Should H & R REIT's High Yield Set Off Warning Bells for GTA Commercial Real Estate Values?

Traditionally, REITs (like bonds), have provided a nice hedge against declining equity markets. The old adage was that as equity markets decline, REITs tend to perform well. The reason being, that REITs returns are locked in under lease contracts. Therefore when other share prices fall as companies fortunes sag, the rental income still flows for the REITs. The current market, however, doesn’t reflect that old adage. Take for an example H&R REIT, recently trading at $4.85 per unit (versus a 52 week high of $21.46) and giving this REIT an extraordinary high 29.69% Yield!
And H&R is not alone:
Dundee REIT $10.40 per Unit (versus a 52 week high of $36.75)giving it a 21.115% Yield, InnVest REIT $3.00 per Unit (versus a 52 week high of $10.87) giving it a 25.00% Yield, Morguard REIT $7.18 per Unit (versus a 52 week high of $15.75) 12.535% Yield,
Homburg Invest Inc. $1.45 per Share (versus a 52 week high of $4.80) 33.103% Yield, Allied Properties REIT $10.18 per Unit (versus a 52 week high of $22.45) 12.967% Yield.
So, what gives with these extraordinary returns? When REIT returns yield more than 8% you know that something has to give. Either the Commercial Property Sector will see many tenant defaults with a lower revenue stream and thus justify the low price of H&R units, or that the market is wrong and there will be no large tenant failures and the unit price will rebound to previous levels. The market in its infinite wisdom is always looking to the future. So when you have a yield on a REIT like H&R with a return yielding 29.69% the market is forecasting a severe decline in its future revenue. But will this happen? H&R has a great property portfolio. It owns 34 Office properties, 124 Single Tenant Industrial Properties, 122 Retail properties and 4 Development properties that the company says has a Book value of $4.931 Billion. The current share price gives H&R a market value of only $708 Million. Add in Debt of $3.1 Billion and you have a total of debt and share value of $3.8 Billion which is $1.2 Billion less than Book Value (a discepancy of around $8 per share). Is the company really worth this little? Looking in the rear view mirror everything looks great. Third quarter distributions were just announced at $0.11 per month (implying an annual distribution of $1.23). The market however is saying that the share price of HR is unsustainable in the forthcoming recession. Thus the abnormally high looking return on units. This means that the market is forecasting a rough ride ahead for real estate assets that HR owns. What does H&R own? Large office, industrial, and retail properties in great locations. It has about 31% of it's total square footage in the U.S. so this might be impacting the unit price as well. The LTV ratio is only 63% based on H&R's book value (but is 81% based on the current market value of the REIT). So, the market is forecasting that there will be many defaults looming as companies restructure/go out of business. If this happens look for lease rates to decrease as companies default on leases and excess product comes on the market. Lower lease rates and excess product can only mean lower prices. Will that be the scenario that pans out, or is the market totally out to lunch? Only time will tell. For every seller of this REIT ther are buyers who think that none of this doom & gloom talk will have a material effect on H&R's distributable income.
If massive layoffs, plant closures, and companies going bankrupt come to pass, then Toronto Commercial real estate values will certainly plunge. The Toronto market is not concerned with the overleveraged concerns that the U.S. is experiencing. The GTA concerns would be how severe a recession/depression will we be seeing?
As for me, I have no idea. I won’t pretend to be smarter than the market. I’ve seen too many people burnt doing that. Something has to give. Either the unit price rises dramatically to reflect that the distributions have remained stable or the Unit price remains where it is as distributable unit income dramatically falls off to reflect the new reality of the commercial real estate market. Let’s hope it’s the former scenario.