Description

Commercial real estate is having whatever the opposite is of its day in the sun.  Office REITs are trading at or near 52-week lows, as the continued impact of COVID, a looming recession, rising rates, and bank failures weigh on the space.  At the same time, return-to-work is driving increased numbers of employees to come to the office, and the looming recession could actually further that trend, as employees seek to enhance job security.  While I don't dismiss the bear base, I feel like Brandywine (BDN) represents a attractive risk / reward propisiton at it's current shareprice.

BDN owns 72 properities with ~13mm sq ft. located in Philadelphia (47% of NOI), Crescent, PA (near Pittsburg; 23%), and Austin (18%).  Office space appears to be Class A with top tenants (fairly diversified) being IBM, Spark Therapuetics, Comcast, FMC, and a host of law firms. Recession resistent customers represent at least half of tennants (legal, insurance, public adminsistration, health, busines services, etc.).   I also like that many of the customer types seem to be leading the return to office / are more suited to return to office like legal, insurance, financial, banking, real estate, health, etc.  I think it's worth noting that trends in actual occupancy (tunrstile swipes, etc.) have been consistnetly trending up and likely understate the need for office.  If everyone shows us four days per week, you can't cut your space by 20%.  

Only 4.4% of leases expire in 2023 and 7.2% expire in 2024.  Leases coming up for renewal average $36.15 and $44.54 in each of those years, respectively compared to averge lease rates of $43.32 per sq. ft.  % leased is 90.4% compared to 92.4% a year ago, so clearly some market driven trouble on leasing activity.  The Company's occupancy rates are much higher than market averages in Philadelphia and Austin where there is a tremendous amount of traditional and sublease supply on the market.  Thus far, lease rates have been increasing modestly on renewals, but with healthy TI and lease commissions required to do so.  

So - why own it?  First, it trades somewhere between an 11% - 14% cap rate depending on if you ascribe value to it's unconsolidated JVs.  Office REITs still average 8.9% cap rates and private market transactions suggest high sixes / low sevens cap rates.  BDN has slighly higher margins than it's peers and leverage appears lower on a net debt to EBITDA basis (whether netting out the values of the JVs as the chart does below or not).  Further, the Company has no 2023 maturities and enough liquidity to get you into 2027 before you have material maturities that will need to be addressed.

 Private market and public market values support significant upside to current prices.  

 Another way to look at valuation is a on an owner earnings basis.  I've tried to estimate normal course T&I / lease commissions by saying (based on recently quarterly information) that leases are 7.5 years in length and at that time require $35 per square ft in such costs.  Even assuming no benefit to lease rates from such expenditures, real estate level earnings produces a 22.6% return on today's market capitalization.  

So, what's the downside look like?  Well, the Company has 27.7% of square ft. expiring over the next four years.  I think a downside case is that 25% - 50% of that is absorbed, meaning occupancy would decline to 70% - 75%.  As mentioned before, rents have stablized and might go up with inflation.  The table below illustrates the upside / downside of various occupancy and rent levels, assuming balance sheet value to the JVs and a 10% cap rate.

Like i said, I'm probably most focused on the $40 - $45 rows and the 70% - 80% columns for downside sceanrios, and thinking you make multiples of your money in an upside scenario (as discussed above).  Also, FWIW - I do think the dividend will get cut, which could create some technical pressure on the stock (although at least some of that seems priced in at a 19% div yield).  I'm leaving a little dry powder to average down in that scenario.  

Catalyst

Recovery in CRE sentiment

Continued return to office