Allied Properties Real Estate Investment Trust T.AP.UN

Scotia comments after conference

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The Hunt for Green October (Seen Enough Red)

OUR TAKE: Mixed. SO rating and most estimates intact (Exhibit 1). With flat expected occupancy (check; Exhibit 2), we saw Q2 results as a non-event, not a driver of 5%+ correction (we also didn’t expect a ~15% July return priorthereto), which we attribute to higher debt costs driving a Q2 miss (Exhibit 3); a decent portion should reverse by 2025 + accretive dispositions + forecast 540bp occupancy recovery = 2025E 3% y/y FFOPU growth vs. 2024E 9% y/y erosion (Exhibit 4). We cited a “Sector Peform” rating as more apt for the past 2 quarters, ahead of Q3 results in late October, which is now approaching. We see AP as fairly binary….Notable occupancy gains by year-end (our NTM forecast = +330bp to 89.1%) =15%+ unit price upside (Exhibits 5-6) on higher distribution confidence (2025E AFFO payout ratio = 97%). Lack of occupancy gains = 100%+ payout ratio = threat of distribution cut = 5%-10% downside (Exhibit 7). We still think AP portfolio institutional appeal is underrated (incl. selling 3%-4% cap rate assets...like FCR). We’re good buying yesterday’s weakness, but you have 3 months to think about it, albeit missing a juicy yield (Exhibit 8).

KEY POINTS

What has changed since we last wrote? For starters...interest expense! As shown in Exhibit 3, it jumped $6.5M q/q (28%) to $29.9M (despite capitalized interest +$1.6M q/q to $17.5M), with ~$4M of the increase from the acquisition of 400 WG and 19 Duncan (see link), with construction debt cost in excess of acquisition cap rate (negative leverage deal that investors have frowned upon generally); the deal impacted FFOPU by $0.04 this Q. Looking forward, AP has $400M+ of debt at a 6.5%+ cost that we think could be refinanced at a blended 4.25%-4.5% cost , creating est. interest savings of $0.03/un, net of capitalized interest, and one reason why our 2025E FFOPU did not fall despite the Q2 miss. Second, we’ve included $400M of asset sales at an avg. 4.5% cap rate, which may be conservative (i.e., mid-3%), another driver of the 3% y/y FFOPU growth in 2025E. Lastly, our Q4/24E and Q4/25E in-place occupancy are mostly intact at 87.0% (was 87.7%) and 91.2% (was 90.4%), respectively.

Call Highlights. AP remains “very confident” in existing distribution sustainabilty, which we suspect is grounded in low-cap-rate asset sales, high-cost debt reduction and higher anticipated occupancy (which sits in line with AP expectations at the start of the year; gains were always back-end weighted). AP lease pipeline = 900k (60% renewal; 40% new) vs. 1.05M q/q (leased 0.4Msf in Q2). While lease spreads were +10%, closer to flat on NER. AP guided to $400M of asset sales through 2025 (double previous expectation; ~4% of Gross IPP) but noted owning ~$1B of similar assets (that theoretically could be sold); the more at IFRS, the better given elevated leverage. AP attempted to instill confidence in its debt latter (noted $250M 2026 loan has 5 1-yr extension options at the existing low rate; should improve perception over 2026E FFOPU on the margin), which should lower net debt/EBITDA from its Q2/24A peak of 10.9x (+1.5x q/q) to closer to 8x by mid-2026. Lots of talk on Toronto condo issues, but AP has seen no weakness at King Toronto (91% pre-sold; no cancelled contracts).

Q2/24 Highlights & Developments

OUR TAKE: Mixed. Recurring FFOPU of $0.526 (vs. $0.578 q/q and $0.588 y/y) was below our $0.55 and $0.56 consensus (range = $0.53-$0.58). The miss vs. us was entirely on higher interest expenses (+$0.035); see Exhibit 21. For context, the acquisition of 19 Duncan and 400 West Georgia (link) impacted Q2 FFOPU by $0.041 per AP.

Specific mention of FFOPU/AFFOPU/SSNOI was removed from the “2024 Outlook” in Q1, replaced by an expectation that “operating results in 2024 will fully support AP current distribution commitment”. AP reiterated that commitment.

