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.

Shock and Awe in ProLogis Share Price Plunge

Oh, how the mighty have fallen.
Less than one year ago shares in ProLogis Inc., the world’s largest developer and owner of distribution/logistics centres, were trading at over (US)$71. Today, as of this posting they trade at (US)$3.35 (hopefully not too many employees took their compensation in the form of share options!)
The current share price gives the company a market cap of (US)$880 Million (versus a Market Cap of well over $18 BILLION at it’s high point).
According to various reports the company has nearly 550 million square feet of space in North America, Europe, and Asia. Those properties are said to be worth upwards of $41 Billion. Chairman and CEO, Jeffrey Schwartz, resigned 2 weeks ago in a stunning move. The company has said that it does not plan any new development activity going forward and the company has cut it’s previously announced dividend of $2.28 per share down to $1. The company has total debt of $14.6 billion versus total equity of $11.3 billion (as of the end of the Third Quarter). The company’s development pipeline stood at a whopping $8 Billion.
My lowly opinion is that ProLogis will start to sell off certain assets in order to generate funds to pay down outstanding debt. The credit markets are currently too tight and expensive to be of much help in securing funds. And the company would be loathe to even consider selling shares at this level even if they could find investors willing to buy! However, having said that, look at the “SIDE NOTE” below.
SIDE NOTE: Just to see how other companies are struggling with raising capital look at A-B InBev’s recent takeover of US beer giant Anheuser-Busch. InBev took on $54.8 Billion in debt to fund this mega-acquisition. Part of the financing was an Equity Bridge Financing component of $9.8 Billion. Yesterday, in a stunning move, it unveiled an $8.2 Billion rights offering at a whopping 69% discount to Friday’s closing share price. Such a huge discount to the existing share price virtually ensures that the rights will be purchased by the existing shareholders making this issue a slam dunk. But what a price to pay! Even with this capital being raised the company is still looking at selling assets to pay off the $1.6 Billion balance. What a market!!

Companies Raising Cash Through Sale/LeaseBacks

With the Stock Market crashing to lows not seen for years, and with slowdowns forecast for virtually every sector in the economy, what options are available for companies strapped for cash?
Well one would normally access the credit markets but these have been severely tightened and the money, if any, to be gotten is expensive and usually inadequate in the amounts available.
Thus the rising poularity of Sale/LeaseBack transactions.
What's a Sale/Leaseback?
A Sale/LeaseBack is simply a transaction whereby a company sells off the real estate it owns to either a pension fund, a wealthy investor, or a syndicate of investors for all cash, and then turns around and enters into a Lease with that Buyer on a long-term basis (usually a 10-year time frame).
What does this accomplish for the Company?
Well, it frees up badly need cash for the company to survive the coming economic slowdown. The cash can be, and usually is, a substantial amount as real estate values have climbed dramatically over the last decade and, even though there has been a slowing of price appreciation, the amount of equity in these properties can be quite substantial.
But you say that the company now has to pay a lease!
True, but the investors out there look to get a 8 - 10% return on their capital (depending on what city the the property is located in, as well as the location within that city) so it is not an onerous term. The other benefit is that the Lease is now a cost of doing business and can be written off as part of the overall expenses.
Although not for everyone, Sale/Leaseback transactions can be a great financial tool for those who need to access cash to survive the downturn and then position themselves to prosper during the ensuing economic recovery.
Make sure to get expert legal, accounting, and real estate advice from your professionals before embarking on any proposed transaction.