TD commentsDream Office is reducing its monthly cash distributions by 50% by implementing a 1-for-2 consolidation of outstanding units and keeping the distribution at $1.00/unit (i.e. $0.50/unit pre-consolidation). The consolidation should be effective on/around February 22, with trading in the new units starting February 27.
In short, we view the distribution reduction as a tactic to mitigate risks regarding uncertainty on both the timeline and ultimate extent of recovery in office leasing fundamentals. The incremental $19mm of annual cash retention will better enable the REIT to i) more comfortably address debt refinancings; ii) fund leasing capex; and iii) be more patient/disciplined while pursuing asset sales.
Late last year, we raised our Risk Rating on Dream Office to HIGH (link) based on a narrowing of the path toward comfortably sustaining the cash distribution. Today's challenges include persistent interest rate volatility, geopolitical risks, macroeconomic uncertainty, increased lender scrutiny on office property exposure, lack of private market transactions to support valuations, and Dream Office's elevated debt levels. Continued sluggishness in office leasing velocity and extended tenant decisionmaking timelines have further clouded the recovery.
Dream Office currently has just 38% of year-ahead lease expiries addressed (vs. the 71% average addressed at this time in 2023 and 2022). Put another way, unaddressed lease expiries for the year ahead are currently 12% of total portfolio occupied area vs. just 5% average exposure at this time in 2023 and 2022. One late-2024 expiry is for ~200,000sf (5% of portfolio occupied area) at 74 Victoria St., where negotiations with an educational institution fell through following the government's decision last month to cap foreign student enrollment.
TD Investment Conclusion With the unit price -10% since February 12 (when MPCT.un eliminated its distribution), we believe Dream Office's $9.10 closing price yesterday (at 55% P/ NAV) was partially discounting a distribution cut. Recent floor relative valuations vs. Allied suggest downside of between $7.40 (45% P/NAV) and $8.00 (~10x P/AFFO). We see these as likely near-term trading levels, and as such, we would offer attractive 30%-plus total return potential to our new $10.00 target price.