Dream Office Real Estate Investment Trust T.D.UN

Scotia comments after conference

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We See Distinct Opportunities and Risks; Unit Price Reasonably Balances the Two

OUR TAKE: Neutral. We maintain our SP rating. Our key estimates fall 1%-30% (vs. 1%-18% for AP and 0%-9% sector avg.; Exhibits 1-2). We felt D was bullish on the call on leasing velocity, admittedly at higher leasing cost. The expected 75bp q/q occupancy jump in Q4 is encouraging, albeit still leading to $0.01 expected q/q FFOPU erosion (to $0.35). The future of WeWork at 357 Bay Street (2.3% of D revenue) is unclear. Net-net, it feels like occupancy has troughed (Exhibit 3), leasing activity is picking up (240k sf conditional/under negotiation) and D is doing a good job of tackling 2024 lease maturities. That said, our revised 2024E AFFO payout ratio of 108% (AP = 86%; Exhibit 4) may have the units trading sideways in the short-term (we’d characterize D conference call comments on the distribution as supportive, but not overwhelmingly so). While we’re not concerned about near-term debt maturities (zero expiring in 2024), overall leverage is elevated (Exhibit 5). Bottom-line, we think further residential density sales (marketing 212 King) to lower debt (and increase FFOPU) is a catalyst, but it may take time given the current (slow) market.

KEY POINTS

What has changed? Consistent with most REITs, our Target Multiple fell (-3.5x to 11.5x) and NAV cap rate rose (+29bp to 6.53%). Our target multiple reflects 10.0x for Dream Office and 17.5x for DIR (consistent with Himanshu Gupta’s DIR estimate), which accounts for 10%-30% of Dream Office (10% = GAV; 30% = NAV). The wide disparity in D and DIR valuation suggests separating the two would make sense (perhaps an option should a distribution reduction be deemed necessary). Exhibit 6 compares our target multiple to historical D AFFO yield spread, with our implied 510bp AFFO yield spread matching historical average (better portfolio offset by higher leverage). Our 2024E FFOPU falls 9% on carried-forward higher interest expense and lower Q3 NOI.

Call Highlights. We felt the best tone was on operations. D still sees a path to 90% committed occupancy in 2025 (Q3/23A = 84.3%; our Q4/25E = 87.3%) and is seeing more velocity in secondary markets like Calgary and Mississauga. Tour velocity is moving higher although lease conversion ratio (~25%) remains below historical avg. (~33%). D is seeing the most success with turn-key solutions as tenants look to minimize up-front capital outlays. WALTs appear to be rising (doing 7 year deals) although NERs are still down an avg. ~20%. About half of tenants are downsizing vs. half upsizing. On capital allocation, we feel D is more actively looking to bring in JV partners into its residential density opps (i.e., 212 King, 250 Dundas, Eglington-Birchmount), which we think is being valued at $0 in the unit price today (and worth our est. $3.00/un+). The benefit = accretive debt reduction.New 2025 Estimates reflect inflationary growth. Our new 2025E FFOPU and AFFOPU are $1.53 and $0.95, and sit 3% and 1% above consensus, respectively. Exhibit 7 provides our key assumption summary. We are reflecting gradual continued occupancy recovery (2025E =87% vs. 2024E of 86%). We reflect modest flat market rents (vs. 2% erosion in 2024 and an average D lease net renewal spread of 1%, driving a 2025E SPNOI of 1.6%. We assume no acquisitions or disposition, nor any NCIB activity. We also assume no sale of DIR units, with DIR FFOPU growth of 11% y/y accounting for all of the D FFOPU growth. We note D has a material ~$600M of debt maturing in 2025 including credit facilities (~45% of total debt). We’re assuming a refi rate of 5.8% vs. 5.16% expiring, impacting our 2025E FFOPU by $0.065.