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H&R REIT: We Are Moving To The Sidelines

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Sunny outpouring time position on Queens Park successful downtown Toronto pinch War Memorial and Legislative Offices, Office of Government House Leader successful nan foreground and iconic CN Tower successful background

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Note: All values are successful Canadian Dollars and banal value references are to nan value connected nan TSX, not for nan OTC stock.

When we past covered H&R REIT (OTCPK:HRUFF) (TSX:HR.UN:CA), we noted that nan REIT was still being punished for its past errors and not getting capable in installments for its translator plan. We stamped a bargain standing and suggested nan shares whitethorn person immoderate room to rise.

But nan REIT remains positioned to win and we judge successful nan NAV supported by precocious value residential and business properties. We are maintaining our value target astatine $16 arsenic nan 2 forces of higher headdress rates and higher USD-CAD speech rate, fundamentally cancel each different out.

Source: H&R REIT Still In Purgatory

The banal has delivered a humble return since then, but that has been astir in statement pinch broader REIT assemblage arsenic represented by iShares S&P/TSX Capped REIT ETF (XRE:CA).

ChartData by YCharts

With Q4-2022 results out, we looked to spot really H&R's translator strategy was progressing.

Q4-2022

The 4th fourth capped disconnected a coagulated twelvemonth for H&R. The REIT delivered a 2 cent hit connected costs from operations (FFO) versus consensus, powered by beardown nett operating income (NOI). The company's occupancy ratio moved up to 96.6%. That number is rather an accomplishment considering that it still has important agency and unit assets successful its fold. In fact, nan gains successful occupancy were chiefly powered by agency and unit segments moving up, while residential stayed flat. Another notable announcement followed successful nan property merchandise pinch Elgin Street being sold for much than a 4th cardinal dollars.

The REIT has entered into an statement to waste 160 Elgin Street ("160 Elgin"), an agency spot successful Ottawa, ON, for $277.0 million. The trading value is successful statement pinch 160 Elgin's worth recorded astatine December 31, 2022. 160 Elgin was classified arsenic held for waste astatine December 31, 2022. Closing is expected to hap successful April 2023.

Source: H&R Q4-2022 Press Release (linked above)

This was a notable waste and reduces attraction wrong nan agency conception further.

And lastly, our Canadian agency segment, not taxable to rezoning, represents nan remaining $1 billion, of this $1 billion, 160 Elgin represents 27% of that agency segment's adjacent worth and is nan only agency spot located successful Ottawa, which is not considered a halfway marketplace for H&R.

On a quadrate ft basis, 160 Elgin represents astir 1 cardinal quadrate feet retired of 3.2 cardinal quadrate feet aliases said otherwise 160 Elgin represents astir 30% connected a quadrate footage ground of our Canadian office, not presently being rezoned.

Source: H&R Q4-2022 Conference Call Transcript

Outlook

H&R's repositioning has gone according to plan.

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H&R Q4-2022 Presentation

The rezoned agency conception is slated to beryllium converted to residential successful immoderate highly pricy areas of Toronto and Burnaby.

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H&R Q4-2022 Presentation

This will beryllium a agelong drawn retired process and investors should not expect speedy results. Most of these will only beryllium approved for rezoning by extremity of 2024. There will beryllium a ample magnitude of capex walk for this and results will return different 3-5 years aft that. What H&R has going for it is an extraordinarily debased payout ratio adjacent 50%. This allows complete $150 cardinal of FFO to beryllium retained and directed towards nan repositioning process annually. The repositioning extends beyond conscionable nan agency rezoning process. It besides involves H&R building and expanding its residential and business presence.

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H&R Q4-2022 Presentation

So H&R has been capable to nonstop capex towards that while lowering nan indebtedness to plus ratio complete nan past 3 years.

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H&R Q4-2022 Presentation

This is contempt immoderate fierce buybacks complete nan past 12 months. The REIT purchased astir 23 cardinal units successful 2022 astatine a weighted value of $12.99. According to nan company's ain valuation process, this was astatine a 40% discount to NAV.

On nan antagonistic side, nan headdress rates connected nan US Office portfolio still look a spot optimistic to us.

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H&R Q4-2022 Presentation

Investors whitethorn disagree pinch our repeated harping connected this but H&R's NAV fell from $22.58 to $21.80 4th complete quarter. This is contempt immoderate fierce buybacks which are NAV accretive. The driver present was nan adjacent worth accommodation connected nan agency and unit side.

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H&R Q4-2022 Press Release

We don't deliberation nan process is adjacent to complete successful an era of 5% consequence free 1 Year Treasury rates successful US. The different antagonistic continues to beryllium nan weighted maturity of nan debt. At 3.2 years it is deigned to inflict symptom successful this liking complaint environment.

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H&R Q4-2022 Presentation

We person not seen it yet arsenic H&R sold almost half a cardinal of assets successful 2022, offsetting nan emergence successful rates arsenic full indebtedness went lower. But nan effect is coming down nan line.

Verdict

We really cannot find immoderate responsibility pinch H&R's strategy. The residential and business look to beryllium nan astir promising areas and that is wherever H&R is focusing its firepower. At nan aforesaid time, agency assets are being sold selectively, alternatively than via a occurrence sale. The institution continues to deleverage and has not sewage chaotic pinch nan payout ratio. While not a critique of nan strategy per se, we deliberation nan headdress rates are still highly optimistic.

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H&R Q4-2022 Press Release

Our numbers get america a to a NAV adjacent $15 aliases $16. This is still a discount comparative to nan banal price, but possibly offers little a separator of information than what galore mightiness desire. What is besides notable is that we spot this aliases amended level of discount crossed galore REITs. We had recently covered Artis REIT (AX.UN:CA) and that trades astatine a wider discount to its ain NAV and to our estimate of its NAV. So nan mobility comes whether we want to prosecute this present pinch nan existent levels of buffer. We person to spell pinch a "no" astatine this point. Despite each nan correct moves being made by management, we don't spot nan existent situation arsenic highly conducive for this. We mightiness get much willing astatine a later clip point, should nan value diminution capable to springiness america a amended cushion. We are downgrading this to a "Hold/Neutral" rating.

Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

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Editor: Naga



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