Commercial Real Estate at Its Best…Or Worst?

Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

It appears that commercial real estate is not the next shoe to drop, meaning it could be the next boom market to follow. Residential real estate has seen an impressive rebound over the last year and this market should help drive the commercial market.

Not to mention the companies outlined below have impressive exposure to discretionary spending, meaning they could perform nicely on the back of a rebounding economy. I think the mall operators and high-end real estate owners should perform well over the long term. These properties were some of the hardest hit as a result of the economic downturn. 

After the real estate crisis begin to unfold, billionaire activist Bill Ackman had to step in and lead a corporate restructuring that allowed mall-operating giant General Growth Properties (NYSE: GGP) to avoid bankruptcy. 

After spinning off a number of properties, General Growth is still considered one of the oldest and most experienced shopping center owners, developers and managers in the U.S. The REIT owns, or has joint ventures for, 144 regional malls (126 in the U.S. and 18 in Brazil).  

At the height of its struggles in 2008, General Growth had $29.6 billion in assets and $27.3 billion in debt. The company suspended its dividend, halted all development projects and cut its work force by more than 20%. Now the company has assets of $26.9 billion with debt of only $16.5 billion. 

Part of its restructuring included the spinning off of certain assets. From 2011 to 2012, General Growth spun off some 30 mall properties into Rouse Properties. Howard Hughes (NYSE: HHC) is yet another addition to the General Growth saga, being spun off from General Growth in 2010. The company is a developer and operator of master-planned communities and mixed-use properties. 

Howard Hughes' portfolio of real estate spans 18 states and includes "high-quality" properties; some have said they were the cherry-picked and best assets from General Growth. A couple of key properties include a large tract of land purchased on the outskirts of Las Vegas in the 1950s, and the South Street Seaport at New York City's Pier 17.

It's long been said that valuing this diverse group of properties is nearly impossible. At the time of the spin-off, General Growth president, Thomas Nolan, noted that "as a collection of assets, it will take time for people to get their arms around the value that's in the portfolio." This still appears to be the case, with only two Wall Street analysts covering the stock. 

Howard isn't a REIT and won't be paying a dividend anytime soon, meaning it can focus on deploying its earnings to more aggressive forms of growth. With $200 million in cash and a debt-to-equity ratio of 30%, Howard Hughes has a strong balance sheet that will allow the company to continue developing its real estate.

The other shoe

While Howard was surging more than 200% over the past couple of years, General Growth was caught in the middle of a battle between Brookfield Asset Management and Ackman. Brookfield is a global alternative asset manager, operating across five broad segments, including renewable power, property, infrastructure, private equity, and asset management. 

Ackman wanted Simon Property (NYSE: SPG) to acquire General Growth, while Brookfield was also amidst the battle to acquire General Growth; meanwhile, Brookfield showed interest in buying the mall operator for itself. 

Simon trumps General Growth as the largest public-REIT mall-operator. At the end of the 1Q, Simon owned some 325 properties spanning 242 million square feet in North America and Asia. Simon also has a near 30% interest in Klépierre, a publicly traded French REIT that owns shopping centers in 13 countries in Europe. 

Since the end of last year, things have cooled down. Ackman has since gone passive on General Growth, abandoning his push to sell the mall-operator to Simon.  

Simon Property still has one of the strongest comparable sales per square foot in the industry. Based on Simon's strong performance, it appears that the mall-operators might be seeing a solid turnaround. 

Simon's strong first-quarter results led the company to up its fiscal 2013 funds- from-operations mid-point guidance from $8.45 to $8.55. Occupancy at its regional malls and outlets was also up 110 basis points year-over-year to 94.7%.

Hedge fund hankering

Billionaire Bill Ackman remains General Growth's most convinced hedge fund owner, with nearly 15% of his Pershing Square hedge fund invested in the stock. That's nearly 75 million shares, or $1.5 billion. 

Brookfield has a much less impressive amount of conviction from major hedge funds. Its top hedge fund owner includes Third Avenue with 5.8 million shares, or 4.1% of the fund's 13F. Other major hedge fund includes SQ Advisors with 5.6% of its 13F in the stock. 

Howard Hughes, much like with General Growth, has activist Bill Ackman owning the most shares among major hedge funds. Pershing owns nearly 3.6 million shares worth close to $300 million and making up nearly 3% of the fund's public- equity portfolio. 

Simon Property has a limited amount of hedge fund interest, but the largest conviction comes from AEW Capital, with 12.6% of its funds invested in the stock. Capital Growth has 3.4% of its 13F invested in the stock. 

Foolish bottom line

With the settling down of the battle between Ackman, Brookfield, General Growth and Simon, let's try to see which stock might be genuinely solid investments. Howard Hughes appears to have the least levered balance sheet, while Simon is levered the most:

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Meanwhile, Howard Hughes also has the top current ratio, and Simon has a current ratio of just over 1.0. 

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Therefore, I like Howard Hughes for the growth prospects, and from a valuation standpoint. As far as investing in one of the mall REITs, Simon Property has the best dividend yield at 2.8% and General Growth has a 2.3% yield. 

While it's unlikely that Simon will come back to the M&A table for possibly acquiring General Growth anytime soon, the real catalyst for General Growth is continued improvement in operations, which should afford the company a similar valuation as Simon. Simon trades at 8.8 times book value, while General Growth is at only 2.4 times. 

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Marshall Hargrave has no position in any stocks mentioned. The Motley Fool owns shares of Howard Hughes. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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