Special Situation in Commercial Real Estate

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Toronto-based Brookfield Asset Management (NYSE: BAM) is poised to form a new publicly-traded entity using an enormous chunk of its commercial real estate holdings. The property giant will retain a majority stake in its new Brookfield Property Partners (BPY - exchange pending) spin-off. If no last-minute regulatory or legal hurdles arise to derail the move, it could be finalized during the first quarter of 2013.

About Brookfield Asset Management and Brookfield Property Partners

Brookfield Asset Management is one of the largest North American property-management firms. The company invests in a range of real estate assets as well as a number of utility and infrastructure properties in North America, South America, Asia, Australia and Europe. It also has a private-equity subsidiary that makes targeted investments in other property-management and real estate companies as well as direct purchases of specific assets. Notable Brookfield holdings include a substantial hydroelectric complex in eastern Canada and a power-transmission network in the New England region of the United States.

Brookfield Property Partners will own a number of recognizable real estate companies and assets. These holdings will include a partial stake in distressed enclosed-mall operator General Growth Properties (NYSE: GGP) and a majority stake in office-park giant Brookfield Office Properties. In addition, it appears likely that the company will make targeted investments in distressed commercial and residential real estate in certain recession-wracked European countries. The entity will function as a holding company for many of Brookfield Asset Management's more complex assets and pay at least $50 million per year in management fees to the larger entity. About 90 percent of Brookfield Property Partners' shares will remain under the control of the parent company. With a portfolio estimated to be worth at least $70 billion, it is expected to have a market capitalization of about $10 billion.

How the Spin-off Will Work

The spin-off will involve the sale of about 10 percent of Brookfield Property Partners' outstanding shares via an offering of warrants to current Brookfield Asset Management shareholders. Expected to raise at least $1 billion for the parent company, the initial offering may be followed by a secondary offering at a higher price point. At this time, Brookfield has not yet pinpointed an initial offering price.

By executing this spin-off in the midst of a struggling market for commercial real estate, Brookfield is clearly betting that the economy is an inflection point. Given its expectation that rents and property values in Europe and elsewhere will rise markedly during the coming years, it may price the new Brookfield Property Partners shares at a slight premium. Investors who wish to grab a slice of BPP's expected $1 billion investment in Brookfield Asset Management's nascent "global property fund" and profit from General Growth Properties’ expected resurgence may be willing to pay such a premium. To sweeten the deal, BPP is expected to initiate a juicy dividend of at least 3 percent within its first year of existence.

Potential Complications and Long-Term Prospects

A major potential hurdle to this deal has recently been resolved. Los Angeles-based activist investor William Ackman had argued that Brookfield Asset Management should sell its stake in Chicago-based General Growth Properties to Indianapolis-based Simon Property Group (NYSE: SPG) as a condition of the pending spin-off. In 2010, Ackman and Brookfield had banded together to infuse enough cash into General Growth to prevent it from filing for bankruptcy. 

Afterwards, their relationship soured. When Brookfield steadfastly refused to meet Ackman's demands, the investor backed down and accepted a "truce" offer that would require Ackman to execute a General Growth warrant sale valued at $270 million and place a strict cap on the value of Brookfield's ongoing stake in General Growth. With the issue settled, the Brookfield spin-off appears substantially more likely to occur.

At this point, the only major hurdle to the deal involves a customary investigation by U.S. and Canadian regulatory authorities. Since the spin-off involves the actual sale of additional shares and will keep Brookfield in control of the new entity, it is unlikely to be deemed tax-free by either country. Nevertheless, the partial Brookfield spin-off offers an intriguing opportunity for investors who wish to take advantage of an improving North American economy and a bottoming European property market. 

At the same time, its unusual structure may render it less attractive than such a spin-off might otherwise be. Since Brookfield Property Partners appears to be shouldering a great deal of the risk associated with the current Brookfield Asset Management portfolio, conservative investors may wish to approach the new Brookfield stock with caution. In the months that follow the spin-off, the parent company may well perform better than the new entity. After all, this deal is a win-win situation for Brookfield Asset Management: It will collect ongoing income from its new subsidiary while insulating itself from some key risks. 

Cautious investors may wait to jump into Brookfield Property Partners until the parent company chooses to raise additional capital by issuing a secondary offering of the stock. Depending upon the health of the commercial real estate market, such a move might not occur until 2014 or 2015. In a way, an investment in BPP is a vote of confidence in an improving developed-world economy. Investors who remain skeptical of this story may wish to remain on the sidelines for the time being.

mthiessen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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