markets and the sheer size of investment class (~$100 billion in apartments trade annually in the US.) should provide ample acquisition opportunities. Post its March 2013 IPO, MST has acquired or agreed to acquire ~8,200 suites via 11 transactions, valued at $1 billion.
Acquisition activity adds quality to the portfolio
MST’s targeted growth-by-acquisition strategy focuses on acquiring newer, higher-quality properties and trimming older, smaller, lower-quality properties. In 2015, Milestone acquired five properties (1,443 units) for a total cost of $178 million. Last year’s transaction activity culminated with the October 22 announcement of a JV with Starwood Capital Group in which MST acquired a 15-property portfolio (4,172 units) for $502 million from Landmark Apartment Trust, a non-traded US REIT. The acquisition properties are, on average, 10 years of age and carry AMR of $958 versus Milestone’s overall portfolio which, as at Q3/15, had a 25-year average age and an $871 AMR.
Shift to US$-pay format; low (and prudent) payout policy
Effective January 16, Milestone unitholders will receive a US$-denominated distribution by default, and at their election, may receive C$-denominated distributions. The shift to a US$- pay format was also accompanied by a change in the distribution rate to $0.55/unit annualized from the former rate of C$0.65. We believe the new US$-denominated distribution simplifies the REIT’s payout policy by aligning with the business’s underlying functional currency. Milestone’s payout ratio (55% on 2016E AFFO/unit) remains low relative to the Canadian peer set. Allowing for significant retained AFFO (more than $30 million, annually), the low payout should be valuable in light of potential value-enhancing capex on the heels of the pending portfolio purchase and the step up in financial leverage, post transaction. The low payout also provides comfortable “headroom” for future distribution increases in the face of what could be moderation in future AFFO/unit growth as the REIT seeks to potentially trim financial leverage.
Strong candidate for 2016 Index inclusion
When the subscription receipts (issued to fund the Landmark Apartment Trust transaction) are converted to units later this quarter, Milestone’s float will tally 58 million units and its total unit count will be 76 million. Based on the current unit price, the float value and fully distributed market cap values will be $0.9 billion and $1.1 billion, respectively. The former is clearly of interest as the criteria for inclusion in the S&P/TSX Composite Index (and by default, the S&P/TSX Capped REIT Index) is a float value of approximately $1 billion. Hence, we believe Milestone’s units are becoming a very strong candidate for 2016 index inclusion. RBC CM’s Global Program Trading Group estimates 4 million MST.un units of potential demand should Milestone be added to the S&P/TSX Composite.
Estimates, price target, and rating
Milestone REIT’s FFO/unit for 2014 was $1.01. Our FFO/unit estimates for 2015, 2016 and 2017 are $1.07, $1.13 and $1.15, respectively. Our one-year price target of C$18.00 is derived by applying a 10% discount to our NAVPU estimate one year hence and implies a ~13-14x multiple to our 2017 AFFO/unit estimate. The P/NAV and P/AFFO valuation metrics ascribed in deriving our MST price target are at a discount to the Canadian multi-res sector average. We believe our target valuation is reasonably reflective of MST’s asset calibre, financial leverage, small unit float, the degree of significant influence that is retained by its two sponsoring unitholders, and the terms and expense ratios associated with its external advisory contract. Based on relative risk-adjusted return expectations, we rate MST’s units Outperform.