could make all the audits available to BPY holders. After all, if an LP tossing $1M at a fund gets them, why not the investor throwing $100M or a few billion?
You say that on one hand BPY is/was nothing but a pawn controlled by BAM to which it paid exorbitant management fees and distributions, and also that BPY is highly leveraged and distressed. Well why might this be the case?
BPY is nothing but a source of cash for BAM, this has always been true of this and former incarnations such as BPO, and will always be true in whatever form it takes in the future. And this includes not only its free cash flow but all of its equity value as well. If BPY sells an asset for a profit it doesn't retain that equity, it is upstreamed to BAM.
When comparing BPY to other publicly traded REITs that are not in this kind of blood sucking control arrangement, BPY appears to be over leveraged and undercapitalized. But why would BAM leave capital stranded at BPY? Just to appease REIT analysts who desire to see higher capital ratios? And why would they set BPY's distribution level at a point where BPY can retain earnings? They deliberately set it to a level beyond BPY's free cash flow to ensure that not only is that cash flow upstreamed but so are all of their disposition gains. And as one of the largest real estate developers in the world, these gains are core to the strategy. BPY's sole purpose to exist was to pay ever-greater distributions, which it did throughout its life until it went private, so in this sense it was a success.
The "mark to market" value of BPY's assets never really made much of a difference because of IFRS and their ability to hold the assets until the next market cycle, and now it matters even less now that it is private. They will surely have no problem selling BPY's assets into private funds in transactions that both allow them to book gains and meet the return thresholds in the private funds. Essentially, the private market for real estate assets is stronger than the public one so they can make money by going from public to private, the opposite of what they are doing on the private equity side where they are buying privately and selling to the public.
All of the hand-wringing about BPY's level of debt and distress comes down to this basic misunderstanding. It was never considered to be a self-sustaining, fully capitalized entity. It's basically a zombie on life support, fully controlled and backstopped by the parent company but which feeds that parent company, in a symbiotic relationship.
Let's just look at the LP investments in the BSREP funds. You write: "[...] how real are those projected returns if dependent on a robust recovery in assets such as Class B malls, which are experiencing secular change?" If you look at the LP investments disclosure in the BPY supplemental, you will see that there is almost zero retail exposure in the BSREP funds. BSREP II has the most retail exposure of of all the funds, and it's just 10%. The private funds are overweight resilient RE assets like industrials and logistics warehouses. Few investors understand that BAM's RE funds look much more like BX's RE funds than BPY's balance sheet investments. You then write: "The stability in BSREP I is not surprising. As an early vintage fund I would expect it to be largely realized. However, this is not the case with the other funds, particularly for the large BSREP II and BSREP III funds." This is untrue. While BSREP I has started to have realizations (I think 9 so far), it has another 2-3 years left. BSREP II has realized two investments as well. Investors in the funds have more than enough disclosure to apply their own cap rates to assets and make their own determinizations of fair value. Most fund of funds do exactly this for their clients. More than anything else, your quote applies to literally every PE firm... no firm waits for a fund to fully liquidate before raising / investing the next one.
My point was simple. On the one hand they report collapsing cash flows for a segment that derives returns from funds it lists. The funds listed have high projected returns. I would like to see that gap bridged.
As for weightings, I used NOI and interest expense figures reported. BPY reported retail and hospitality as 45% of the LP Investment segment NOI.
I am only working with information given. If you have fund audits - pass them along. I'd love to see them.
Yeah I was just talking about the LP investments / BSREP funds themselves. Those make up 15% of the BPY balance sheet + there is a miniscule amount of retail exposure in them, so I just don't see why you think the private funds specifically are the issue.
All these funds will mature and when they do there is no hiding the true values. So what would be the point for BAM to play games with asset values? How does it serve them?
Before they mature and are fully liquidated, they will raise new funds. Investors will base their decision to invest in the new fund, in part, based on the returns of the older funds. So, higher is better.
Yes, but what's the long term advantage? Why would BAM destroy its reputation for a short-term boost to AUM? Unless you think management just wants to goose the share price so they can cash out all their shares.
Which seems unlikely given the senior partners own ~20% of the company comprising basically their entire net worths and are paid low cash comp (80-85% of senior director comp is in RSUs /DSUs / escrowed shares)
The incentives just seem all wrong for BAM management to engage in behaviour that damages its reputation. Why would Bruce Flatt who built the company in its current form and owns a huge amount of stock want to damage the long term value of the company?
The structure is riddled with incentives for management to engage in behavior that is long-term detrimental, in a number of ways, to holders. Management's ownership does not change that.
Edper was very similar in both incentives and ownership. But maybe the outcome will be different this time - but maybe not. And the 'maybe not' is supported by BPY's public financial disclosures.
The strategy of the BSREP funds is to invest in turnarounds (distressed assets). So one would expect that NOI of the properties they acquire would be low or zero at the time of acquisition. That could account for the high interest cost relative to NOI in your table. Current NOI may not be reflective of asset value. The fact that NOI has dropped below interest costs may not be relevant given the above.
In Q2 2021 earnings materials, BAM disclosed that BSREP 4 (flagship real estate fund) has raised $9bn so far and should eclipse BSREP 3's $15bn fundraise. We know from prior BAM disclosures that the re-up rate from LPs is quite high (i.e., likely that if you invested in fund 3 you'll invest in fund 4), so I think a fair number of the BSREP 4 LPs are also BSREP 3 investors and have made their latest investments with full understanding of BSREP 3's returns thus far. In this post you wrote, "I think it is likely that the funds are currently deeply distressed." Does this new info change your mind, and if not, why?