Economic and Leased occupancy were flat q/q (1st time in 6 quarters), consistent with broader market (see our note) with AP expecting a “positive inflection point” by year-end (our Q3/24E and Q4/24E q/q are +53bp and +122bp). Overall, we feel occupancy gains may take longer than envisioned. We still believe higher unit price requires increasing occupancy (ultimately providing confidence in the distribution).

In the Q2 Preview (link), we opined flat q/q occupancy felt neutral to the unit price (Q3 is likely the main event), but we chose “mixed” due to the Q2 miss (carry forward of higher interest expense).

High-level results. Disclosed AFFOPU fell 11% y/y (Q1 = +0.8%). Leased occupancy was +10bp q/q to 87.1% (Q1 = -30bp q/q), while Economic occupancy fell 10bp q/q to 85.9% (Q1 = -50bp q/q). We est. 19 Duncan and 400 West Georgia had a +6bp and -9bp impact, respectively. We estimate PUD reclasses/asset sales had a ~+10bp q/q impact on quoted occupancy (sale of Telus Sky improved quoted occupancy by ~20bp). Rental SANOI fell 2.3% y/y vs. -2.0% in Q1/24, with all regions ex. Montreal&Ottawa negative. In-place rent was +4% q/q at $25.08/sf (Q1= flat q/q).

Capital Recycling. AP will complete the previously announced reorg of Telus Sky, receiving $32M of net proceeds in Q3, and has the pending sale of 5 assets in Montreal (2 in Toronto) at/above IFRS in 2H/24 for ~$200M; AP is receiving intensfication value on 3 of the assets (other 4 = cap rate acquistions). Aggregate dispo cap rate not disclosed, but AP noted recycling into debt reduction = AFFOPU positive (we don’t have dispositions in our forecast). AP is targeting another $200M of sales heading into 2025.

IFRS NAVPU fell $0.41 q/q (-0.9%) to $44.43 (Q1 = -1.7% q/q), still well above our $26.50 and ~$22.83 consensus. FV loss of $45M vs. $119M loss q/q, incl. $48M loss on PUD (Q1 = $31M). Overall IFRS cap rate fell 2bp q/q to 4.82% (Q1 = +1bp q/q) vs. our 6.2%, with Toronto -4bp q/q and Calgary +1bp q/q. We est. +1bp cap rate change in our Q2 CBRE Cap Rate Survey report (see Exhibit 3 in the report). Potential incremental density of 9.9Msf fell 0.1Msf q/q (Q1 = flat).

Operations. AP tenant tours fell 13% q/q to 262 (-10% y/y, Q1 = 300), leasing 0.47Msf vs. 0.54Msf q/q and 0.7Msf y/y. Tenant retention fell to 60% vs. 69% q/q, below the historical 70%+. The lease renewal spread was 9.7% on yr.1 (Q1 = 4.7%) and 16% over lease term (Q1 = 10%). We est. market rent for 2024 expiries was +0.7% q/q (Q1 = +4% q/q), with AP est. MTM of 17% on a gross basis (Q1/24 = 12%). Sublet (as a % of portfolio) was -30bp q/q to 5.0% (Q1 = +20bp q/q). We estimate sub-let space as a % of total vacancy = 26% vs. 27% q/q and ~16% national average.

Leverage moves higher (as expected) on Westbank acquisitions. Debt/GBV was +320bp q/q to 39.1% (Q1 = +120bp q/q) and Net Debt/EBITDA was +1.5x to 10.9x (Q1 = +1.2x q/q). PUD as a % of GBV was flat q/q at 11.4% (Q1 = -0.5% q/q) and above AP target of ~5% by Q4/25 (disclosure stopped in Q1). Q2/24A assets held for sale = $286M (vs. $130M as at Q1/24). AP cited expected repayment of the 2 debt expiries in 2025 ($200M debenture + $400M unsecured term loan) via sale of non-core assets (up to $400M), and possible CMHC financing at 19 Duncan ($50M). Discussions to extend the $400M are also underway.