Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comments

[incomedreamer11]

Bouncing Along the Bottom; Catalysts Still Weighted to 2H/24 in Our View

OUR TAKE: Neutral. Consistent with Q1/24, the CBRE Q2/24 Office update shows no major changes q/q (see Q1 update note). While the headline 2.2Msf of net positive absorption appears encouraging, most of it = 3 pre-leased towers coming on line in Toronto and Montreal; absorption was a bit negative in Toronto, Montreal, and National ex. these 3.

Allied Properties: In the short term, we think the results support our view that investors may have to wait until Q3 results in late October for critical occupancy gains (we est. AP market occupancy was flat q/q, consistent with expectations; Exhibit 1). We continue to see 20%+ total returns relatively quickly should occupancy gains materialize (200bp-300bp+), with 5%-10% downside in the event of a distribution cut (we think 2025 distribution will be announced in December). See our recent AP note for the relevant analysis (particularly Exhibit 9 in link). AP is our top Office pick.

Dream Office: For D, asset monetizations improving liquidity are more critical (than q/q occupancy), in our view, with recent reports suggesting 438 University has been put under contract.

KEY POINTS

Positives are similar to Q1; no major negatives this time around. DT sublet space fell again (Exhibits 2-3); asking rents are mostly holding with Vancouver and Toronto falling ~1% q/q (Exhibit 4; we suspect NERs are still falling), and new supply (as a % of inventory) is the lowest since 2005 (was 2011 in Q1; Exhibit 5), with only 5.7Msf to go (1% of inventory); would add ~20bp to national vacancy at current ~40% pre-leased level. Neutral = slight negative Toronto absorption drove DT vacancy +10bp q/q to 18.1% (National vacancy = down 10bp q/q to 19.4%; Exhibits 6-8), but Canada’s 2nd-largest market (Montreal) vacancy fell 30bp q/q, similar to Q1.

Occupancy gains likely still weighted to 2H/24, with Q3 Results the likely pivotal point for AP, in our view. We estimate Downtown Class A vacancy weighted to AP / D markets were flattish q/q at 18.7% / 19.9%, respectively, vs. our flat q/q Q2/24E for both (at ~14% and ~15%); Exhibit 1. Showing occupancy gains is a bit more important for AP, as D occupancy likely already troughed in Q1/23 at ~80%. Similar to Q1, one slight positive is the 30bp q/q decline in vacancy in Montreal, one region where we think AP expects occupancy gains in 2024/2025. All-in-all, we think the market is (rightfully) taking a wait-and-see approach with AP occupancy gains, despite management-cited strong touring activity on both the Q4 and Q1 conference calls. Our Q4/24E and AP Q4/25E vs. Q1/24A of 86% = 88% and 90%, respectively, with every 1% = ~2% AFFOPU.

Secondary markets (and Montreal) saw better q/q improvements. As shown in Exhibit 7, q/q vacancy fell in Edmonton (-60bp), London (-40bp), Waterloo (-80bp) and Montreal (-30bp), with the largest increase in Toronto (+60bp) and Ottawa (+40bp).

Supply cycle is gradually coming to an end; conversions are not the golden solution. Office starts have (appropriately) come to a halt with no meaningful projects started in Q2 (similar to prior 2 Qs). With 3.0Msf delivering in Q2, the remaining total (Downtown + Suburbs) pipeline of 5.7.1Msf = 1% of national inventory (1% Downtown; Exhibit 8); <50% of pipeline is set for delivery in 2024 (currently 40% pre-let). Office conversions are helping on the margin (0.9Msf in Q2 is similar to Q1; 20bp of GLA), but ever slightly so (reduced YTD vacancy by a very modest 10bp).