As downtown skyscrapers sat empty in the aftermath of the pandemic and central bankers were about to embark on the fastest pace of interest-rate hikes in a generation, the Canadian asset-management giant Brookfield doubled down on one of the bets that made its name: buying office buildings.
The firm’s property funds spent US$7.2 billion on office real estate investment trusts in Germany, Belgium and Ireland in late 2021 and early 2022, decisions that sparked debate both internally and from some of its major investors, according to people with knowledge of the discussions. Yet the deals went through, in accord with Chief Executive Officer Bruce Flatt’s longtime playbook of buying seemingly undervalued assets and wagering they’d appreciate over time.
It’s a strategy that helped build Brookfield Corp. into one of the world’s biggest owners of commercial property. Now, as office values languish and higher rates persist, the investment firm is at the center of a global real estate shakeout.
Prices for most European and U.S. offices have tumbled in the past two years. And the effects are rippling out, pummeling banks from New York to Japan that have bet big on the space.
Brookfield has defaulted on more than $3 billion of U.S. commercial mortgages, walking away from properties including two Los Angeles office towers and Manhattan’s famed Brill Building. In December, S&P Global Ratings cut its credit rating on subsidiary Brookfield Property Partners to junk status, warning weak office demand could hurt prospects for $2.7 billion of loans maturing through 2025.
Brookfield, set to report earnings this week, is now trying to raise $15 billion for a new real estate fund to capitalize on an expected wave of value deals. One year in, it’s almost halfway there; in the sunnier days of 2021, its previous property flagship took just a few months to attract $9 billion. The European acquisitions and investors still waiting on more capital to be repaid from previous funds are causing some to rethink committing money to the latest vehicle, according to interviews with more than two dozen fund managers, advisers, analysts and corporate executives.
Real estate is in Brookfield’s blood. Property bets helped build a firm that now runs $865 billion, second only to Blackstone Inc. among alternative-asset managers. The parent, Brookfield Corp., has invested about $8 billion of capital in the asset manager’s property funds, as well as a separate portfolio of trophy real estate from London’s Canary Wharf to New York’s Manhattan West. While the company has the financial means to easily weather the turmoil, it has signaled to investors that it plans to sell properties to cut its real estate holdings from roughly $24 billion to $15 billion by 2028.
Few investment firms better exemplify the rapid shift happening in a property industry that’s been upended by the twin shocks of higher interest rates and a pandemic that fundamentally altered how buildings are used and priced. Flatt views this downturn as another opportunity to strike; others see a more permanent change. For many investors, deals that once looked like good values now look like value traps.
“This is a time in the market where defaults are happening, particularly on office,” said Margaret McKnight, head of real estate portfolio solutions for Stepstone, which advises institutional investors. “Whether that affects your fundraising is a function of the bigger manager, and it has to do with their overall track record and whether you can get confidence in their ability to make money in the future.”
The doubts driven by the current environment aren’t just seen in the slower fundraising. While Brookfield Asset Management’s stock has climbed 24 per cent since its spinoff in late 2022 due in part to strength at its renewables, infrastructure and credit businesses, the shares in New York have lagged Blackstone and Apollo Global Management Inc. And shares of Brookfield Corp. have stubbornly hung around half what the company says are their intrinsic value.
Brookfield executives argue they own mostly high-quality real estate that will prove its value beyond the current down cycle. The company successfully refinanced more than 160 loans last year.
“We have always considered ourselves to be value investors and that often involves taking a contrarian view that is different from the rest of the market for a period of time,” Brian Kingston, CEO of Brookfield’s real estate business, said in an interview. “I think we are in one of those periods now, and we will ultimately be proven right.”
Brookfield was a voracious buyer of real estate in the last decade’s era of rock-bottom interest rates, snapping up companies such as GGP Inc., the second-largest U.S. mall owner, and office developer Forest City Realty Trust. It was the No. 1 acquirer of retail properties, thanks largely to the GGP deal, and the fourth-biggest purchaser of offices globally in the last 10 years, according to MSCI Real Assets. Real estate research firm Green Street places Brookfield Property Partners as the second biggest office owner in the U.S., behind Hines.
