RioCan Real Estate Investment Trust T.REI.UN

Is the Distribution Safe?

[RetailRube]

The purpose of this post is to share what I learned when I tried to understand if the dividend is safe.  I am new to REIT investing, but I am an old accountant.  I have also prepared several corporate tax returns years ago.  If you are looking for a simple answer, stop reading now.

RioCan's objective is to distribute all of its TAXABLE INCOME to unitholders. (See page 57 of the 2020-1Q MD&A and several places in the notes to the financial statements.)  Taxable Income is a lot different than Accounting Income.

I searched the 2019 Annual Report and the 2019 AIF for a reconciliation from Accounting Income to Taxable Income.  It doesn't seem to be disclosed.  I found clear reconciliations from accounting income to measurements such as FFO.  So I dummied up the 2019 Full Year reconcilation myself, best I could.

2019 Net Income attributiable to Unit Holders was $776m
Funds from Operations was $576m
Cash Flow from Operations was $568m
"Adjusted" EBITDA was $761m
Actual Distributions to Unit Holders were $443m

Distributions per Unit:  2017=$1.41;  2018=$1.44;  2019=$1.44;  2020 run-rate = $1.44

WOW!  Their taxable income is really stable.  I wish my personal tax planning was that accurate.  This is why I think they have some flexibility in determining what taxable income is, and therefore what the distribution is.  My theory is RioCan adjusts the amount of Capital Cost Allowance they claim in the year to force the taxable income to the desired number.  Rental Buildings are recorded in Class 1 pool, on which you can claim a maximum of 4% per year.  But you can claim any number from zero up to 4%.  What you don't claim in the year stays in the pool to be claimed up to 4% of the pool next.  By my calculations, this could be around $90m per year of flexibility in determining taxable income.

Here is what I think their reconciliation from accounting income to taxable income looks like.  Really, this is their tax return, since when filing a tax return, you start with audited financial statements and back out things that are not deductible for tax purposes.

Net Income attributable to Unit Holders: ........................... $776m
(back out) Fair Value Gains on Investment Properties ..... (248m)
add:  Gains on actual disposals of buildings .....................      ?
(deduct): 50% of gain because it is not taxable ................     (?)
add back:  Fair Value Losses on Marketable Securities ...    16m
add back:  Depreciation ....................................................      4m
(deduct):  CCA (max 4% of value of Class 1 Pool) ...........   (90m)
equals:  Taxable Income before deducting distributions ... $443m

In my reconciliation, $90m is the plug to balance.  There is other little stuff in the reconciliation that I didn't show in the list (e.g. untaxed 50% of realized gain on disposal of marketable securities) and stuff I couldn't figure out (e.g. the question marks, as well as income in incorporated subsidiaries not yet dividended up to the parent trust).

Note that REITs don't depreciate their buildings since they mark them to market at the end of every period.  They only depreciate their equipment, which is tiny.

As far as I can tell, if a REIT does not distribute 100% of its taxable income to Unit Holders, it is taxed in the Trust at T3-Return tax rates, which are 33% federal + 20.5% provincial if you do business in Ontario = 53.5%.  Comparable corporate tax rates are 28%.  This is not refundable and unit holders do not get credit for it through a gross-up and credit mechanism.  So it is a REALLY BAD idea to not distribute 100% of taxable income in a REIT.

One final comment:  the 50% of capital gains on building disposals is excluded from taxable income.  So management never has to distribute it.  It remains in the REIT.  In corporations, dividending this money out to shareholders would be called a "Capital Dividend", which is not the same as "Return of Capital".  I am new to REITs.  Has anyone ever seen a "Capital Dividend" declared by RioCan?

Editorial comment:  I don't see why RioCan can't disclose the above reconciliation from accounting income to taxable income.  Who thinks "Adjusted EBITDA" is important but "Taxable Income before deducting distributions" is not?

Whew!  Long post.  So is the distribution safe?  I think as long as the COVID issues don't linger more than 3-6 months, it would not surprise me if RioCan maintained their current distribution.  $90m of profit is a lot of flexibility.  We really need to see Sept quarter financials to see how far they have climbed back toward normal.