Allied Properties Real Estate Investment (TSX: AP.UN) has declined about 23% from its 52-week high of $41 to $31.60 per unit. Is this pullback a good opportunity to buy its shares?
About Allied Properties
Allied Properties’s Class I office space can be found in 10 urban cities, but its properties are primarily in Toronto (about 43% of its gross leasable area), Montreal (28%), and Calgary (11%).
Tenant diversification
As of December 31, Allied Properties had a diversified tenant base with 29% of rental revenue from telecommunication and information technology tenants, 28% from business services and professional tenants, 13% from retail (head office and storefront) tenants, 13% from media and entertainment tenants, and 5% from government tenants.
Furthermore, none of Allied Properties’s tenants contribute more than 3% of its gross revenue. Allied Properties’s top 10 tenants contribute 19.5% of gross revenue, and they include Equinix, Ubisoft, Morgan Stanley, and Bell Canada.
2015 results
From 2015 to 2014, Allied Properties’s net asset value (NAV) per unit increased 6.5% to $33.05. Its interest coverage ratio (including capitalized interest) is 3.1 times, 0.1 times stronger than it was in 2014. Its funds from operations (FFO) per unit increased 3.3% to $2.17.
In 2015 Allied Properties completed four developments. Further, it strategically acquired $130 million worth of properties in downtown Toronto, which have value-creation potential that can be realized in three to five years.
Distribution and valuation
Allied Properties yields 4.8%, which is sustainable with an adjusted FFO payout ratio of 81%. Allied Properties is fairly valued based on its NAV. The real estate investment trust (REIT) has a multiple of about 14.5 times, which also indicates fair valuation. This means that the decline of 23% brought the REIT from overvaluation to a reasonable valuation.
Tax information
If you’re buying REIT units in a TFSA or RRSP, you do not need to worry about the rest of this section. However, if you want to learn about REIT’s tax-advantaged nature, read on.
REITs pay out distributions that are unlike dividends. Distributions can consist of other income, capital gains, foreign non-business income and return of capital. Other income and foreign non-business income are taxed at your marginal tax rate, while capital gains are taxed at half your marginal tax rate.
On the other hand, the return of capital portion reduces your adjusted cost basis. This means that that portion is tax deferred until you sell your units or until your adjusted cost basis turns negative. So, if you buy REIT units in a non-registered account, you’ll need to track the change in the adjusted cost basis. The T3 that you’ll receive will help you figure out the new adjusted cost basis.
Of course, each investor will need to look at their own situation. For instance, if you have room in your TFSA, it doesn’t make sense to have investments in a non-registered account to be exposed to taxation.
Conclusion
Allied Properties is a quality office REIT that’s fairly valued and offers a safe 4.8% yield. It’s not a bad entry point here, but would be a better buy on further dips.