Hi, As I said on Twitter. The BSREP 3 and even BSREP II are late vintage funds. Whatever returns they are posting now may or may not be representative of fully realized returns at the end of fund life. Further, I have no clue how fully BSREP investors understand their returns. I don 't know if they look at a tearsheet from a consultant or spend their days scrutinizing the audits and questioning valuations. Nor do I know if their investors either know or care how returns are generated. For example, are the IRRs driven by savvy purchase, fix, occupy collect higher rents, or are they driven by the financial engineering of buying, large cash out refil to return cash early to drive IRR. And if they do look at this level, do they care. I have no clue.
So, no. None of that changes my mind. Rather than speculate on how much investors may or may not know about their portfolios, I relied on the numbers Brookfield published in BPY's financial statements. They were a disaster.
Of course, given BPY is often the largest investor in BAM funds, they could make all the audits available to BPY holders. After all, if an LP tossing $1M at a fund gets them, why not the investor throwing $100M or a few billion?
You say that on one hand BPY is/was nothing but a pawn controlled by BAM to which it paid exorbitant management fees and distributions, and also that BPY is highly leveraged and distressed. Well why might this be the case?
BPY is nothing but a source of cash for BAM, this has always been true of this and former incarnations such as BPO, and will always be true in whatever form it takes in the future. And this includes not only its free cash flow but all of its equity value as well. If BPY sells an asset for a profit it doesn't retain that equity, it is upstreamed to BAM.
When comparing BPY to other publicly traded REITs that are not in this kind of blood sucking control arrangement, BPY appears to be over leveraged and undercapitalized. But why would BAM leave capital stranded at BPY? Just to appease REIT analysts who desire to see higher capital ratios? And why would they set BPY's distribution level at a point where BPY can retain earnings? They deliberately set it to a level beyond BPY's free cash flow to ensure that not only is that cash flow upstreamed but so are all of their disposition gains. And as one of the largest real estate developers in the world, these gains are core to the strategy. BPY's sole purpose to exist was to pay ever-greater distributions, which it did throughout its life until it went private, so in this sense it was a success.
The "mark to market" value of BPY's assets never really made much of a difference because of IFRS and their ability to hold the assets until the next market cycle, and now it matters even less now that it is private. They will surely have no problem selling BPY's assets into private funds in transactions that both allow them to book gains and meet the return thresholds in the private funds. Essentially, the private market for real estate assets is stronger than the public one so they can make money by going from public to private, the opposite of what they are doing on the private equity side where they are buying privately and selling to the public.
All of the hand-wringing about BPY's level of debt and distress comes down to this basic misunderstanding. It was never considered to be a self-sustaining, fully capitalized entity. It's basically a zombie on life support, fully controlled and backstopped by the parent company but which feeds that parent company, in a symbiotic relationship.
Let's just look at the LP investments in the BSREP funds. You write: "[...] how real are those projected returns if dependent on a robust recovery in assets such as Class B malls, which are experiencing secular change?" If you look at the LP investments disclosure in the BPY supplemental, you will see that there is almost zero retail exposure in the BSREP funds. BSREP II has the most retail exposure of of all the funds, and it's just 10%. The private funds are overweight resilient RE assets like industrials and logistics warehouses. Few investors understand that BAM's RE funds look much more like BX's RE funds than BPY's balance sheet investments. You then write: "The stability in BSREP I is not surprising. As an early vintage fund I would expect it to be largely realized. However, this is not the case with the other funds, particularly for the large BSREP II and BSREP III funds." This is untrue. While BSREP I has started to have realizations (I think 9 so far), it has another 2-3 years left. BSREP II has realized two investments as well. Investors in the funds have more than enough disclosure to apply their own cap rates to assets and make their own determinizations of fair value. Most fund of funds do exactly this for their clients. More than anything else, your quote applies to literally every PE firm... no firm waits for a fund to fully liquidate before raising / investing the next one.
My point was simple. On the one hand they report collapsing cash flows for a segment that derives returns from funds it lists. The funds listed have high projected returns. I would like to see that gap bridged.
As for weightings, I used NOI and interest expense figures reported. BPY reported retail and hospitality as 45% of the LP Investment segment NOI.
I am only working with information given. If you have fund audits - pass them along. I'd love to see them.
Yeah I was just talking about the LP investments / BSREP funds themselves. Those make up 15% of the BPY balance sheet + there is a miniscule amount of retail exposure in them, so I just don't see why you think the private funds specifically are the issue.
All these funds will mature and when they do there is no hiding the true values. So what would be the point for BAM to play games with asset values? How does it serve them?
Before they mature and are fully liquidated, they will raise new funds. Investors will base their decision to invest in the new fund, in part, based on the returns of the older funds. So, higher is better.
Yes, but what's the long term advantage? Why would BAM destroy its reputation for a short-term boost to AUM? Unless you think management just wants to goose the share price so they can cash out all their shares.
Which seems unlikely given the senior partners own ~20% of the company comprising basically their entire net worths and are paid low cash comp (80-85% of senior director comp is in RSUs /DSUs / escrowed shares)
The incentives just seem all wrong for BAM management to engage in behaviour that damages its reputation. Why would Bruce Flatt who built the company in its current form and owns a huge amount of stock want to damage the long term value of the company?
The structure is riddled with incentives for management to engage in behavior that is long-term detrimental, in a number of ways, to holders. Management's ownership does not change that.
Edper was very similar in both incentives and ownership. But maybe the outcome will be different this time - but maybe not. And the 'maybe not' is supported by BPY's public financial disclosures.
Could you describe what you see are the incentives for management to engage in long-term detrimental behaviour to the company?
I agree. Of course you live with this kind of risk investing in any business, but I don't see any writing on the wall here.
Ha!