The Fed’s latest interest rate change, where 0.25% was shaved off the U.S. headline rate, reducing it to between 1.5% and 1.75%, has not only boosted the economic outlook but made real estate investment trusts (REITs) more attractive investments. This is because REITs are capital-intensive, requiring significant funding to support property acquisitions, development, and maintenance. A lower headline rate effectively reduces financing costs for REITs, bolstering their profitability. It also boosts their popularity among income-hungry investors because near historically low interest rates means that they can’t earn high enough yields from traditional income-producing assets such as bonds.
One REIT that is very attractively valued and poised to benefit from the latest rate cut is Brookfield Property Partners (TSX:BPY.UN)(NASDAQ:BPY), which is essentially the property management arm of Brookfield Asset Management and has gained 14% since the start of 2019.
Quality global assets
Brookfield Property, because it owns a globally diversified portfolio of real estate assets, will benefit from the renewed optimism surrounding the world economy sparked by the rate cut and growing likelihood of an end to the U.S.-China trade war. The REIT is also in the process of making its portfolio more productive, having implemented a strategy aimed at selling mature non-core assets, developing existing core properties, and making accretive opportunistic acquisitions. That program is making considerable progress at unlocking value, as evident from Brookfield Property’s third-quarter 2019 results. Net income shot up by an impressive 20% year over year to US$870 million, while funds from operations (FFO) grew by a notable 7% to US$324 million.
Brookfield Property’s core business makes up around 85% of its balance sheet and is composed of premier office and retail properties across the globe, with marque properties in New York, London, Los Angeles, Las Vegas, and Texas. That means the REIT will benefit solidly from the expected improvement in U.S. economic growth, while its retail properties have demonstrated that because of their high quality, they are sheltered from the retail apocalypse currently underway.
Brookfield Property’s LP Investments division, which, for the third quarter 2019, was responsible for roughly a fifth of its FFO, allows it to engage in speculative investments that, while being risky, create the opportunity to generate outsized returns.
Improved consumer and business sentiment coupled with a lower headline interest rate will drive greater demand for Brookfield Property’s assets, leading to higher rents and assets prices, which will ultimately lift earnings.
The REIT’s US$44 billion of asset-level debt obligations means that a lower headline interest rate provides Brookfield Property with the opportunity to substantially reduce its financing costs as it renegotiates and/or rolls over that debt.
A key aspect of Brookfield Property that makes now the time to buy, aside from its sustainable distribution yielding a juicy 7%, is that the REIT is trading at a 42% discount to its net asset value (NAV), highlighting the considerable upside available.
The recent decline in Brookfield Property’s share price has created an opportunity to acquire a quality REIT at a very attractive valuation and to lock in a 7% yield. There is every indication that as the economy picks up, Brookfield Property’s earnings will grow, improving the sustainability of its distribution and ultimately giving its market value a healthy lift.
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Fool contributor Matt Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Brookfield Asset Management and BROOKFIELD ASSET MANAGEMENT INC. CL.A LV. The Motley Fool recommends Brookfield Property Partners LP.