Allied Properties Real Estate Investment Trust APYRF

Scotia comments after conference

[incomedreamer11]

Medicine, Not Chocolate, Is the Order of the Day Though Positive 3-6 Month Outlook Doesn't Change

OUR TAKE: Neutral. SO rating intact (1 of only 2 left), with our TP -$0.25 to $21.75 (Exhibit 1). No feasting on chocolate yesterday; just medicine (AP -4.9% vs. -1.8% for Sector and -1.9% for U.S. Office REITs) on a risk-off day, but also maybe due to absent occupancy gains vs. some U.S. peer gains (Exhibit 2), leading to a lagging YTD unit price (Exhibit 3). We opined in our Q3 Preview the bar was higher at $20 than $16 and Q3 felt void of catalysts, but we’re surprised by the bar height (i.e., -4.3% seems excessive). We get AP is now a “show-me” story with management commentary severely discounted by investors, but still believe occupancy marching towards 90%= higher unit price, while investors are treated to a $1.80/yr distribution (~10% yield) that is highly likely renewed in December. We think justified confidence in distribution = ~7.5% yield = ~$24 unit price = 30%+ upside (Exhibit 4) and the AP portfolio private demand is underrated by the public market; likely more relevant absent occupancy gains. Net-net, a good economy (uncertain population growth is a new risk) and AP-specific leasing should = one of the better 6-month TRs in our universe.

KEY POINTS

What’s changed since last week’s Preview? Exhibit 5 = our quarterly economic occupancy forecast, with Q4/24E, 2025E and 2026E down an avg. 100bp, 150bp and 50bp. Recall, we believe Occupancy of ~91% (vs. Q3/24A of ~86%) is required for a sub-100% AFFO payout ratio (we get there in Q2/26E). Our forecast dispo cap rate is -25bp to 3.5%, while our 2025E/26E debt refi cost fall 40bp/25bp (to 5.25%), adding $0.01-$0.02 to our 2025E/26E FFOPU. Exhibit 6 = our waterfall chart showing how AP can refinance higher cost debt in the next 6 months with est. annual savings of $28M (~$0.20). Our Current NAVPU falls ~$1.00 on slightly lower NOI ($0.10) and lower development value, despite a $154M re-class into IPP (i.e. our NOI is flat despite the $154M; could be intra-Q timing with the NAV rebounding in Q4).

Call Highlights. AP lagged CAD REITs & U.S Office REITs by 1.5% and 3% going into the call and ended -2.5% and -2% vs. each. AP reiterated commitment to distribution and increased optimism over rising occupancy (much higher than start of the year), referencing rising tenant expansion space demand (Shopify took an extra floor at KPC), higher space utilization, and bigger user requirements in the market. AP expects occupancy to gradually move higher (i.e., no more sequential dips), with limited known tenant move-outs through 2026 (cited 4 tenants). AP is confident in selling $400M of assets (at an avg. 3.5% cap rate; PR said by 1H/25). AP reiterated Development FFO = 50% of development EBITDA (likely doesn’t factor losing high-rate mezz income), with 2025E and 2026E incremental EBITDA of $17M ($0.12/un) and $20M ($0.14) vs. our forecast ~2% FFOPU erosion through 2026. Disclosed WALT for sub-let space in portfolio (=5.7 years incl. Shopify; 3.9 years ex. vs. avg. total portfolio WALT of ~6 years). Expect disclosure on interest expense/G&A capitalization with Q4.

Q3/24 Highlights & Developments

OUR TAKE: Neutral. Reported FFOPU was $0.556, although we est. recurring FFOPU of $0.535 (vs. $0.526 q/q and $0.598 y/y) was 1.5% above our $0.527 and $0.528 consensus (range = $0.516-$0.542).

“2024 Outlook”: Specific mention of FFOPU/AFFOPU/SSNOI was removed in Q1, replaced by “operating results in 2024 will fully support AP current distribution commitment” in Q2. Today, the reference to the distribution commitment was removed, although we suspect no change in that commitment (“Outlook” is simply not just the distribution is our take).

