In the grand scheme of things, Dream Office Real Estate Investment Trst (TSX:D.UN) has been largely unloved. Since 2013 the real estate investment trust’s (REIT) unit price has declined about 50%, and that’s after it rallied 20% from the start of February.
Could this be an opportunity to invest in Dream Office for a high yield and the potential for juicy capital gains?
First, let’s take a look at the reasons for its unloved units.
Why the decline?
Since 2013 Dream Office’s funds from operations (FFO) per unit have been declining. This doesn’t bode well for its monthly cash distributions to unitholders because these distributions are paid from the REIT’s FFO.
Additionally, the Canadian office leasing market has been challenging, which is particularly evident in Alberta where Dream Office earns 26% of its net operating income.
As the WTI oil price fell from more than US$100 in 2014 to below US$50 in 2015, the market started to worry about Dream Office’s exposure to Alberta and that a distribution cut might occur. So, Dream Office’s unit price started declining more rapidly in the second half of 2015.
Eventually, Dream Office cut its distribution by a third in February, but this move was a part of its strategic plan, which sent its unit price higher.
Strategic plan
Dream Office’s strategic plan is an attempt to reduce the discount between the REIT’s unit price and its net asset value (NAV), which was $30.31 at the end of the first quarter.
Other than reducing the distribution and eliminating the distribution-reinvestment plan, which was probably diluting unitholders’ stakes in the REIT, the strategic plan also involved identifying $2.6 billion of non-core assets and setting a three-year goal to sell $1.2 billion of properties from this group of assets.
As of the end of the first quarter, $212 million, or 18% of its non-core asset sales target was reached. It also had $123 million of dispositions that were firm and $200 million of properties under contract or discussion. Dream Office plans to use the proceeds to repay debt, strengthen the balance sheet, and invest in its properties.
Is Dream Office’s distribution safe?
The sale of the $535 million of non-core assets would represent more than 40% of the target, or 7% of the REIT’s 2015 year-end portfolio.
Assuming these sales are going to reduce Dream Office’s FFO per unit by 7% (which is unlikely because core assets probably contribute more to FFO), its 2016 FFO per unit would be $2.73.
Dream Office’s monthly distribution of 12.5 cents per unit equates to an annual payout of $1.50 per unit, which implies a payout ratio of 55%.
However, let’s not forget that Dream Office still has $665 million of non-core assets that it plans to shed. As the sales occur, its FFO will continue to decline. So, that’s why there’s a huge margin of safety for its payout ratio currently.
Conclusion
The market reacted positively to Dream Office’s strategic plan and the stock has rallied 20% since February. At $19 per unit the REIT still trades at a discount of more than 36% from its NAV and offers a juicy yield of 7.9%. Moreover, there’s a big margin of safety in its monthly distribution as the REIT leaves room for the FFO reduction from its non-core asset sales.
