Over the next decade, I think the most interesting and exciting investment area will be the real estate business. We have seen prices collapse over the past four years as the credit crisis unfolded. Housing sales have shown some signs of picking up, but they are still well below the historical norm. Commercial real estate is still suffering from high occupancy rates and many have stayed foreclosure only by perfecting the game of extend and pretend.
The brokers and agents I talk to around the country tell me that outside of major markets like New York, Boston and Washington D.C., it is much tougher to make a living. Subsequently, the number of agents and brokers has declined dramatically since the real housing boom.
When an industry falls apart the way real estate has, the most important question you have to ask is if the business is necessary and will come back when the cycle changes. In the case of buggy whip manufacturers or Betamax video cassettes, the answer was no, the business was no longer necessary and would not experience another positive cycle. When the oil industry sold off in the 90s as oil went below $20 per barrel, the answer was that the industry was necessary and would see an eventual turn upward. Long-term investors made a lot of money by getting into the oil business when the conditions were poor and the outlook muted. I think this is the case for the real estate business today.
Over the past several years, I have aggressively bought real-estate-related securities with mixed results. Some, such as management and investment company W.P. Carey (WPC), have done very well. Others, such as CommonWealth REIT (CWH), have not done as well in the shorter term. In my personal and client accounts, we own hotels, retail malls and office buildings though real estate investment trusts (REITs) such as Sunstone (SHO), Ashford Hospitality (AHT), Kite Realty (KRG) and others. We have exposure to the brokerage and consulting business through our stake in BGC Partners (BGCPWPC). We also have exposure to both CRE financing and residential mortgages through stakes in NorthStar Realty Finance (NRF) and Invesco Mortgage (IVR). I love everything about the industry and have been able to invest in it when the issues were safe and cheap. Unless the world truly ends, I expect to do extremely well with these positions.
When I was running my cheap stock screens this week, I noticed another name I will be adding to the portfolios. Brookfield Office Properties (BPO) currently sells at just 80% of tangible book value. This looks like an attractive entry point for a collection of premier properties in some of the world's best markets. The company has 122 properties that encompass more than 80 million square feet of office space and include some of the world's best known buildings. In New York, Brookfield holds more than 19 million square feet and it has almost 8 million square feet in the strong Washington, D.C. marketplace.
Because of its prominent position in key markets, the company has a 93% occupancy rate and its average tenant has an A credit rating. If not for the semi distressed Los Angeles market, the occupancy rate would be much higher. Even in that market, it is worth noting that the company as a 15% vacancy rate compared to the average building's 20% vacancy rate.
The average lease still has more than seven years until expiration, so much of its cash flow is locked in for a substantial period of time. The leases that are rolling over in the next few years are priced about 20% below current rates, so there is some upside potential for revenues via rent increases. In 2013, the company will have more than 3 million square feet of space expiring in the World Financial Center in Manhattan. Although many view this as a significant challenge, I think it may well turn out to be an upgrade in cash flow for the company. It has had no problem leasing space in other New York properties and I think this 3 million square feet will be rented more quickly than many expect.
Through BPO, this world class collection of office properties is available for less than the tangible book value of the underlying real estate. At just 3.6%, the dividend yield is a little lower than I like in a REIT, but if world does not end, the dividend will grow and the value of these properties should take the shares much higher over the next decade. At the current price, I find it to be safe and cheap. Investors who like the real estate business should start scaling into the stock.