MCS Steel Non-Voting DR MSTUF

RBC

[retiredcf]

July 27, 2016

Milestone Apartments REIT

$106.5MM asset manager internalization proposal

First impression

Agrees to internalize the asset manager – Milestone Apartments REIT ("MST") has agreed to acquire TMG Partners L.P., (“TMG”), its external asset manager, for aggregate consideration of $106.5MM. The terms of this “internalization” proposal were negotiated and are unanimously recommended for approval by the REIT’s independent trustees

Equity + cash consideration – The $106.5MM price tag will be funded via $25MM of cash (to be drawn from MST’s revolver) and the issuance of 5.3MM class B LP units valued at $81.5MM (based on a 10-day VWAP of C$20.20, translated at the Jul-25 noon rate of US$0.756). The gross dollar figure is large and it reflects: 1) the lucrative nature of the fees paid to TMG; and, 2) the 6.5 years remaining on the contract, to Mar-2023.

Financial impact: AFFO – Asset management and incentive fees are currently annualizing at ~$12.5MM. Adjusting for ~$3.0MM of expected incremental salaries and overhead, annualized net “G&A” savings to MST should be $9.5MM. Imputing $0.7MM of interest expense on the $25MM cash component, and adding 5.3MM LP units to the equity base, we pencil-up 2017E AFFO/unit accretion of ~$0.05/unit, or ~4%. This accretion appears consistent with MST’s disclosures.

Financial impact: NAV – Issuing 5.3MM LP units + the $25MM cash payment dilutes our NAV by ~$1.30/unit, or 8–9%. The terms and expense ratios associated with MST’s external advisory contract have been a key element of our 10% discount to NAV price target derivation approach.

Stronger alignment – TMG is owned by MST’s CEO and his business partner. ~1.3MM of the Class B LP units received from the internalization will be subject to a two year-hold, with the 4MM balance subject to a five- year hold. Post-closing, MST’s management team will own 10.9MM units and LP units, for a stake of ~13% (7% currently).

Sensitive to the issues: Some good governance – The independent trustees received an opinion from an investment bank that the consideration paid by MST to acquire TMG is fair from a financial point of view to unitholders other than those affiliated with TMG. Targeting a Sept. 30th effective date, the transaction will be tabled for unitholder approval at a meeting in September where a simple majority of the unaffiliated votes will be required. Securities laws did not require this vote. Yet showing sensitivity to the large dollars involved, we think this is a good governance move. MST’s portfolio has delivered solid AFFO/unit growth since its IPO and the REIT has been acquisitive (average acquisition volume over the past three years has exceeded $300MM). Portfolio performance and future acquisitions are key variables in assessing the potential value of TMG and we are hopeful that the unitholder information circular will contain both qualitative and quantitative support for the “fair” conclusion