On the final trading day of the year, shares of Dream Global REIT (TSX:DRG.UN) hit their 52-week high. At a price of $9.45, the yield is still an astonishing 8.5%. Clearly, many investors have gotten excited at the picture on the surface and are not doing enough homework before clicking the buy button.
Dream Global REIT is a company spun out of the Dream family in 2011. It holds the overseas real estate assets located in Germany and Austria. Although the large majority of the assets are located in Germany, there are still 300,000 square feet of space available for rent in Vienna, Austria.
Because it is listed on the Canadian exchange in Canadian dollars, investors can gain international exposure without having to go too far. The currency risk, however, is still assumed by the investor. Given the assets are mainly located in Germany, the rents (revenues) and expenses are received and paid in euros and then translated back to Canadian dollars when earnings are reported.
Let’s run through this in a simple example.
As of the time of this writing, one euro translates to approximately to a 40% premium in Canadian dollars. This can be expressed as €1 = CAD$1.40. Assuming the euro does not move in the next year, but the Canadian dollar appreciates in value, the new exchange rate could look something like: €1 = CAD$1.30. If the dollar rises, one euro may only lead to CAD$1.30 instead of CAD$1.40. The rents coming in from Germany are now less valuable to Canadians.
If the Canadian economy or the Canadian dollar falter in the next year, investing in Dream Global may be an excellent way to hedge one’s exposure to a falling Canadian dollar. Alternatively, if the euro increases in value in the next year, this could also lead to gains for shareholders.
Looking at the tangible book value of the company, the share price of $9.45 is at a clear discount to the tangible book value of approximately $11.15 per share. The reason for this lower share price may actually have nothing to do with the value of the assets, but instead may have everything to do with the potential for management to cut the distribution.
For REITs, the distribution is measured as a percentage of AFFO (adjusted funds from operations) and not from net income. In the case of Dream Global REIT, the payout percentage in 2014 was 96% followed by 104% in 2015. Through the first three quarters of 2016, the payout ratio was 103% of AFFO.
The distribution is not only in danger of being cut because it amounts to more than the available cash, but the foreign currency translations are another contributing factor which could force the hand of management sooner rather than later.
As an investor, I always wonder what am I paying vs. what am I getting. In this case, I like what I am getting for what I have to pay. Patience, however, will serve me very well as I hope to wait for a cut in the distribution before I proceed to hit the buy button.