Economic and Leased occupancy were flattish q/q for the 2nd consecutive quarter (Q2 = 1st time in 6 quarters;), a bit better than the broader market (see our note) with AP expecting leasing activity to accelerate in 2024 and into 2025 (our in-place Q3/24E and Q4/24E q/q are +53bp and +122bp), buoyed by seeing higher tenant expansion space.

In our Q3 Preview (link), we noted an expected lack of unit catalysts with Q3 results and on the surface (pending the c/c), that seems to be the case. We still believe higher unit price requires increasing occupancy into the 90%+ range (ultimately providing confidence in the distribution)

High-level results: Occupancy stable q/q. Disclosed AFFOPU fell 15% y/y (Q2 = -15%; Q3/23 = $0.500). Leased occupancy was +10bp q/q to 87.2% (Q2 = +10bp q/q to 87.1%), while Economic occupancy fell 20bp q/q to 85.6% (Q2 = -10bp q/q to 85.9%). We est. 184 Front E, 388 King W and Dominion Square reclass had a +20bp impact, while 3510, 3530-3540 Saint-Laurent and 1001 Robert-Bourassa had a -9bp impact. We estimate PUD reclasses/asset sales had a ~+15bp q/q impact on quoted occupancy. Rental SANOI fell 3.1% y/y vs. -2.3% in Q2/24, with all regions negative. In-place rent was +0.9% q/q at $25.30/sf (Q2= +4% q/q).

Capital Recycling and Debt update. No major update. By review, AP completed 3 dispositions in Montreal ($51M) and expects to complete another 5 in 2024 (for $142M); all net proceeds put towards higher-cost variable debt. Target for 1H/25 remains another $200M of sales. In addition, AP noted mortgage commitments totaling $343M at an avg. ~4.8% also going towards repaying higher-priced variable debt. Lastly, it is finalizing a $340M CMHC-insured loan at ~3.5% at 19 Duncan (10 yrs), which will also go towards paying down higher-cost debt.

IFRS NAVPU fell $0.67 q/q (-1.5%) to $43.76 (Q2 = -0.9% q/q), still well above our $22.25 and $21.30 consensus. FV loss of $47M vs. $45M loss q/q, incl. $24M loss on PUD (Q2 = $48M). Overall IFRS cap rate fell 1bp q/q to 4.81% (Q2 = -2bp q/q) vs. our 6.2%, with Toronto -2bp q/q and Calgary -1bp q/q. We est. flat cap rate in our Q3 CBRE Cap Rate Survey report (see Exhibit 3 in the report). Potential incremental density of 9.8Msf fell 0.1Msf q/q (Q2 = -0.1Msfq q/q).

Operations. AP tenant tours were +2% q/q to 266 (-13% y/y, Q2 = -13% q/q), leasing 0.62Msf vs. 0.47Msf q/q and 0.4Msf y/y. Tenant retention was flat q/q at 60%, below the historical 70%+. The lease renewal spread was -6.3% on yr.1 (Q2 = 9.7%) and +2.1% over lease term (Q2 = 16%), or +0.5% ex. one temporary Flex lease in Toronto. We est. market rent for 2025 expiries was +1.0% q/q (Q2 = +3.7% q/q), with AP est. MTM of 6% on a gross basis (Q2/24 = 5%). Sublet (as a % of portfolio) was +80bp q/q to 5.8% (Q2 = -30bp q/q to 5.0%). We estimate sub-let space as a % of total vacancy = 29% vs. 26% q/q and ~16.5% national average. We note capitalized interest and G&A were flat and -$0.2M q/q to 36% and 30% of total reported (ex. TR swap), respectively (Q2 = 37% and 33%).

Leverage is flattish. Debt/GBV was +60bp q/q to 39.7% (Q2 = +320bp q/q) but Net Debt/EBITDA fell 0.2x to 10.7x (Q2 = +1.5x q/q). PUD as a % of GBV fell 70bp q/q to 10.7% (Q2 = flat q/q) and above AP target of ~5% by Q4/25 (disclosure stopped in Q1). Q3/24A assets held for sale = $315M (vs. $286M as at Q2/24).