This Is Your Surest Bet On A Housing Rebound
Shmulik is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
There are many ways to play a housing rebound. You can invest directly through stocks of home-builders, or indirectly through home maintenance supplies like carpeting, paint or dishes. You can even take it one step further and invest in banks with high exposure to retail mortgage portfolios, such as Wells Fargo, which controls roughly a third of the U.S retail mortgage market. But there's another way, a worry-free, risk averse way, to play a rebound in the housing market: investing in asset management firms.
The core business
Brookfield Asset Management (NYSE: BAM) is a former owner of real estate and other cash-generating assets, but has transformed into an asset management business. Brookfield manages about $152 billion, invested among four distinct types of assets: real estate, renewable electric power, infrastructure (like toll roads, sea ports, and gas pipelines), and private equity. As an asset management company, Brookfield handles other people's capital. It invests capital on behalf of its clients, the largest of whom are government and private-pension funds. Brookfield also usually buys between 20%-40% of the investments it makes for clients.
Management has skin in the game alongside shareholders, too. Brookfield's management and directors own 19% of its outstanding shares, providing a powerful incentive to potential investors. Because it owns a significant portion of shares, management's interests are aligned with shareholders', which creates shareholder value. So it's no surprise that Brookfield's track record is excellent--shareholders have enjoyed an average year-over-year growth rate of 16% over the last 20 years. That's nothing short of spectacular.
You see, Brookfield's management is known for pouncing on deeply distressed investments. That's how they make their great returns. They don't need to sell anything to anyone, they don't depend on market currents or on the banking sector's success. They simply wait on disastrous events, buy assets at basement prices and then rent these assets, and sit on them. The return on capital is more than satisfactory.
Brookfield's management has demonstrated its bargain-seeking capabilities several times in the past. In 2002, fearful of another terrorist attack, tenants fled Manhattan. Brookfield stepped in and paid $128 a square foot for Lehman Brothers' stake in one of the four World Financial Center towers adjacent to the site of the former Twin Towers. Two years ago, a similar building sold for over $600 per square foot. Today, Brookfield owns all four World Financial Towers, totaling 7.97 million square feet of Class A office space in the world's biggest, busiest, most important financial center.
Another more recent victory for Brookfield involved General Growth Properties (NYSE: GGP)– then the 55-year-old second-largest mall operator. Back in 2008, the financial crisis froze credit markets, leaving GGP unable to refinance its $27 billion in long- term debt. It was a high-quality business in financial distress. Brookfield's first investment in GGP was in deeply discounted, defaulted bank debt. Banks don't like to hold distressed investments, which attract negative attention from regulators. They usually want to get rid of distressed assets as fast as possible, creating opportunities for investors to purchase them at substantial discounts. That's how Brookfield was able to buy GGP's unsecured bank debt. Even before General Growth Properties emerged from Chapter 11 bankruptcy, the bank debt returned to par value, providing a solid return on Brookfield's investment. But that wasn't the end of it. The real money was to be made in the restructuring of General Growth.
In August 2009, Brookfield formed and quickly invested $1 billion in a new business designed to acquire undervalued real estate debt and equity like General Growth Properties. One year later, GGP emerged from bankruptcy and Brookfield owned 30% of it. Shortly after emerging from bankruptcy, GGP sold $2 billion of new shares for $14.75, providing Brookfield a quick 50% return on its original reorganization investment.
Today, Brookfield owns 40% of GGP. Brookfield's share of GGP's 2011 funds from operations (free cash flow) was $213 million – an 8% cash return on Brookfield's total GGP investment of $2.6 billion.
A great partner
Last year, Warren Buffett foresaw the rebound in housing prices, and positioned Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) to reap the benefits from such a rebound. Among other things, Berkshire has bought a brick-maker and won the loan portfolio of bankrupt mortgage lender Residential Capital LLC at auction. But the most aggressive step made by Berkshire was to form a venture with Brookfield Asset Management Inc. as low interest rates, inventory and prices spur a real-estate rebound. Berkshire’s HomeServices of America Inc. unit is now the majority owner of the venture to manage a U.S. residential real- estate affiliate network.
I believe that having Berkshire as your business partner is the ultimate Kosher label for any business, especially a business as well run as Brookfield.
Brookfield trades for only 1.28 times book value--that's a fairly cheap price to pay for such a seasoned business. A better way to look at it is through its cash generation capabilities. As of the end of 2012, Brookfield made $1.94 of free cash flow per share, up from $1.76 in the year before. With the stock currently trading at $36, the investor pays 18 times free cash flow. That's not very cheap, but not very expensive either.
My foolish conclusion
I believe that the best way to ride the rebound in housing is through asset management companies. Brookfield has had a rich and successful record of achieving an exceptionally high return for its investors. Now, with Buffett at the helm, I'm positive that it will also have a bright future.
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Shmulik Karpf has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. 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!