Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comments after conference

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Don't Call It a Guidance; It's Been an Outlook for Years

OUR TAKE: Negative. Our key estimates fall 4%-9% (Exhibit 1). We discuss keeping our SO-rating below (as REIT earnings progress), but we’re clearly leaning more heavily on the “~10% distribution yield + medium-term structural catalyst = mid-teen multi-year Total Return CAGR ” thesis. If our investment horizon was 3-6 months (instead of 12), a “Sector Perform” rating is likely more apt (i.e., more patience needed than envisioned). We’re disappointed with occupancy guidance (may go down before going up in 2H/24; Exhibit 2) and based on the 4%-6% decline in our 2024E and 2025E FFOPU, we now see a 3-4-year period (incl. 2023) of no FFOPU growth and possibly erosion (we don’t have 2026 estimates, but $850M of maturing debt in 2026 at in-place 3.4% cost is a foe; say ~$0.13/un impact at our 5.5% 2025E refi; ~6.8% today). We’re also disappointed with the “Outlook” (not Guidance; Exhibit 3) as FFOPU may fall without any structural change to Westbank JVs (see below). That said, we still think a mid-teen Total Return CAGR through 2025-2026 is achievable (albeit perhaps not in a straight line) but we don’t see many controllable catalysts in Q1/24, which are more reliant on the macro (i.e., soft landing, private office market transactions).

KEY POINTS

Reasons for intact rating. In addition to going through REIT earnings, bottom-line, our challenge is that we see a very good portfolio (very good = both the physical office layout and location but also immense residential value at a time when Canada has a dire housing shortage) trading at an implied ~$300/sf and 9.4x 2025E AFFO (Exhibits 4-6) and it is rare to see such quality (a portfolio that we think would be in demand by opportunistic institutional capital with longer-term mandates) at such a high distribution yield (Exhibits 7-9). AP trades at the lowest P/24E AFFO in our universe! While economic occupancy may take until 2H/24 to recover, we think the unit price reacts on news of large leasing deals being done, rather than commencement of cash rent (i.e., maybe 3 months instead of 6).

Reasons to potentially downgrade the rating. Our revised 2024E and 2025E AFFO payout ratio = 95%, perhaps increasing investor questions on whether Allied can remain committed to the distribution (we think they are). We believe the unit price moves with occupancy, which may fall in 1H/24 before going up. There could be further Westbank noise (we estimate completion of the Westbank JV developments could erode FFOPU by ~6% given the high mezzanine interest being earned by AP exceeds development yields and capitalized interest by a wide margin). AP may lag the sector on FFOPU growth for several years (i.e., poor PEG ratio, even at a sector-low AFFO multiple; Exhibit 4). We completely agree with management’s laser-focus on leasing, but perhaps preparing residential value is the opportunity cost. Lastly, we think a hard recession would = underperformance, even at current valuation (i.e., would likely violate the distribution commitment).

See Page 2 for “What Has Changed Since We Last Wrote” and “Conference Call Highlights”

What has changed since we last wrote? Our 1H/24E economic occupancy falls 160bp to 86%; our 2024E and 2025E are down 160bp and 50bp to 88.1% (Q4/23A = 86.4%) and 89.6%. Just to quantify the sensitivity, our 2025E FFOPU would jump ~12% to ~$2.50 if we assumed 95% stabilized occupancy in 2025 and our NAVPU would move to ~$31.00. We lowered our Current and Forward NAVPU by $1.00 to reflect a 2%- 2.5% decline in expected cash NOI following the negative Q4 variance (Exhibit 19). We boosted 2024E development fee income following the $2.4M recorded in Q4, in addition to increasing our interest income.

Call Highlights. It was perhaps the shortest AP call in recent memory (outside of the one with substantial technical difficulties several quarters ago). AP confirmed the variation in the 2024 Outlook pertains to the pace of leasing, as opposed to any potential changes in Westbank JV partnerships; we assume -5% y/y FFOPU implies no leasing while 0% y/y implies cash rent on expected leasing starting in Q3/24. We also assume Allied has not set-up an “easy-to-achieve” outlook. AP also confirmed the potential 5% erosion doesn’t apply equally to FFOPU/AFFOPU/SSNOI (given its expectation for positive lease renewal spreads in the 7% range for 2024; consistent with 2023). AP downplayed any near-term transactions to surface the underlying portfolio residential value (one could argue that makes sense given softness in the land market), reiterating a laser-focus on leasing. On that front, AP noted no expected significant non-renewals in 2024, which should provide the basis for occupancy improvement (i.e., no major offsets to new leases). AP leasing pipeline remains at ~1.1Msf (vs. 1.1Msf set to expire in 2024), with lease discussions taking 12-18 months vs. 3-9 months pre-pandemic. AP remains confident in boosting occupancy back up to 94%-95%, but is less certain on timing. Regarding capital allocation, AP noted 400 West Georgia in Vancouver is 82% occupied, with leasing potentially taking it to 90%+, where it would be able to attract permanent mortgage financing. Recall, AP has the right to acquire a 50% stake at cost from Westbank. We suspect flexibility exists on acquiring a greater %. Our model assumes a 90% acquisition for ~$280M at a 5.75% cap in Q3/24.