Business Description

Brookfield DTLA Fund Office Trust Investor Inc. (“Brookfield DTLA” or the “Company”) is a REIT that owns 6 different Class A office properties in downtown Los Angeles. The Company was formed in order to acquire the assets of MPG Office Trust (“MPG”) in 2013 and is an indirect subsidiary of Brookfield Property Partners (“Brookfield,” NYSE: BPY).

Situation Overview

In 2008, MPG got into financial trouble due to deterioration in its real estate portfolio during the downturn and stopped paying dividends on its preferred stock dividends in October 2008. The dividend began accruing and continued to accrue until 2013. In 2013, Brookfield Office Properties Inc. acquired MPG, structuring the transaction so that the preferred would not have to be redeemed. Instead, it was determined that the value of the underlying real estate portfolio still did not adequately cover the value of the preferred. A lawsuit was filed and settled for $2.25 / share (paid out in 2015). Since then, preferred dividends have continued to accrue.

In August 2017, Bulldog Investors LLC (“Bulldog”), a well-known activist hedge fund, acquired ~4% of the outstanding shares and called for a special meeting. Bulldog is currently seeking to elect two of its principals to Brookfield DTLA’s board. The Special Meeting of shareholders is to be held on November 11 and should Bulldog win the proxy fight and receive the two board seats, they have stated that they would seek to have Brookfield DTLA become current on its dividends. Interestingly, the Board of Directors has not taken an official position “for” or “against” the Bulldog nominees.

With a cumulative value of ~$39 / share, DTLA preferred shares of 30% upside from current prices. In the meantime, DTLA continues to accrue a 7.625% dividend.

Investment Thesis

Bulldog nominees will be elected to the Board and thereafter work to re-instate the dividend;

Should Bulldog lose, Brookfield has indicated it expects to reinstate the dividend anyway, by 2023;

Investment Risks

Preferred shareholders vote against Bulldog’s nominees;

Timetable;

Series A preferred shareholders get layered;

Brookfield decides to never reinstate the dividends

Summary

The current situation is binary and depends on Bulldog winning seats and reinstating the dividend. If Bulldog loses, I still look at the preferred as a favorable risk / reward, although it may end up taking several more years. Ultimately, if Brookfield would ever like to extract value (via upstreaming dividends) from its Los Angeles portfolio, it will need to address the preferred overhang.

What will Shareholders do?

Tough to know. Based on publicly disclosures, I could only account for 17% of the shares:

However, any shareholder in this case would clearly want to see the dividends reinstated so it is tough to understand the rationale for not supporting Bulldog. Additionally, the Board has not mounted any campaign against Bulldog and has taken no official position in the proxy regarding election of the Bulldog nominees.

Why would Brookfield pay dividends?

Brookfield DTLA cannot pay any dividends to equity holdings (i.e. Brookfield Property Partners) until payments of the accrued and unpaid dividends to preferred shareholders have resumed.

In support of the 2015 settlement with preferred shareholders, in a sworn affidavit Mark Brown, Chief Investment Officer of Brookfield Office Properties Inc. and Chairman of Brookfield DTLA stated “it is highly likely that Brookfield DTLA will begin paying the accrued and unpaid dividends on the preferred stock within the next eight years” and later said that is a “conservative” estimate and “not unrealistic” that they would pay sooner. Since then, downtown LA commercial property values have continued to appreciate. Accordingly, Brookfield DTLA should be able to recapitalize the Company and refinance mortgages on the underlying properties as the mortgages come due. A recapitalization of the portfolio by Brookfield DTLA could lead to payment of the accrued dividends and/or redemption of the Brookfield DTLA Preferred Stock altogether. In the affidavit, Brown added that Brookfield DTLA could redeem the preferred stock using proceeds from new senior debt that would be most cost effective to the Company.

What is the real estate property worth?

I’m hesitant to place a hard value on the real estate portfolio, except to determine whether there is value in excess of the preferred stock. As part of the MPG merger, Brookfield created a new subsidiary to own all of Brookfield’s existing downtown LA assets. Brookfield paid $3.15 / share and the transaction had a TEV of $2.0 billion ($180mm equity value). The Company reflects ~$570mm in book equity value today. I calculate 2016 FFO of $50mm, and applying a 15x multiple, I back into an equity value of ~$700 – 750mm.

My view is that there is and continues to meaningful equity value here Brookfield would want to extract and in order to do that, the preferred stock would need to begin paying dividends again.

Proxy Fight Overview

In August 2017, Bulldog filed a proxy statement that they owned 400,000 shares (4% of outstanding shares). They called for a special meeting to elect Phil Goldstein and Andrew Dakos (the investing principals at Bulldog) to the board. Bulldog argues that while the Company seems to be doing well, no regular dividends have been paid to preferred stockholders in years. The total amount of unpaid dividends is ~$14 / share and the liquidation value of the Preferred Stock is $25 / share for a total of more than $39 / share.

The Special Meeting of Holders of 7.625% Series A Cumulative Redeemable Preferred Stock will be held on November 10, 2017. Shareholders of record as of October 16, 2017 are entitled to vote.

Capital Structure

Brookfield DTLA has a fairly complicated capital structure. The Company’s stock is ultimately indirectly owned by Brookfield Property Partners, however the actual legal entity that issued the preferred stock (Brookfield Fund Office Trust Investor Inc.), actually has several different layers of mezzanine equity. I took a stab at putting together a simplified org chart in order to better track and understand the capital structure:

Series A Preferred Stock: This is the interest that is publicly traded

Series A-1 Preferred Interest: issued by a separate subsidiary and owned by a Brookfield intermediate Holdco. Liquidation preference is par with Series A Stock and share pro rata 48% to Series A-1 / 52% Series A in a liquidation.

Senior participating preferred interest: put in place as part of the merger, this interest acted similar to an intercompany loan from Brookfield DTLA Holdings to the DTLA OP subsidary. It originally comprised a $240mm preferred interest (7% coupon + 4% interest in the residual value). As of 12/31/2015, the 7% preferred interest has been fully repaid.

Series B preferred interest: As part of the merger with MPG, Brookfield DTLA Holdings made a commitment to make capital contributions in cash or property to New OP, up $260mm. On behalf of those contributions, Brookfield has contributed $93mm in cash contributions. These interests are entitled to a preferred return of 9.0% and are structurally senior to the Series A preferred stock

The question I keep coming back to (and haven’t necessarily found a good answer yet) is what the purpose of the various subsidiaries are. Part of it appears to be an attempt by Brookfield to pull cash out of the property portfolio, while not triggering change of control provisions that might require it to redeem the preferred stock. Frankly, it’s been incredibly challenging to understand this structure based on public disclosures, and I may update it if I find more information.

Risks