Shares of several real estate investment trusts (REITs) have trailed the broader markets by a wide margin in the last two years. Typically, REITs are capital-intensive entities that raise debt to acquire properties and fuel their expansion plans. However, rising interest rates have increased the cost of debt significantly, eroding REIT’s profit margins and dragging share prices lower.
One such REIT is Allied Properties (TSX: AP.UN), which trades 71% below its all-time highs, increasing its dividend yield to more than 10%. Let’s see if you should buy the dip in Allied Properties and if the REIT can maintain its high dividend payout amid a challenging macro environment.
An overview of Allied Properties REIT
Valued at a market cap of $2.3 billion, Allied Properties owns and operates urban workspaces in major Canadian cities. It aims to provide knowledge-based organizations with a workspace that is conducive to human wellness and creativity.
Basically, the office landlord repurposes industrial and warehouse spaces for tenants across multiple sectors, including technology.
The value of the REIT’s portfolio of assets has risen from $157 million in 2003 to $10.6 billion in 2023, indicating an annual growth rate of 23.7%. A widening base of cash-generating properties has allowed Allied Properties to raise its annual dividend payout from $1.14 per share in 2004 to $1.80 per share in 2023. Despite the drawdown in share prices, Allied Properties stock has returned an average of 9.7%, outpacing the TSX index and peers in this period.
How did Allied Properties perform in Q4 of 2023?
Allied Properties reported an operating income of $82 million in the fourth quarter (Q4) of 2023, up 6% year over year. Its adjusted funds flow from operations (AFFO) stood at $79 million, or $0.562 per unit, in Q4, up from $76 million, or $0.545 per unit, in the year-ago quarter.
It suggests that the AFFO payout ratios for Allied Properties stood at 80% in Q4 of 2023, which is sustainable. A low payout ratio provides Allied Properties with the flexibility to lower balance sheet debt and reinvest in capital projects, driving future cash flows higher.
What’s next for Allied Properties REIT stock?
Rising interest rates and the shift toward working from home have driven property rates significantly lower since the COVID-19 pandemic.
According to a research report from Altus Group, commercial real estate investments in Toronto fell by 27% year over year in Q2 of 2023. Further, office investments fell 61% to $414 million, down from $1.07 billion in the year-ago period. Notably, McKinsey Global Institute estimates remote work could wipe out US$800 billion from office building values globally.
In Q4 of 2023, Allied reported a net loss of $499 million, primarily due to a fair value loss on investment properties. The REIT emphasized that development-property valuations declined by $70 million, while rental-property valuations fell by $425 million.
Allied Properties ended 2023 with an occupancy rate of 86%, down from 90% in 2022 and less than 95% prior to the COVID-19 pandemic. Moreover, the REIT sold two data centres located in Toronto for $1.35 billion in 2023 to strengthen its balance sheet as interest rates surged to multi-year highs.
While the dividend yield might seem attractive, Allied Properties remains vulnerable to macro headwinds and might underperform going forward.
