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Wednesday, 09 January 2008 05:00

General Growth Properties & the Commercial Real Estate Crash, pt III - The Story Gets Worse

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This is part III of a IV part series on GGP. Reference parts one and two for context. The majority of work on GGP is now done, and I will (as my time permits) start disseminating the non-proprietary research to the public domain through my blog. This is an extended summary with a supplemental download that will list the profitability and cap rate of each of the 260 properties that GGP has ownership rights in. Next week, I will actually post a 30 page valuation model for each of the 260 properties and will make them available to "serious" followers of the blog upon request. I need to do this to conserve bandwidth, for having 2,000 people pull 2 gigs off of my servers daily will cause congestion and expense - plus I want to know who my researched opinion goes out to. The numbers presented here are not final, for there are some issues that need to be ironed out. I am going to try something new here, and allow the constituency to participate in the research and report back with an opinion, in lieu of me and my team doing all of the work on a proprietary basis. Consider it open source analysis.

Valuation

I have summarized GGP's valuation under the three scenarios of ï¿½Recession', ï¿½Base Case' and the most ï¿½Optimistic case'. From the table below, one can clearly witness that amid current conditions of weakening fundamental in the US, as being increasing confirmed by declining employment data, softening trend in consumer spending, rising risk, adverse liquidity condition and the deteriorating residential sector, General Growth Properties (GGP), a pure real estate investment trust, doesn't command a healthy premium over its current price even in the most optimistic scenario of growth in commercial rentals over the longer-term.

In the ï¿½base' scenario, assuming a moderate decline in commercial rentals over the next couple of years (owing primarily to expected slow-down in consumer spending and in particular reference to lower-than-expected retail sales in 4Q2007) and thereafter expecting the rentals to witness a nominal growth of 0.2%, 0.5% and 0.8% in 2010, 2011 and 2012, respectively, we expect GGP's valuation to be approximately $7,254 mn, translating into an expected share price of $29.8, a 12.2% lower from its current price of $33.9 per share (see valuation below under the ï¿½Cash Flow After Tax' basis). This is over and above the 17% decline the stock has already witnessed over the past week. Among other assumptions, the most important include the following:

An occupancy rate of 89.7%, lower than the current rate, expecting softness in demand for commercial rental space amid weakening fundamentals
GGP's cost of financing to increase to 6.14% as the company refinances its existing debt and borrows additionally to meet its capital expenditure amid tight credit market situation

As we have discussed earlier, in the event of the US economy going into recession, the downside risk to GGP's share price from the current level of US$33.9 would be around 22%, indicating the weakening financial and operating condition for the company.

We expect recession to impact GGP's NOI primarily in 2008 and 2009 post which we expect the US economy to drift back to recovery though gradually. However, the recovery would be much slower than the growth assumed (in 2010-12) under the ï¿½base' scenario discussed above. We have hence estimated negative growth in rentals for 2008-2010, with near flat growth for 2011 and 2012. Thereafter, we expect conditions to start normalizing, and have hence built in long-term normalized growth in rentals.
We also expect interest rates in the recession version to be higher than in the ï¿½base' case as the company treads through highly difficult credit conditions in the next few years, particularly when that a large chunk of its debt is due for repayment/refinancing (see notes on refinancing towards the end).
We have also expected lower occupancy rates in the ï¿½recession' version from the current levels, expecting lowering demand for shopping space in the wake of falling retail sales and consumer demand.

We have built the most ï¿½optimistic' case for GGP based on reasonable estimates of GDP growth, population growth and household income growth in the company's operating locations. We believe the following assumptions represent a best case scenario for GGP -

Under the most ï¿½optimistic' scenario we expect GGP's asking rentals to witness a nominal 0.5%, 0.7% and 0.8% growth in 2008, 2009 and 2010, respectively, with occupancy level of 90.9%.
However even under the most ï¿½optimistic' scenario we expect GGP's additional cost of financing to increase moderately to 6.02% as we believe that tight credit to persist owing to spill over effect of sub-prime concerns.
Despite the fact that GGP's share price has declined 22% over last 9 trading sessions from $43.3 to $33.90 presently, and after considering the most optimistic assumptions, GGP is expected to yield only 3.1% upside from its current share price of 33.90 with an expected valuation of $8,524 mn translating into expected share price of $35.

Caveats and holes to be plugged in the aforementioned analysis.

Point to consider 1: Financing Issues

Due to the current tension in the credit markets, the days of the high and ultra high LTV loans are gone, at least for now. Word on the street is that some 60-65 LTV loans are not even going smoothly and some loans are not getting funded without additional equity, especially on the refinance. I welcome the input of any commercial mortgage broker/banker on this. About 40% of GGPs portfolio consists of properties that are 80 LTV or over, with a substantial amount of those in negative cash flow. This will effectively prohibit a straight refinance on them. The table below illustrates the financing requirement for GGP (based on overall LTV of 60%)

Value of all GGP's properties base case (A)	$ 29,649,606,770
Value of encumbered GGP's properties (B)	21,483,005,632

Maximum Loan to Value (60% of A)	17,789,764,062
Maximum Loan to Value (encumbered properties) (60% of B)	12,889,803,379
Maximum Loan to Value (unencumbered properties)	4,899,960,683

*Loans o/s (property specific)*	19,541,366,000
Refinanced through encumbered properties	12,889,803,379

*Balance to be financed through*	6,651,562,621
less: Financed through unencumbered properties	4,899,960,683

To be financed through Cash flows and sale of office properties	1,751,601,938
Percentage of total GGP properties	5.9%

According to our base case scenario, GGP’s properties are valued at approximately $29.7 bn which allows the Company to re-finance a maximum of approx $17.8 bn (assuming 60% loan to value). However GGP has O/S loan of $19.5 bn against $21 bn worth of encumbered properties. Appling a 60% LTV on these properties which comes around $12.9 bn, GGP will have to re-finance additional $6.6 bn through un-encumbered properties or through other internal sources. If the Company encumbers rest of its properties assuming LTV of 60% which comes to approximately $4.9 bn, the company still has to re-finance approximately $1.7 bn through sale of office properties and internal cash flows. We believe that GGP would be able to refinance the requirement based on the following observations -

GGP has existing debt maturities in 2008 and 2009 worth $2.6 bn and $3.3 bn out of which GGP has already re-financed $359 million. GGP is also currently negotiating the terms of the agreements to refinance debt maturing in 2008. Under the terms of these new long term loans agreement, the company can borrow up to approximately 50%-60% of property value for financing purposes (which are valued at capitalization rates below 7.5%) with an effective interest rates of approximately 5.75%.

The Company also intends to sell certain office assets upon expiration of tax-related restrictions in 2008, and is presently offering for sale a number of suburban office buildings.

Further, the Master Planned Community land is substantially unencumbered. The value of GGP's investment Land and Land Held for Development and Sale as on December 31, 2007 stood at $3.3 billion.

Of concern is the selling price GGP will get for retail/office space in suburban areas where pricing is leading the way into soft territory. I will follow up on this with additional analysis next week.

The full pdf summary version of this post with condensed summary info on ALL of GGP's properties is available for download now (see GGP Valuation Summary - Release Candidate (719.48 kB 2008-01-09 22:19:32)). It has all of GGP's properties listed with cap rates and performances under the recession sensitivity analysis, as follows...