Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comments after conference

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Return to Office... REIT Buying? Lowest Multiple in 19 Years

OUR TAKE: Positive. We maintain our SO rating but our TP and multiple fall 17%-18% (Exhibit 1). We're surprised with AP unit price (+8% on Thursday), which we attribute to AP’s commitment to the distribution; we had felt was a near certainty (post UDC sale). We are also surprised AP noted it still could hit ~91% occupancy by year-end (citing Q3 = inflection point)… without PUD reclasses in Q4 (+300bp q/q and matching Q1 guidance); PUD reclasses helped Q3 occupancy by ~60bp. Occupancy outperformance is critical to AP “distinguishing” itself from commodity office to narrow its trading discount (Exhibit 2; didn’t in Q3). Bottom-line, tax-loss selling and the potential impact on taxable unitholders from the UDC sale (see below) could see choppy trading persist into what we think could be a very good 2024 for Allied unit price (key catalyst = non-PUD-reclass occupancy gains). Assuming NO multiple expansion, investors get an 11% yield, which combined with a 2023E-2025E AFFOPU CAGR of 2% = attractive 13% total return CAGR, with a free call option on AP’s immense residential land value (see our note) that we think can be monetized in 2025 and beyond. AP is trading at its lowest multiple in 19 years (Exhibit 5; red line).

KEY POINTS

Q4 FFOPU should be interesting. Intact guidance mathematically reflects Q4/23E FFOPU of $0.67-$0.70 vs. our and prior consensus at $0.62; we’re comparing 2022A FFOPU of $2.44 and YTD of $1.77. Using the $0.67 implies 12% q/q growth (vs. Q3). It could reflect higher interest income on cash balance (UDC proceeds; $~500M as at Q3), but the delta is still hard to explain. In any event, a negative Q4 headline print appears unlikely given the above.

Much closer to GFC trough than peers; NTM AFFO Multiple cut in half. Exhibit 3 compares current REIT unit prices GFC trough, as well as the P/NTM AFFO multiple. The avg. CAD REIT unit price is +119% from GFC trough (equal-weight; REIT sector = +96%), reflecting only ~9% multiple erosion. By comparison, Allied is +56% with 44% multiple erosion. Similarly, as shown in Exhibit 4, we still see 2024E AP AFFOPU is +111% vs. 2019A, while AP has lost 68% of its trading multiple post-pandemic.

Non-cash special distribution should dwarf disclosed cash one of $65M ($0.47/un). AP is working through the details of the non-cash distribution. Quantum is n/a, but we had previously estimated a combined capital gains tax of $1.50-$2.00 on a hypothetical $200M UDC tax value (see link); maybe at the lower-end of that range given the lower 2023 FFOPU guidance with Q2 results (i.e., lower taxable income).

See Page 2 for Call Highlights, What Has Changed Since We Last Wrote and New 2025 Estimates.

Call Highlights. AP was +5% going into the call and ended up +7%, extending its outperformance vs. CAD REITs and U.S. Office REITs by 1% and 0.5% in the process. It was a long call but 3 things stood out to us. First, if there is a change in the distribution, it is upward; not downward. AP opined no need or desire to cut the distribution and is contemplating its typical 2%-3% (find out in December). Second, AP believes occupancy has hit an inflection point, with a 1.2Msf leasing pipeline (~50%/50% new/renewal) vs. ~1.5Msf expiring through 2024; 2024 tenant renewal rates are expected to fall between 2023E (50%-60%) and normal (70%+) Third, AP believes a prolific Vancouver office transaction (sellers = Oxford/CPP) may get completed vs. our (and market) expectation of the deal getting pulled. We view a sub-6.75% cap rate as a constructive price relative to AP’s implied cap rate of 8.8%. Lastly, we look forward to expanded development pipeline disclosure with Q4 results in January; specifically, expected development FFO (as opposed to just EBITDA). AP is targeting $46M of EDITDA (avg. interest capitalization rate = ~3.2%). Our 2024E and 2025E FFOPU include $0.01 and $0.02 from development completions, respectively.

What has changed since we last wrote? Our new 12.0x target multiple implies a 400bp AFFO yield spread to current 10YRGOC, well above the 370bp historical avg. (Exhibit 5). The embedded implied cap rate in our $25.00 TP of 660bp = 260bp spread, below 390bp historical avg. (Exhibit 6). We’re spending more time on this given AP remains one of the few REITs trading at above-historical-average spreads to the 10YRGOC (Exhibit 7). Our NAV cap rate is +40bp to 6.0%, equating to a ~200bp spread to 10YRGOC (still tighter-than-historical avg). We believe the 200bp spread is supported by significant land value. Lastly, we lowered our avg. lease term to 5 years (from 7), impacting our annual AFFOPU by $0.005/un.

New 2025 Estimates reflect modest growth, virtually none of which comes from development. Our new 2025E FFOPU and AFFOPU are $2.47 and $2.09. Exhibit 8 provides our key assumption summary. We are reflecting gradual continued occupancy recovery (2025E = 90% vs. 2024E of 88%). We reflect modest market rent erosion (1%) and an average AP lease renewal spread of 6.5%, driving a 2025E SPNOI of 2.8%. Our estimates assume 108 5th Street and The King are completed but given an avg. target yield of 4.7%, we expect minimal FFOPU contribution as capitalized interest is removed. We assume no acquisitions or dispositions.