Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comments on update

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Moody's Credit Downgrade + Distribution Sensitivity Analysis

OUR TAKE: Mixed. According to Bloomberg, Moody’s downgraded AP’s senior unsecured debt rating to Ba1 (non–investment grade) from Baa3; negative outlook intact. We think it came out before 2:00pm, with most of AP’s underperformance vs. CAD REITs taking place before on a broader “risk-off” day (Exhibit 1). AP is -0.4% vs. CAD REITs today and notably lagging U.S. peers (“risk-on” post–U.S. CPI), so some impact has likely been felt. We think the downgrade likely increases the cost of its $800M unsecured revolver modestly (only $51M drawn as at Q1/24; limited near-term FFOPU impact), and is perhaps marginally negative for sentiment. AP was one of the most topical REITs in our recent marketing, with investor focus on distribution sustainability and occupancy. Net-net, we reiterate the thesis laid out in our Q1/24 results note. A “Sector Perform” rating remains more apt for the next 2-4 months (was 3-4 back in June), but a mid-teen TR CAGR is achievable through 2025E/26E. Simply put, higher occupancy = greater confidence in distribution = significant unit price upside (Exhibit 9), with Q3/24 results (late Oct) the key progress date, in our view.

KEY POINTS

AP trades at tightest gap between implied cap rate and unsecured debt YTM… The ~90bp gap between AP implied cap and average unsecured debt YTM ranks the lowest in our universe (Exhibit 2; was 123bp as at Feb 2024) as AP has gone from a low-debt REIT to higher (based on our GAV estimates; Exhibit 3) and hasn’t really participated in the recent credit rally (Exhibit 4 shows AP’s higher G-spreads vs. peers courtesy of Malavika Suresh on Scotiabank’s Credit Sales & Trading team). A partial offset is AP’s limited near-term debt maturity schedule (Exhibit 5), with the next significant maturity = $202M in April 2025, meaningful availability on lines ($716M) to fund remaining development cost to complete ($164M) and construction loan repayments, and positive initial response to asset dispositions (aligns with our view that the “institutional” value of the portfolio is likely notably higher than the implied ~$325/sf today).

...and meaningful probability of a distribution cut. Our 2025E AFFO payout ratio = 97% (Exhibit 6) and reflects a ~200bp occupancy gain this year (to 87.7%) and another 270bp jump by Q4/25E (to 90.4%); every 100bp of occupancy = 2% to AFFOPU. As shown in Exhibit 7, AP ~11% distribution yield = ~4x STDEV above the mean spread to both 10YR GoC and Sector (Exhibit 8). Mean reversion on distribution yield vs. 10YR and Sector = a 6.5% and 5.2% yield, or $27.70 and $34.60 unit price on an intact $1.80 distribution (we acknowledge mean reversion = very aggressive given higher-than-avg. debt, lower-than-avg. forecast FFOPU growth on potentially structurally lower Office demand). Exhibit 9 provides unit price sensitivity to distribution yield and AFFO payout ratio. For example, a 50% distribution cut = ~5.6% pro forma yield = 7% unit price upside to hit historical yield spread to sector (5.2% = -30bp vs. Current Sector) but 14% downside to hit historical yield spread to 10YR GoC, implying say ~10% unit price downside on a reduction of that magnitude, in our view (more than double the upside though on an intact distribution from occupancy gains).