RE: white rock reit AFFOI'm still working on depreciation and amortization with respect to AFFO, or in other words, is that cash really there and available for distribution? Basically, I look at a WRK acquisition that says the property is well maintained and in need of very little capital expenditure because, to use a real life example, over $20-million of "improvements" have been done during the last seven years. I look at that property's acquisition cost of $83-million and note how $20-million is such a huge chunk.
I know that office properties usually require a major renovation every 15 years or so. A long term triple net lease of 20-30 years duration with Encana or the government obviously won't undergo a major investment that the REIT will have to pay. This is the beauty of WRK's early investments with gov't entities and HR REIT's core philosophy. However, WRK's latest string of acquisitions have generally been multi-tenant properties with 7-8 year average remaining lease term, so the cost of the major renovations is significant. WRK isn't threatened at all by this since its small size and staggered lease expiries will cover over any renovations for years to come. Nonetheless, I would like to get a handle on this.
Something has to be BS in the add back of so much of the D&A. Sure, sure, there's capex expense subtracted but that only includes TI, LC and maintenance. There's also amortization of financial, leasing and acquisition related items in the D&A that is added back that I'm not really concerned about either. IMO, it is this which amortizes more quickly than buildings that drives the more mature REITs to show increasing income (and declining depreciation), i.e. they're not trying to to stay ahead of anything, it's just how the rates of amortization for different assets works out.
The major renovations are recurring but infrequent, not directly recoverable from tenants and not always revenue enhancing. Since it's a predictable expense and, when amortized over 15 years, is large even compared to the expensed annual maintenance and other capex, I think it should be included as an expense in calculating FFO/AFFO. A 10% cap rate isn't an honest rate of return if you have to spend 20% of the gross book value of the building every 15 years to improve it to market expectations. Compounding this is that REITs don't ever have that kind of cash on hand, they have to raise it through expensive equity or debt. The debt is never really retired as leverage is generally desired at a constant level and, as we're all too aware, REITs never buy back and cancel units on a significant level. (Riocan could've made the best investment of its existence with a major buyback in 08/09, but instead bought more property at steep rates.) So, if the renovation doesn't bring a big boost in NOI, the returns from that property are diminished by both the up front capital used to renovate, and the drag of interest and distributions.
Anyway, I need to see average rental rates for the GTA suburban office market for 1980 to present. I found some info on the Chicago suburban office market which had rates as basically flat since the late 80's. The cost and drag of releasing on a REIT that's not covering its distribution can be seen in the impact of re-leasing some space at 655 Bay and the bankruptcy out East on WRK's AFFO numbers. Luckily, 655 didn't require expensive major improvements to lease up and the vacancy was small at 5-10%, IIRC. Even in well leased multi-tenant office properties like 655 Bay, The West Mall and others there's often 10-20% of NOI coming from weaker tenants with lower credit quality. The majority is high quality and nothing to worry about, but the high leverage WRK uses means that the 10-20% of weaker credits play a big role in returns. One way of looking at it is that the high credits pay off the big time interest expense that comes with 65%+ debt (and the G&A) while the remaining 20% is the profit. I think that the CEO of HR REIT realizes this, and combined with the perception - or is it fact? - that office is the most expensive category of commercial RE to operate , he focused his REIT, which uses a similar 60-65% leverage, on single tenant triple net leases. What would help the most to understand this would be to see the seller's historical financials for The West Mall that ROI Capital and WRK bought. IIRC, they bought it for about $60-million. When HR owned it, they sank $4-5-million into it, but I'm not sure when they did it, whether it was just before selling, just after acquisition, things like that. I know HR sold it at least 3-4 years ago. I don't know if the buyers (those that sold it to ROI/WRK) bought it from HR for $60-million or not - I'll have to see the property disposition entries in an old HR annual report, and even then it might be blended in with other sales with gains/losses. What I'm getting at, is I want to see what the occupancy was, what the average rent was, what the NOI was prior on acquisitions and prior to the $20-million of investments (that would likely have included work done under HR ownership). I want to see if major improvements earn a good return in a situation where you're not buying a half vacant asset that needs a lot of work to bring it up to market conditions. I know that HR's cash available for distribution has been pressure for the last few years outside of The Bow fiasco due to the fact that some of its single tenant leases were expiring and creating multi-tenant buildings.
As if this isn't a long and rambling enough post....
"Is it a realestate play , like many believe ? At the whim of property values?....Not in my opinion."
I think it is. To the extent that cap rates in the market rise, REIT NAVs decline and analysts change their outlooks downward. So they will reflect the market somewhat. They can't carry a lot of cash or development assets, land banks or ancillary businesses due to their financial and tax structure, leaving pretty much all real estate/property to be valued.
"Is it a managemnet business , like a fund of funds? again not so much."
I think it is. REITs and real estate as a part of a diversified portfolio are much more common today. Wall Street/Bay Street are there, of course, to fill that need. Money is allocated to real estate and the REIT executives manage it by investing in real estate. They simply capture spread. We agree on that. There's not much of a dynamic business underneath it all to manage day to day. It's a financial company, and a very simple one.