Dream Office REIT (TSE:D.UN) in 2024

 

If you haven’t been living under a rock you’ve surely seen some of the headlines about companies choosing to extend their work from home policies beyond COVID-19. A few companies, like Shopify, are saying they are going to primarily have employees work from home from now on.

Canadian REITs handling commercial space such as Dream Office REIT (TSE:D.UN) are trading near their March lows because of these headlines and due to investors’ uncertainty about how companies will operate in the future.

It is possible that there is going to be less office space demand in the next few years as companies realize some of their employees can be just as productive from home. But most companies are still going to use offices – there are just some things that are better done face to face in a collaborative environment.

 

Dream Office REIT dividend and REIT analysis

Dream Office REIT is a real estate investment trust that acquires, manages, and leases primarily central business district and suburban office properties in urban areas throughout the country. The vast majority of the company’s property is located in the provinces of Ontario and Alberta.

The bulk of the company’s revenue comes from mid to long term lease agreements with commercial tenants, with most of them being in the finance, insurance, science, and government sectors.

As of June 30th, 2020 the company had 5.5 million square feat of gross leasable area and an occupancy rate of 88.3%.

The company has more than $2 billion in assets in the downtown Toronto area and is currently looking to invest another $50 million in what it believes to be one of the finest office markets in North America.

An interesting note on the company, nearly 35% of the trust is held by Dream itself, and insiders. High insider ownership is often a good thing, as it is a strong signal of management’s confidence in the company.

As well as strong insider ownership, Dream Office REIT also has a 16.2% interest in Dream Industrial REIT, which operates a diversified portfolio of high quality industrial space in growing markets in North America.

Dream Office price and price to cash flow over the last 5 years

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Market Cap: $1.13 billion
Forward P/E: 12.50
Yield: 5.52%

 

Leasing Data

Dream Office REIT leasing suggests the doom and gloom may be exaggerated.

In the press release announcing its Q2 earnings, Dream Office said that it had leased 250,000 square feet of space, at rates 40% over those of the expiring leases. Additionally, it is in discussions for leases on another 400,000 square feet at rents similar to those being paid prior to COVID-19.

All told, demand for Dream Office’s premiere office portfolio (over 80% of which by value is in downtown Toronto) is likely to outlast demand for more suburban offices. Companies will want to keep their downtown office space, which is where most workers are, and where skilled immigrants are likely to choose to live.

 

Occupancy Downside

Of course, it’s possible that tenants are signing leases now because they were already planning on it before COVID-19, or because they don’t yet appreciate their ability to get work done with employees working from home. What happens if Dream Office faces a rash of vacancies in the near future?

Dream Office owns 5.5 million square feet of space. Between now and the end of 2021, leases on 1.29 million square feet are expiring, but Dream Office has already leased 734,000 square feet of that.

That means that unless a tenant breaks their lease (a costly endeavor that companies only do as a last resort), at worst Dream Office’s occupancy can drop 10% over the next year. And that’s only if Dream Office can’t sign one single lease between now and then.

Since it’s in talks to lease 400,000 square feet now, there’s almost no chance that worst case takes place.

Again, imagine the hypothetical worst case scenario. If occupancy dropped 10%, revenue and net operating income (essentially a REIT’s gross margin) would drop by roughly $12 million.

Even if NOI dropped by $12 million, today’s price would represent a 5.5% cap rate (calculated by dividing NOI by the REIT’s enterprise value). Downtown Toronto class A offices sell for around 4.5% cap rates right now, showing how undervalued Dream Office is even in the worst case scenario.

If Dream Office traded at a 4.5% cap rate on its worst case NOI, units would be $27. On current, normalized NOI, Dream Office would be $31 at a 4.5% cap rate.

Dream Office REIT presents a strong chance of capital gains given its low valuation and premiere real estate.

The high, safe yield might be just as attractive as the potential for capital gains.

At today’s price, Dream Office offers a 5.3% yield.

The funds from operations (FFO, a measure of a REIT’s cash flow) payout ratio in 2019 was just 59%. In the worst case scenario where NOI drops by $12 million, FFO would drop by the same $12 million and the FFO payout ratio would still be less than 65%.

 

Conclusion

All of the headlines out there have the market scared that office real estate is in for a world of hurt, but even in the worst case scenario, Dream Office REIT is undervalued and the distribution is safe. As the market realizes occupancy isn’t going to fall off a cliff, Dream Office REIT should trade up to at least $27, which is roughly its net asset value today.

As long as companies continue to use office properties to run their businesses, Dream Office REIT will provide investors a good return. Canadian REITs span a multitude of different areas from residential, retail, and industrial or commercial spaces. There is something for everyone and interesting projects such as “SmartVMC”, the development from SmartCentres REIT (TSE:SRU.UN).