GGP’s valuation comparison under ‘base case’ and ‘base case assuming foreclosure and sale’

As the above table demonstrates, GGP’s valuation under the assumed foreclosure and sale of properties with our base case assumptions falls to approximately $4.8 bn against $6.9 bn under the previous base case scenario (without incorporating foreclosure and sale). On a per share basis, the company’s valuation on CFAT basis falls to $19.7 against $28.4 previously, implying a further downside potential of 45.6% from the current market price of $36.3 (as of January 29, 2007).

Re-financing needs:

Under the foreclosure scenario, we expect GGP to foreclose approximately 6% of its portfolio accounting for approximately 20% of its total outstanding debt resulting in an estimated total debt of $19 bn as at the end of 1Q2008. This would reduce GGP’s loan re-payment obligations by nearly 20% each in 2008 and 2009, to $2.0 bn and $2.6 bn, respectively, from $2.6 bn and $3.3 bn presently.

In addition to foreclosures, we expect GGP to sell some of its un-encumbered properties to finance a portion of its current funds requirements on debt repayments and capital improvements. The properties short-listed for sale in our analysis are based on the premise that sale should meet approximately 30% of the company’s total re-financing needs in 2008 and 2009. Overall, we expect GGP to realize net sales proceeds of $1.2 bn and $1.5 bn in 2008 and 2009, respectively. Further, we have also curtailed GGP’s estimated capital improvement requirements by approximately 50% and 70% in 2008 and 2009, respectively, to $0.8 bn and $0.5 bn from $1.6 bn and $0.7 bn, previously, considering the difficult credit conditions GGP is facing.

Consequently, the assumed foreclosure and sale properties together with estimated curtailment in capital expenditure would bring down GGP’s total financing needs by 50% and 42% in 2008 and 2009, respectively, to $2.7 bn and $2.4 bn versus our previous estimates of $5.4 bn and $5.7 bn.

GGP foreclosure and sale assumptions:

Foreclosures:

We have used following key parameters to identify GGP’s properties that coule be potential candidates for foreclosure:

· Properties with a huge amount of debt maturing over the next 2-3 years

· Properties with high LTV (greater than 100%)

· Properties with low cap rates

Based on the above analysis, we have identified the following properties which are most likely to be foreclosed –

As a result of foreclosures, GGP’s outstanding debt is expected to reduce by $4.8 bn to $19.3 bn. The estimated market value of these properties is $2.3 bn while the book value net of depreciation stands at $4.8 bn with a corresponding outstanding debt of $4.8 bn. Pursuant to the assumed foreclosure, GGP is expected to record a net loss of $0.08 bn in its books on these properties.

Additional cost of financing:

We believe that foreclosure would strongly impact the company’s credit standing owing to which GGP would have to bear increased cost of raising additional funds from the debt markets. We have assumed an approximately 200 basis points increase in the company’s cost of borrowing (on re-financing during 2008-2011) resulting in an additional cash outflow of $47 mn and $70 mn in 2008 and 2009, respectively. GGP’s average cost of financing is expected to increase from 5.8% in 2007 to 6.0% in 2008 and further to 7.1% in 2012. GGP’s present value of interest expense as a result of additional cost of financing is approximately $3.4 bn.

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Sales:

In addition to foreclosures, we expect GGP to sell a few of its un-encumbered properties to partly meet its re-financing requirements. We have assumed that GGP could meet approximately 30% of its re-financing needs in 2008 and 2009 through sale of properties. Based on the aforesaid assumptions, we expect GGP to realize net sales proceeds of $1.2 bn and $1.5 bn in 2008 and 2009, respectively. We have identified the following 10 properties that would meet the re-financing needs:

Owing to the current low level of investment interest in the retail real estate market and the prevailing tight credit market conditions, GGP may face a hard time in realizing appropriate values for its for-sale properties. We assume the company would have to sell these properties at a discount of 15% to our estimated fair values. In addition, we estimate 8% cost of sale expenses on these properties. Overall, we estimate GGP to realize net sales proceeds of $1.2 bn and $1.5 bn in 2008 and 2009, respectively, with a book gain on sale of $0.20 bn and $0.50 bn.

Tight cash now causes GGP’s new development and re-development plans shrink by up to 70%, thus reducing future NOI and FFO: the company is devaluing...

As a result of the likely difficulties in meeting its re-financing needs following foreclosure, we expect GGP to reduce its capital expenditure towards maintenance and development activities. We now expect GGP to spend $1.6 bn and $0.7 bn towards capital expenditure in 2008 and 2009, respectively, which is approx. 50% and 70% below our previous estimates.

GGP detailed valuation summary – under foreclosure and sale

GGP’s portfolio analysis

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Based on our estimates of property values and rental growth, approximately 19% of GGP’s properties have cap rates greater than 10% while more than 51% of the its portfolio has cap rates below 4.5% (in nearly 25% cases the cap rates are even less than the current U.S treasury rate). Most of these properties with low cap rates were purchased during 2003-2007 when the property prices were high and credit to finance these purchases easily available. As property values have declined significantly since then, many of these properties are currently sporting negative equity with their LTVs rising above 100%. We believe that these are the properties that are most vulnerable to foreclosure in case GGP is not able to meet its re-financing requirements in 2008 and 2009 (a distinct and likely possibility).

GGP’s properties purchased over the last 3-4 years have lower cap rates (3-4%) owing to higher purchased price. In addition, these properties were purchased with a significant amount of debt. As a result of recent decline in rentals and property prices, properties purchased with high leverage have negative equity which continues to drive down company’s overall valuation. As seen from the table above, around 45% and 26% of properties (these properties were acquired in 2007 and 2004) have negative equity as against only 2-5% properties acquired during 1990’s and early 2000.

GGP’s financing options

As of September 30, 2007, GGP had a total mortgage debt of around $24 bn. GGP’s net investment in real estate on its books (at gross value after adding back depreciation) on that day stood at $26.6 bn while its shareholder’s equity was $1.5 bn. GGP is one of the most highly leveraged REITs in U.S with debt-to-assets of 84.4%.

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Besides being highly leveraged, GGP has a significant portion of its debt due for maturity over the next few years. Nearly $5.9 bn or 24.7% of GGP’s total debt is due for maturity over 2007-2009, while by 2011, a significant 74% of the company’s outstanding debt is due for maturity. By the end of 2007, GGP was able to refinance only 6.1% (or $359 mn) of debt due to mature over 2008-2009. However, as the company approaches the period of its next debt maturity date, the task of refinancing could only be expected to get more difficult in context of continually tightening credit market conditions. The threat of monoline failures, combined with significant asset write downs by banks and real estate companies aggravated by sharp declines in housing demand and prices, together with an increase in defaults and foreclosures, have created one of the tightest lending environments in the recent history. An environment that will be even tighter for a considerably above average risk, as we see GGP!

Faced with tough times arranging refinancing and amid high expectations of further deterioration in the credit and capital market conditions, at least in the near term, we believe GGP, though reluctantly, might have to opt to foreclose some of its highly leveraged properties to meet its debt obligations in order to preserve its other income-generating properties.

As a result of the assumed foreclosure of $4.8 bn worth of loans in 2008 and the assumed the sale of $2.7 bn worth of properties in 2008 and 2009, we believe that GGP would be left with approximately $2.7 bn and $2.4 bn of financing needs in 2008 and 2009, respectively, out of which $1.9 bn and $2.2 bn is related to re-financing debt repayments while $0.8 bn and $0.20 bn in 2008 and 2009, respectively, is related to capital improvements.

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GGP – Peer group analysis and relative valuation

Key charts

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Written by :

Reggie Middleton