Vaibhav Munjal, Gabriel Veilleux, Louis-Philippe Gagnon
In the past 2 years, hybrid work has been more popular due to the lockdown during COVID-19. This work environment caused a lot of headaches for directors since rent needs to be paid every month. With the vacancy rate increasing, is commercial real estate dead? Do we need to divest to other asset classes? Brookfield doesn’t think so. Indeed, they want to raise a new $15 billion real estate fund doubling down on their signature bets: buying office buildings.
One of the world’s biggest owners of commercial real estate, Brookfield Corporation is a Canadian asset-management giant having $865 billion assets under management. Brookfield owns over 700 properties around the world, mainly in the US with 80% of their holding. Problems emerged when prices for most European and US offices tumbled in the past 2 years causing Brookfield to default on more than $3 billion of US commercial mortgages. On top of that, S&P Global Ratings cut its credit rating to junk status, stating that weak office demand could affect around $2.7 billion of loans maturing through 2025. To rebound on these losses, Brookfield is trying to raise $15 billion for a real estate fund to capitalize on expected value deals. They already attracted $9 billion in 2021 to buy European properties. However, investors are still waiting to receive their invested capital and are worried about investing again in future acquisitions. Their 2018 fund has fallen behind its main rival and investors’ expectations, while the company has historically excelled in returning capital at a faster rate than its competitors.
While many other investors see this market shift like a permanent one, Brookfield thinks its contrarian stance on investment strategies has benefited them a couple of times in the past. Brian Kingston, CEO of Brookfield’s real estate business, sees an eventual evolution “I think we are in one of those periods now, and we will ultimately be proven right.” That position is confirmed by Bruce Flatt, CEO of the asset management company, as he sees the situation in commercial real estate as an opportunity despite investor apprehension. Unfortunately, this dissenting perspective is what makes it difficult for the company to raise funds, investors prefer to stay careful regarding this market. In fact, after one year, Brookfield attracted half of its $15 billion objective for the fund, while they were able to draw $9 billion in only a few months for its previous fund. The long waiting period for the return of their capital is also an element that slows down fundraising. One important factor to consider when evaluating the riskiness of Brookfield’s plan is their potential use of non-recourse debt, a type of financing that big landlords like Blackstone, Goldman Sachs and many others use to protect themselves. Since the debt is secured by property collateral, this tool enables them to protect their other assets if one location is a heavyweight. Briefly, the company is not personally liable for the loan if it goes wrong, even in cases where the collateral falls short of fully covering the defaulted amount. This type of debt is costlier than corporate-level borrowing, especially to cover the greater risk. Since 2021, Brookfield has used this lifeline to default on at least 20 U.S mall and office properties, and this has not affected the parent company nor its credit rating till recently. However, fund contributors do not invest their money in projects for it to go bust, so the use of this backup is as a last resort.
As Brookfield navigates these turbulent waters, the broader implications for the commercial real estate market are profound. The shift towards hybrid work does not signify the demise of office spaces but rather underscores the need for innovation and adaptability in property management and investment strategies. Brookfield's substantial bet on office buildings amidst widespread skepticism highlights a fundamental belief in the market's cyclical nature and the inherent value of well-located, high-quality commercial properties.
Looking forward, the commercial real estate sector may indeed be at a crossroads, with changing work patterns and economic pressures reshaping demand. Yet, Brookfield's strategy, grounded in a deep understanding of market dynamics and a long-term investment horizon, suggests a vision that transcends immediate challenges. Whether this approach will yield the anticipated dividends remains to be seen. The outcome will not only test Brookfield's resilience and strategic acumen but also provide valuable insights into the evolving landscape of commercial real estate.
In summary, Brookfield is navigating against the current and crosses its fingers for it to turn around. While a lot of investors remain doubtful about the future of the commercial real estate market, Brookfield is strongly confident in its strategy and deeply believe that the value of these assets is currently mispriced. Looking at the company’s size, resources, expertise, and ability to address these types of situations, their unique perspective of the situation could lead them to decent profits if they are right. Conversely, if the workforce behaviors stay this way, they can’t miraculously fill offices by forcing people to go back, so it could lead to adverse outcomes. Is Brookfield exhibiting genuine acumen or reckless greed, disregarding significant risks illustrated in the past years? Only time will tell.
Equity Research Team