Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comment

[incomedreamer11]

What If It Was Allied RESIDENTIAL Properties REIT?

OUR TAKE: Neutral. We maintain our SO rating but our target price falls $5.50 (12%) to $40.50 as a 14% decline in our target multiple (from 21x to 18x; Exhibit 2 = support) offsets a transition to 2024E AFFOPU (+2% y/y); Exhibit 1 = summary of key changes. Our introduced 2024E reflects a 2022E-2024E AFFOPU CAGR of 4.3% vs. 2.7% LTA; the 4.3% = 1.0% ex. expected development completions (i.e., it is big part of the story; ~$0.17 of AFFOPU in 2024 and ~$3.00 of NAVPU accretion). In addition to the new 2024 estimates, we also analyzed residential values in Allied neighborhoods, concluding the material gap in valuation (AP vs. condos; Exhibits 4-5) + significant LT intensification upside (Exhibit 6) = protection from the higher private cap rates already priced into AP unit price (Exhibit 12). While we think there is excellent long-term value here for patient investors (Exhibits 13-15), consistent with the message in our Office Report (see link) very negative Office sentiment requires REIT-specific catalysts to emerge, which for Allied we characterize as hitting target 94% occupancy by year-end, more active asset recycling program (incl. UDCs), and development completions (i.e., AFFOPU growth; Exhibit 7).

KEY POINTS

We think residential intensification = cap rate expansion repellent. We estimate land value = $7.00-$7.50 per unit (Exhibit 4) based on avg. condo selling price of ~$1,000/sf in Allied neighborhoods (Exhibit 5). We estimate Allied is trading at ~40% of residential replacement cost. We don’t see private market Allied cap rates rising 270bp (like AP implied cap rate during COVID; Exhibit 12) given the significant residential optionality.

New 2024 estimates keep the gains in 2023, but not much more. Exhibit 8 = our assumption summary table. We expect more modest ~2% y/y growth in 2024 following solid ~6% growth in 2023. Our model reflects occupancy of 92%-93% through 2024 (combined 25% of portfolio leases expire) and declining market rents.

The only REIT where trading spread to 10YR GoC matches or exceeds historical avg on both implied cap and AFFO. AP implied cap and AFFO yield spread of 3.8% and 4.6% compares to 3.9%/3.3% 10-year historical avg. (Exhibit 14). To put this into perspective, for REITs we covered 10 years ago, REI and AX are next closest, trading at a 70-80bp lower-than-avg. implied cap rate spread to 10YR yield. On AFFO yield spread (AP is +120bp vs. historical avg.), only AX is trading worse at +200bp vs. historical avg.; pretty select company.

Key Q3 focus areas: guidance on near-term occupancy and broader market rent trends, lease renewal spreads, sub-let space and any shifts in capital allocation strategy. AP reports on Wed, Oct. 26 (typically ~5:00 p.m.) with a c/c on Thurs, Oct. 27 at 10:00 a.m. (#1-866-378-3566).

What If It Was Allied RESIDENTIAL Properties REIT?

We think residential intensification = cap rate expansion repellent. AP has identified ~10Msf of incremental density; the figure represents office GLA, which we suspect would be notably higher if it was residential GLA. We est. ~25% is already zoned, 10% in progress and ~65% remains (Exhibit 3). As shown in Exhibit 4, we est. the “residential” NPV per buildable sf is ~$7.25/un (27% of unit price; implies ~$240/sf), or ~$3.50/un if we assume the issuance of ~120M units (i.e., doubling existing unit count) to fund the $6B-$7B est. construction cost over time. We spent a lot of time reviewing condo pricing in Allied’s neighbourhoods and est. current market average of ~$1,000/sf, ranging from ~$600 in Calgary to $1,700 in Vancouver (Exhibit 5). Assuming a 15% development margin = avg. condo replacement cost of ~$850-$900/sf, materially above Allied’s implied ~$370/sf at ~$27/un. In essence, we est. AP is trading at ~40% of Residential replacement cost today. While this analysis may ring hollow for Office REITs with less potential “change of use optionality”, we firmly believe Allied can surface material value over time, with residential = 50%+ of portfolio upon our described hypothetical build-out. The key-word here = “over-time” as we also firmly believe investors will pay zero for this in the imminent future. Exhibit 6 compares Allied long-term intensification upside to Retail REITs, as well as near-term development completions (which we think the market will pay for upon completion). As shown, AP densification pipeline rivals the best of them, however, it also has the most near-term completions, something we think is a 12-month catalyst as discussed (Exhibit 7).

New 2024 Estimates

New 2024 estimates keep the gains in 2023, but not much more. Exhibit 8 = our key assumptions. Our new 2024E FFOPU and AFFOPU are $2.66 and $2.25 (3%/0% vs. consensus). We still expect 6%-7% 2023 y/y FFOPU/AFFOPU growth (consistent with AP soft guidance of “low-to-mid single-digit growth”), followed by ~2% growth in 2024. With 2024E SPNOI of ~1% offset by higher interest expense ($0.03 impact on “re-pricing” of 2% CHP promissory note to ~4%), the primary driver of growth in 2H/23 and 2024 = development completions. 2024E lease and debt expiries as % of total = 7% and 8% (2023E = 11% and 2%). Our 2022E-2024E occupancy = 92%-93% range (vs. AP Q4/22 target of 94%; Q2/22A = 89.5%). We reflect a 2023E and 2024E avg. market rent decline of 5% and 1.5%, resulting in negligible 2023E-2024E lease spreads. Exhibits 9-10 compare AP occupancy and SSNOI to CAD Real GDP growth over time (2024 consensus CAD Real GDP = 1.2%). On capital allocation, we reflect no acquisitions/dispositions, nor unit buy-backs and avg. 2%-2.5% annual distribution/un growth, although we attach a decent probability to the sale of a stake in its UDC portfolio by 2023.

Q3/22 Preview

Our Q3/22E FFOPU of $0.61 (+1.1% q/q; -1.6% y/y) and current NAVPU of $44.00 (-$2.00) are in line with consensus, while our 2023E FFOPU of $2.61 = 2% higher than consensus (Exhibit 11). Key Q3 focus areas: guidance on near-term occupancy trends, the lease renewal spread, sub-let space and any shifts in capital allocation strategy. AP reports on Wed, Oct. 26 (typically ~5:00 p.m.) with a c/c on Thurs, Oct. 27 at 10:00 a.m. (#1-866-378-3566). AP has met or exceeded quarterly consensus FFOPU 72% of the time since Q2/15 (Q1/22 & Q2/22 = in-line). We note AP has lagged the REIT sector by 6% post Q2/22 results (+5% vs. U.S. Office REITs).