Value in a Canadian office REIT at less than 5x AFFO
Intelligent change in capital allocation, several catalysts already underway, and massive buybacks. (TSX: TNT.UN) 🇨🇦
Disclaimer, I am a shareholder of True North Commercial Real Estate Investment Trust.
True North Commercial Real Estate Investment Trust (TSX: TNT.UN)
The REIT is an unincorporated, open-ended real estate investment trust established under the laws of the Province of Ontario. The REIT currently owns and operates a portfolio of 40 commercial properties consisting of approximately 4.6 million square feet in urban and select strategic secondary markets across Canada focusing on long term leases with government and credit rated tenants. The REIT is focused on growing its portfolio principally through acquisitions across Canada and such other jurisdictions where opportunities exist.
Introduction
True North Commercial has faced many challenges over the past 3 years. Losing large tenants, cutting their dividend by 50%, and then stopping it altogether. And the sale of several buildings they have not yet completed.
Since 2023, there have been several changes in the trust structure. The management in place seems competent, and we can see this with their decision to cut the dividend in difficult times.
The opportunity exists for many of the reasons mentioned above, and it's a good one for us.
It's rare to see a REIT company suspend its dividend and then proceed with share purchases. (It's a rare decision in this sector.) However, it is an intelligent capital allocation decision.
Based on volume over the last 3 months, we can estimate that they will be able to buyback around 11-12% next year (2025). This guarantees a good return, as well as a high margin of safety on the cost of buyback. It seems to me that they will have to start paying a dividend again in 2025 or 2026, because they will probably have a lot of money and will be taxed if they keep it for the second tax year.
Buyback
For non-Canadian residents or for those who don't know the difference between US and Canadian REITs. Crucial information for understanding why buyback are so advantageous on a Canadian and not an American REIT.
U.S. REITs are corporations while Canadian REITs are mutual fund trusts. U.S. REITs are required to pay out 90% of taxable income as shareholder distributions vs. a 100% rule for Canadian REITs. Canadian REITs tend to use more debt to finance operations, including mortgages secured by property holdings.
Macro
Here's an overview of Canada's rental office sector. Our focus is on the Alberta (Calgary) and Toronto markets. We are seeing a slowdown in construction and rental demand.
Insider
The Chairman and CEO own around 12%1 of outstanding shareholders. This also includes the “Special Voting Units” which give him a voting power of over 34%.
Risk
We have a few risks, such as losing other tenants. They're having trouble leasing their largest office in Calgary and Toronto. The burden of debt and mortgage renewal will be considerable in 2025-2026. And also not being able to sell the last buildings (3 left) for 2025.
Catalysts
We have a number of catalysts, some of which have already been activated.
Canada Rate drop (below of 3%)
Calgary & Toronto Office Recovery
More buyback at cheap value (14$ or less)
Introduction of a dividend by 2025 (A wave of buying by dividend investors is highly likely.)
Here are Canada 1, 5 and 10-year rates. What concerns us most is the 5- and 10-year rates. To estimate the current refinancing rate, we would need to add about +/- 1.20% to the 5-year rate.
Held for sale
Now we need to talk about the offices for sale, which will have a major impact on cash flow in 2024 and on the value in 2025.
Looking at the 2024 activities, we note that 4 offices were sold with their price.
This gives an idea of the average price for the Toronto and British Columbia region.
Here are 3 offices for sale, with a rough estimate of the value we could achieve.
It is estimated that the sale of the 3 offices will bring in around 70 million. Let's do a quick calculation. After fees paid and the remaining mortgage payment (I use 65%), we could get around 21 million.
With all that potential cash flow in 2025, there's a good chance of big buyback or a special dividend in 2025-2026. Nevertheless, it's likely to take several months to sell its big offices.
Value
If we remain conservative, with a price of 8x AFFO by the end of 2025, we can expect a price of between $16 and $20. If the dividend reaches a yield of 10% in 2026, there is likely to be a large number of buyers (investors/dividend hunters). We should be above $22.
I estimate that we should have an AFFO per share of between $2.30 and $2.60 with the remaining 37 offices. This would give us more than $2.10 in cash flow available for distribution by 2024-2025.
This gives us an IRR of around 30% for 2 years (25 months) if the purchase price is $12 and we exit at +$22 or more. (without dividend and buyback adjustment)
Our margin of safety is solid, and share buybacks enable us to maintain the price and generate value that will be unlocked over the next 2 years.
We can also value the company on its tangible book value of approximately $30 (CAD). If we think we will exit at a value close to 80% (10-years avg) of the tangible book value. This gives us a very good IRR (+40%) over 2 years.
-Max