“If you had one shot, one opportunity, to seize everything you ever wanted – one moment – would you capture it, or just let it slip?”
So inquires Eminem in his Oscar-winning song from the soundtrack of 8 Mile, a film that stars the famous rapper in the role of freestyling protagonist ‘B-Rabbit.’
Board members at Brookfield Property Partners LP and GGP Inc. may have been separately considering, from differing vantage points, questions similar to Eminem’s in late March, when they agreed to terms for Brookfield’s purchase of a 66% stake in GGP. The deal will make GGP – the United States’ second-largest mall operator – fully owned by Brookfield, which already holds a 34% stake in the company.
While Detroit, the city where 8 Mile is set, is approximately equidistant – a little over 200 miles, as the crow flies – from Brookfield’s Toronto headquarters and GGP’s Chicago home base, there is by contrast a sizable disparity in pricing distance between the $23.50 per share cash portion of Brookfield’s offer, which GGP has accepted, and significantly higher valuations in the range of $24.50 to $34.00 per share that many analysts thought GGP should have merited. (The cash portion of the deal is limited to 61%, with the remaining portion comprised of Brookfield Property Partners LP units (“BPY”) or shares of a newly formed US REIT that will track shares of BPY.)
Implied cap rates for the cash portion of the deal are estimated to be in the high five-percent range, with the full offer pricing GGP north of a six-percent cap rate when considering the deal’s stock portion. By comparison, Unibail-Rodamco SE’s successful bid in December 2017 for another publicly listed high-end mall operator, Westfield Corporation, came in at a substantially lower estimated implied cap rate for US assets alone, in the high four-percent range. Both acquisitions are portfolio entity deals driven by public-to-public mergers and acquisitions market forces, but it is worth noting that the sales productivity of Westfield’s US assets, approaching $700 per square foot, is higher than sales productivity of under $600 per square foot for GGP’s assets, all of them located in the US, which is a factor that likely contributed to pricing variation. Another potential contributor is the inclusion of a substantial number of Class B assets in GGP’s portfolio, in addition to the portfolio’s considerable proportion of Class A properties, in a market environment where pricing for Class B assets has weakened considerably as the distinction between retail winners and losers becomes sharper.
Even so, there is a comparatively wider gap between the Brookfield-GGP deal’s implied cap rate range and recent Open End Diversified Core Equity (“ODCE”) value-weighted appraisal cap rates for institutional-quality malls, which averaged 4.2% in the second half of 2017. The last major high-end mall transaction to be realized in the private markets took place in 2016, when GGP sold a partial interest in Las Vegas’ Fashion Show Mall to TIAA Global Asset Management in a deal with the even lower cap rate of 3.9%. The difference in cap rates between recent public-to-public Class A mall deals and private institutional-quality mall valuations may mean that a persisting portfolio discount is larger than some realize, with discounted public equity cost of capital likely playing a role as well.
While the Brookfield-GGP transaction is significant in size and likely to carry influence with respect to private market pricing, it is perhaps not fitting to suggest that pricing for all Class A malls should reflect its embedded pricing levels, given the considerable ranges of quality and productivity levels within GGP’s portfolio. The relationship of asset quality and variance in forward growth characteristics remains highly correlated, and it is probable that underlying asset pricing will follow suit, as winning retail properties continue to garner premium pricing vis-à-vis assets that will inevitably experience ongoing tenant disruption, loss of pricing power, or even obsolescence.
As they survey the market landscape, some experts say that Brookfield, like B-Rabbit, is seizing the moment with its GGP purchase – and making off like a fox – taking advantage of a rare, one-time chance to acquire, at a bargain price, a large portfolio that includes a number of Class A mall properties, along with a significant densification opportunity, before market valuations return to expected norms.
Others point out that publicly traded Brookfield was the only willing buyer to step up with a bid for GGP, which may indicate a lack of capital demand for Class A malls facing fierce digital retail competition from the likes of Amazon. A growing chorus of analysts says that digital competition will continue to erode the market value of bricks-and-mortar malls held by GGP and other operators. Faced with this prospect, the analysts assert, GGP shareholders did not get the price they may have wanted, but were nonetheless capturing the one available chance to take cash off the table.
With the reasons for the disconnect between the implied cap rate of the Brookfield-GGP deal and the latest available cap rate data for public and private transactions still being debated, many investors may find themselves paraphrasing a well-known line of another Eminem hit with the question, “Will the real A-mall cap rates please stand up?”
Markets, both public and private, may get a clearer picture of what cap rate range will become an accepted reality after the next marketed private sale of a Class A mall takes place. Investors are not sure where private Class A malls are pricing on an applied basis, and have not known for some time, since the last major private transaction took place almost two years ago. More recent public-to-public trades of large portfolios have been comprised of a relatively broad spectrum of asset quality, and have thus provided little direct insight with respect to private market views of the top tier.
What new bar will the next major sale set for private A-mall cap rates, and will the public markets follow suit? Answers to these questions will help investors judge whether the Brookfield-GGP transaction represents a one-off anomaly for Class A malls, with Brookfield seizing an exceptional opportunity, or a bellwether for a new market reality, with GGP making a wise decision to take its one available shot at an early exit. At the same time, these answers may provide valuable forward-looking guidance on prudent investment approaches to malls, as the divergence of future prospects for higher- and lower-quality properties becomes more pronounced, even within the Class A segment.
1. Eminem, Lose Yourself, on 8 MILE: MUSIC FROM AND INSPIRED BY THE MOTION PICTURE (Shady Records 2002).
2. Cap rate estimates, Heitman Real Estate Securities LLC.
4. Esther Fung, Brookfield’s Underwhelming Bid for GGP Pushes Down Retail REITs, THE WALL STREET JOURNAL, March 27, 2018, available at https://www.wsj.com/articles/brookfields-underwhelming-bid-for-ggp-pushes-down-retail-reits-1522189136.
5. Eminem, The Real Slim Shady, THE MARSHALL MATHERS LP (Aftermath Entertainment and Interscope Records 2000).
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