The Motley Fool

Is This REIT Doomed as One of its Biggest Tenants Leaves for the U.S.?

It was a seismic shift in the Alberta oilpatch, this week’s announcement that Encana Corp (TSX:ECA) is moving its corporate headquarters to the U.S. and changing its name to boot. Encana is an iconic Canadian energy producer and once held the title of the country’s biggest energy company.

While the news was a surprise, Encana’s decision to move south is not that big of a deal to Alberta in the long run, because the company has been a terrible performer over the last few years, destroying almost 75% of its shareholder value.

I would not be surprised if the company’s troubles continued, regardless of where precisely it calls home. What may be slightly more important to Albertans and the rest of Canadians is whether other companies get caught up in the turbulence of the Encana departure.

Who will feel the Encana pain?

I can see at least one company that may feel the pain, and that is Encana’s landlord in Calgary, H&R REIT (TSX:HR.UN). H&R, one of the country’s largest diversified real estate companies, has the dubious honour of being the owner of The Bow, a phenomenal office building in Calgary that couldn’t have been built at a worse time for the province.

Calgary’s office vacancy rate has remained about 20% to 25% for the last few years and the Bow boasts two million square feet of prime office space in downtown Calgary, which is a recipe for disaster at the moment.

Some casual investors may think Encana’s move, and the fact that it will be vacating the Bow, will lead to a substantial loss of rental income for H&R. Thankfully for H&R investors, it doesn’t quite work like that – iron-clad, long-term leases protect the landlord in cases of default or similar troublesome situations.

However, H&R has been looking to sell the Bow for some time now. Encana’s move will add to the general economic anxiety that Albertans are feeling right now, and it is entirely possible that there will be no sale in the near future, given the uncertainty surrounding tenants.

Encana has to abide by the terms of its lease until 2038, which means H&R will get paid, even if space is sub-let out to another tenant. What is more damaging to H&R in the short run at least is the fact that the proceeds from the sale of the building could have been used to pay down corporate debt or better yet, repurchase shares that have been languishing in the $22 to $23 range for an eternity.

The stock price couldn’t be more attractive!

To put things in perspective, H&R shares changed hands at $22 way back in 2006 and then again in 2011. This means ultra-long-term holders of this stock have seen nothing but pain as the stock price stagnates. Compared to that, Allied Properties is up almost 50% and First Capital Realty is up 20% during the same period.

The stock price didn’t tank on the Encana news, as expected. Instead, for once, investors kept their eye on the big prize. They tuned out the Encana noise and focused on the big picture, which is still excellent for H&R, which has plenty of catalysts for growth.

I believe the biggest catalyst for H&R’s future growth is not in Alberta or even in Canada; rather it is down south in the U.S. “sun-belt”. H&R is one of the only large-cap Canadian REITs that has a sizeable U.S. business, especially since RioCan REIT sold its U.S. portfolio a few years ago.

The Foolish bottom line

H&R is focused on new developments as well as acquiring existing buildings in Florida, California, and Texas – all areas with excellent long-term rental fundamentals.

A perfect example of that strategy is the very recent acquisition of Lantower Grande Flats in Orlando, a 314 unit monster rental community, located in Orlando’s popular tourism hub, which is anchored by major employers and a $50-billion tourism industry.

Long-term investors should take a very close look at H&R for its U.S. strategy and look to potentially accumulate shares at the $22 level to set up for top-quartile returns over the next few years.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Rahim Bhayani owns shares of First Capital Realty Inc. The Motley Fool recommends FIRST CAPITAL REALTY INC.

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