Brookfield Ord Shs Class A T.BN

RBC

[retiredcf]

February 15, 2024

Brookfield Corporation
Key takeaways from BN White Paper on the U.S. Office market

NYSE: BN | USD 40.53 | Outperform | Price Target USD 53.00

Sentiment: Neutral

Brookfield published today a white paper with their views on the U.S. Office market. BN's shares trade at a 26.5% discount to NAV, with its share price implying zero value for Real Estate and a 15% discount on non-Real Estate private assets (e.g., Insurance). Please refer to the white paper for more details, but here are the key takeaways regarding the U.S. office market:

• Brookfield's key argument is that the vacancies are concentrated in older office buildings that are not desired by tenants and that there is limited supply of new or renovated office buildings with the amenities sought by tenants. They cite a 2023 JLL report that indicated that within U.S. office:
   1% of buildings comprise nearly 17% of total U.S. office vacancy;

   10% of buildings comprise over 60% of total U.S. office vacancy;  30% of buildings comprise over 90% of total office vacancy; and  40% of buildings have no vacant space.

• In contrast, BN suggested that the top quartile of office buildings are experiencing record-high rents and stable vacancy rates and consistent with their prior comments, they expect this growing divide to widen further as legacy leases expire and that tenants are likely to seek new spaces that fit their post-COVID needs for space, amenities and sustainability goals.

• CBRE estimates there are 495 "prime" (BN calls them "trophy") buildings in 16 major markets in the U.S. that are deemed higher quality than Class A. These prime/trophy buildings represent 8.9% of total stock (based on ft2). Relative to offices classified as "functional" and "the rest", based on JLL data as of Q4/23, U.S. trophy buildings have much higher net rents and much lower vacancy rates (see Exhibit 1).

• Office vacancy rates are substantially higher in the U.S. (18.4%) and Canada (16.5%) compared to other countries (5.5% in Germany, 6.7% in France, 9.5% in the U.K. and 12.8% in Australia), according to data from CBRE, JLL and Cushman & Wakefield.

• Since Q2/20 (i.e., the start of the pandemic), buildings completed since 2015 have a cumulative net absorption of +127.3MM ft2, whereas other vintage cohorts have had negative absorption (see Exhibit 2)

• Occupancy expenses are <5% of a Corporation's G&A expense and as a % of revenues, this has declined by 50% over the past 30 years, based on Eastdil Secured data, which we assume the point is rents aren't a major OpEx bucket so tenants may not be that sensitive to higher rent per ft2, especially if they are renting less office space.

• Post-pandemic, new trophy offices are seeing an even greater premium (+60%) vs. market average rents than the historical average (+40%) whereas older buildings are experiencing much wider discounts vs. market average rents than the historical average (e.g., 25-year old buildings have rents that, post-pandemic, are ~40% below the market average, substantially wider than the historical average of ~20% discount).

• Tenants do not appear to be deterred by higher rent prices. Based on CBRE data, there were more leasing transactions in New York at >US$100ft2 from 2021 to 2023 than there were in 2017-2020 time period (see Exhibit 3).

• BN believes cities could help by providing incentives to convert office buildings into residential, particularly in cities facing severe housing affordability issues.

• Within Brookfield's U.S. office portfolio:
   ~95% are either new build or best-in-class stock;
   Its Core portfolio saw a 5% Y/Y growth in net operating income; and
   As an example of strong rent performance, its Two Manhattan West property is on track to achieve a 35% premium on rents vs. its sister building, One Manhattan West, which was completed just 5 years ago and leased prior to the pandemic.