The company and Blackstone were the unequivocal winners of the shifting fortunes in private equity real estate after the 2008 financial crisis, with platforms from previous powerhouses like Goldman Sachs Group Inc. and Morgan Stanley struggling to raise new capital. By contrast, Blackstone and Brookfield continued to raise ever-bigger funds, widening the gap between themselves and the rest.
As real estate markets recovered and asset values soared in the cheap-money era, Blackstone evolved from a firm known for buying distressed assets and fixing them to one that made big bets on sectors where it sees demand outstripping supply, as in the e-commerce-driven warehouse boom, and piled into them relentlessly. As a result, the proportion of its real estate portfolio invested in the traditionally core sector of U.S. offices shrank from about 60 per cent at the time of its IPO in 2007 to less than two per cent today.
While Brookfield also diversified and made bets on student dorms, warehouses and holiday parks, the company continued to execute contrarian trades — such as buying out mall landlords in the midst of a retail bust and office REITs in the aftermath of Covid — expecting their values to recover. Its roots are deeply tied to developing and holding on to some properties for the longer term.
Brookfield’s value approach starts with Flatt, a Winnipeg native and son of a mutual-fund executive whose tenure at the firm stretches back more than three decades. His first big deal came in the early 1990s, when the company took over bankrupt Olympia & York, a Canadian developer that built London’s Canary Wharf and New York’s World Financial Center. In 2002, he was promoted to CEO.
He’s since diversified Brookfield with multinational divisions in alternative energy, infrastructure, private equity, credit and insurance. But real estate remains its biggest business, with Flatt’s strategy of paying low prices for mismanaged or over-leveraged properties earning him the nickname of Canada’s Warren Buffett.
“The easiest way to make money in real assets, especially in real estate, is to buy great assets with bad capital structures,” Flatt, 58, said at an investing conference in December.
Brookfield began raising money for its new $15 billion real estate fund last January, barely months after closing a $17 billion fund. An initial closing was expected in July 2023, according to an investor presentation. In December, the company said it expected to complete the first close shortly with total commitments of about $7 billion, including Brookfield’s capital, according to a person familiar with the matter.
Real estate fundraising has slowed across the industry, with the end of last year marking the slowest quarter since the onset of the pandemic, according to Preqin, an alternative investment industry data service. Investors also are turning to bigger managers perceived as safer bets in tumultuous times. In the third quarter, 50.2 per cent of money raised went to the top 10 largest funds, a record, Preqin data show.
Other fundraising efforts have been successful. In December, Brookfield closed a record-sized $30 billion infrastructure fund. It also announced a $3 billion commitment from the Abu Dhabi sovereign wealth fund for a decarbonization initiative. Blackstone closed a record-breaking $30 billion real estate fund in 2023.
Real estate investors are contending with a plunge in office prices that likely will last for years as companies need less space. Office demand in nine global cities including London, San Francisco, Shanghai and New York is expected to fall 13 per cent from 2019 levels by 2030, putting $800 billion of real estate value at stake, according to a July report by McKinsey Global Institute. And while interest rates may have peaked, they’re unlikely to return to the low levels that fueled price surges in the pre-pandemic runup.
Still, the commercial real estate market is showing signs of recovery in some areas, and the highest-quality buildings have held their value better than other properties.
“Despite changes in working and shopping patterns, great real estate in the best cities will continue to be in demand from tenants and will provide excellent investment returns over the long term,” Kingston said.
Brookfield hasn’t been immune to price declines. Australia’s largest pension fund, AustralianSuper Pty, has said the US office assets it co-owns with the firm are valued at “far less” than what it purchased them for in 2015. In May, Brookfield repurchased a minority stake in Manhattan’s One Liberty Plaza from Blackstone for $1 billion — 33 per cent less than what Blackstone paid in 2015.
