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Investment Thesis
Brandywine Realty Trust (NYSE:BDN) is a REIT with a geographic focus on Philadelphia, Washington D.C., and the Austin markets. BDN develops and manages urban-centric mixed-use portfolios and has a strong tenant industry mix minimizing exposure to sector-focused downturns.
The 54% decline in the price of BDN has pushed the yield to over 12% and made the valuation compelling. BDN is a publicly traded REIT and must pay at least 90% of its income out as a distribution; this is not a qualified dividend. With a grudging recovery in the commercial real estate sector underway as COVID-19 concerns wane, BDN is a compelling income investment with a potential price recovery opportunity in our opinion.
Estimated Fair Value
Estimated Fair Value = E23 FFO (Funds from Operations) times Price/FFO
EFV = E23 FFO X P/FFO = $1.25 X 8.0x = $10.00 per share
Properties
The FY22 recovery, post-COVID-19 recession, with year-end occupancy expected to reach 91-93%, is targeted for 8-10% cash rent increases. This combination should increase same-building net income by around 2%. BDN has an 11 million sqft mixed-use land bank that can be developed. Presently 42% of BDN real estate is office space, 29% is residential, 16% is laboratory/education, and 13% is other.
|
Region |
% of Total Sqft |
% of Net Income |
% Leased |
|
Philadelphia, PA |
20.6% |
24.4% |
98.1% |
|
Philadelphia (University City), PA |
14.1% |
21.5% |
96.5% |
|
Suburbs, PA |
29.1% |
28.8% |
94.3% |
|
Austin, TX |
20.4% |
19.5% |
86.8% |
|
Washington, DC |
5.7% |
3.3% |
75.1% |
|
Other |
4.3% |
2.1% |
73.7% |
Returns on real estate are measured in cash yield (also known as cash-on-cash return). It is a measure of the annual cash flow before taxes, divided by the total cash invested into the property.
Development highlights include a JV (Joint Venture) development project in the University City area, including 200,000 sqft of research space and 326 residential units. This project is a JV between BDN and two Universities, Maryland and Drexel.
This $287 million investment is expected to have a 7% cash yield. A similar mixed-use development in King of Prussia, PA is expected to cost $83 million and have an 8% cash yield.
Financial Performance and Market Dynamics
FY22 capital usage of $57 million is expected for development and $20 million for maintenance.
Longer-term goals in the pipeline are expected to provide $165 million in incremental net income by 2026. 3Q22 Debt to EBITDA was 7.2x and is expected to fall to 6.8x by the end of the year with a target of 6.0x. Clearly, the current leverage is too high, and the costs of refinancing have gone up with interest rates over the past couple of years. The leverage and refinance risks need solid operation fundamentals to prevent the risks from being realized.
E22 FFO (Funds from Operations) is sitting at $1.40 per share with expectations of dropping to $1.25 for 2023. The reason for this decline is primarily due to an increase in interest expense and finishing costs for current projects. We believe the compelling valuation, 61% FFO distribution coverage and 12.6% yield, and superb execution combines to make BDN a reasonable income holding.
|
Brandywine Realty Trust |
E2022 |
E2023 |
E2024 |
|
Price-to-Sales |
2.1 |
2.0 |
1.9 |
|
Price-to-FFO |
4.4 |
4.9 |
4.5 |
Risk
Increased work from home will be a permanent change in the US even with lockdowns ending and employers inviting employees back to the office. Bloomberg reported that average occupancy across the 10 largest metros in the United States is hovering at around 50%. Before the pandemic, this was 95%. The National Bureau of Economic Research expects that the introduction of hybrid-working schemes will cause approximately 30% of workdays to remain at home. Even in cities experiencing strong growth like Austin, where BDN operates, office occupancy remains at a lowly 60%. Although more work from home has caused an increase in housing costs for both buyers and renters. BDN’s mixed-use experience should help the REIT if converting offices to apartments becomes optimal.
Interest rates are on the rise, and much of the cheaper <3.5% yield debt issued by BDN is maturing soon. Refinancing or issuing new debt will likely be in the 7% yield neighborhood which will add to interest expenses hurting cashflows and making balance sheet improvements more difficult.
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