In Europe, where Brookfield made its post-pandemic purchases of Ireland’s Hibernia REIT, Belgium’s Befimmo SA and Germany’s Alstria Office REIT-AG through its fourth real estate fund, offices in Dublin and Brussels have seen double-digit declines in capital value in the period since the acquisitions, CBRE data show. Alstria said its properties were valued by a third party at 4 billion euros (US$4.31 billion) at the end of last year, down from 4.6 billion euros in 2022.
Those REITs were bought by opportunistic funds, as opposed to the properties that are on Brookfield’s balance sheet as longer-term holdings. The company has a complex structure that includes a mix of private funds, insurance units and publicly traded affiliates.
Brookfield’s affiliates are the biggest investors in its private funds, accounting for about a quarter of the asset manager’s fee-bearing assets as of the end of September.
The insurance arm, which owns American National and a stake in American Equity Investment Life Holding Co., has absorbed some of the parent company’s real estate assets. Last year, Brookfield’s property unit transferred a partial interest in six office buildings in the US and Canada to Brookfield Reinsurance Ltd., booking total net proceeds of $612 million, according to a filing for Brookfield Property Partners. A few months later, Brookfield said it planned to transfer $1.6 billion of its interest in the real estate flagship funds to its insurance business.
“They were moved across as a more efficient way to own those assets for long-term, provide an added capital base to the insurance business, and those were transacted at fair value and assets that are quarterly valued and reviewed by auditors,” Brookfield Corp. Chief Financial Officer Nicholas Goodman told investors in November.
Brookfield also has been able to weather some bad bets by simply giving up on them, thanks to its embrace of non-recourse debt. That type of financing — which protects a company’s other assets if something goes wrong at one location — has enabled big landlords including Blackstone, Starwood Capital Group and Goldman Sachs to walk away from buildings rather than pour more resources into money losers.
“With non-recourse debt, handing back the keys often seems like a reasonable decision,” said Cedrik LaChance, director of research at Green Street.
Non-recourse debt is costlier than consolidating borrowing at the corporate level, but “pays for itself” during times like these, Kingston said during a September call with investors. It’s essentially a safety net that has allowed Brookfield to default on at least 20 U.S. mall and office properties since the end of 2021 without imperiling the parent company or its credit rating. DBRS Morningstar upgraded the credit rating of Brookfield Corp. in November.
Brookfield is still making deals and reaping profits. It sold a portfolio of manufactured home communities earlier this month for $325 million, capitalizing on strong demand in that sector. An office and retail building on Paris’s Champs-Elysees sold last year for about $1 billion, more than 25 per cent above Brookfield’s purchase price 18 months earlier.
Still, it’s been slower on other sales, such as an investment in Center Parcs, a U.K. resort owner that it purchased in 2015. Brookfield was considering a sale by late 2019, only to be thwarted by the Covid-19 pandemic. By the time the company resumed the formal process last year — after the resurgence in resort demand from consumers eager to travel after lockdowns — rising interest rates had thinned demand for big-ticket acquisitions. Almost nine years after the company’s initial investment, investors are still waiting for their money back on the deal.
Brookfield sold only nine of 27 investments in a 2015-vintage property fund as of June, according to a presentation by advisory firm Hamilton Lane, though it has sold pieces of many of the others.
While the firm has traditionally topped most competitors in its pace of returning capital, its 2018 fund has been slower than its key rival and what Brookfield investors are used to. Brookfield had given investors in that third opportunistic real estate fund about 22 per cent of their money back as of September, according to a company presentation. A Blackstone real estate fund that was investing in roughly the same time period had returned 40 per cent of capital through September. And in Brookfield’s first property fund, a public pension noted that five years in it had already gotten 89 per cent of its contributions back.
Phillip Goldstein, principal of Bulldog Investors, an investor in Brookfield’s downtown LA offices, said the landlord would have been better off to shed its downtown Los Angeles portfolio. But the tumult of the past several years in commercial real estate changed values in ways that were hard to foresee.
“In retrospect, it’s better to say they should’ve sold the properties,” Goldstein said. “But no one could have predicted the effect on the high-rise office market resulting from Covid.”