Artis Real Estate Investment Trust (TSX: AX.UN) is an unincorporated closed-end REIT based company in Canada. Artis REIT's portfolio comprises properties located in Central and Western Canada and selected markets of the United States. The properties are divided into three categories, namely: office, retail, and industrial. The industrial properties account for most of the portfolio, followed by the office properties and the retail properties.

Investment rationales

• Increase in distribution: Recently, the Board of Artis Real Estate Investment Trust announced an increase in common unitholder distribution to CAD 0.60 per unit annually from CAD 0.5562 per unit annually, effective from the March 2021 monthly distribution representing an increase in the distribution by 11.1%. Despite the challenging environment, the company increased its dividend distribution, while most businesses are cutting down or suspending their dividend distribution. This shows the group's financial strength and suggests that the group is a friend of income investors. 

• An income play: The Company has an excellent track record of dividend distribution and has increased its distribution over the years, reflecting business resilience and healthy cash flow generation. This dividend pay-out practice translates into an essential factor for regular income-seeking investors with a long-term horizon. Moreover, at the last closing price, the stock was offering a healthy dividend yield of 5.55%, which is decent considering the current macros and interest rates.

Source: Refinitiv (Thomson Reuters)

• Decent margin profile: Despite the turmoiled period, the Company maintained its pace and witnessed spirited performance across its operating margin and net margin and ROE in Q1 2021. However, the EBITDA margin of the industry median was higher than the Company. We believe the momentum to continue in the foreseeable future, as the Company had an extensive development pipeline to support future growth.

Source: Refinitiv (Thomson Reuters)

• Improving portfolio occupancy along with healthy rent collection: Despite the ongoing challenges related to the COVID-19 pandemic, the group reported a strong occupancy along with healthy gross rent collection in Q1 2021. Complete portfolio occupancy increased from 89.9% in Q4 2020 to 92.5% in Q1 2021, including commitments, reflecting high-quality tenants and strong operating fundamentals. For the three months ending March 31, 2021, the REIT received 98.6% of rent charges. In the middle of the current economic cycle, this seems remarkable.

Source: Company

• Rise in the renewed leasable area: During the first quarter, the company signed new leases for 281,751 square feet and lease renewals for 495,596 square feet. Renewal rentals increased by 4.2% on average compared to expiring rents on renewals that started during the quarter.

Source: Company

• Diversified portfolio: The REIT holds a diversified portfolio across five Canadian provinces and six U.S. states, which span across the industrial, office and retail asset classes. On March 31, 2021, the REIT's portfolio comprised 207 commercial properties totaling approximately 22.5 million square feet of gross leasable area ("GLA"). In Q1 2021, the five most prominent segments of its portfolio (by Proportionate Share Property NOI) were Twin Cities Area office, Twin Cities Area industrial, Madison office, Greater Toronto Area industrial and Winnipeg office.

Source: Company

• Healthy profile of Top 10 tenants: In Q1 2021, the occupancy rate improved to 92.5%, and the management seeks to acquire properties with strong tenant covenants. The REIT's portfolio includes 1,584 tenant leases with a weighted-average term to maturity of 5.2 years. Approximately 51.0% of the REIT's gross revenue is derived from national or government tenants. The largest tenant by gross revenue is Bell MTS Inc., which is one of Canada's leading national communication companies providing voice services, internet and data services, and television. Graham Group Ltd., which offers construction management, general contracting, design-build, and public-private partnership services to the manufacturing, commercial, and engineering industries, is the second-largest tenant by gross sales. The top ten tenants generate 17.4% of overall gross revenue.

Source: Company

• Healthy development pipeline: The company had three ongoing development projects named 300 Main, Park 8Ninety V and Park Lucero East. 300 Main is a mixed-use commercial and residential/multi-family property located in Winnipeg, Manitoba. It would be a best-in-class amenity-rich apartment building with main floor commercial space.  Park 8Ninety V is the final phase of an industrial development project in the Greater Houston Area, Texas, and is expected to comprise three buildings totaling 677,000 square feet once complete.  The company has a 95% interest in Park 8Ninety V in a joint venture arrangement. Park Lucero East is a state-of-the-art industrial development project located in the Greater Phoenix Area, Arizona, which is expected to comprise three Class A industrial buildings totaling approximately 561,000 square feet upon completion.  Artis has a 10% interest in Park Lucero East in an associate's form of investment.

• Strategic investment from Sandpiper group: The Sandpiper group is continuously increasing its position in the REIT. It believes that the units of the company are undervalued and represent an attractive investment opportunity. It recently expanded its position through Sandpiper Real Estate Fund 4 L.P; together with its joint actors, in Artis Real Estate Investment Trust, it holds approximately 12.25% shares of the company's total outstanding shares. The sandpiper group believes there is deep value in the REIT, and it is on a positive path forward to closing the value gap.

• Dispositions to attract liquidity: The company is focused on its strategy to reduce its leverage and increase liquidity over the next five years. Recently, the company entered into unconditional sale agreements for a portion of Signal Centre, a retail property located in Fort McMurray, Alberta, the Victoria Square Retail Portfolio, comprised of two retail properties located in Regina, Saskatchewan and Fleet Street Crossing, a retail property located in Regina, Saskatchewan. These dispositions closed in April 2021 for an aggregate sale price of CAD 57.2 million. After March 31, 2021, the REIT also sold Sierra Place, an office property located in Calgary, Alberta, for a sale price of CAD 4.8 million. Furthermore, it converted its industrial property located in the Greater Toronto Area, Ontario, to commercial condominiums and sold 17 units for aggregate consideration of CAD13.9 million.

• Solid balance sheet and ample liquidity: The Company maintains a solid financial position with significant liquidity and a substantial unencumbered asset pool. As of March 31, 2021, CAD 40.9 million of cash in hand and CAD 382.2 million were available on its revolving term credit facilities. 

• Change in Board and Management: Recently, the company announced a new vision and strategy to become a best-in-class real estate asset management and investment platform focused on growing net asset value. To achieve this vision, the group made some changes in its board and management. It appointed Ben Rodney as Chair of the Board of Trustees, Samir Manji as Chief Executive Officer and Kim Riley as Chief Operating Officer. 

• Risks associated with investment: The Company's revenue and operating results depend significantly on the occupancy levels and rent collection. Hence, any fluctuation occupancy rate or delay in rent collection would affect the group’s performance. The other risks include government regulation changes, competition from other players, and general economic conditions.

Financial overview of Q1 2021

Source: Company

• In Q1 2021, the REIT reported lower rental revenue from investment properties, which stood at CAD 107.0 million compared to CAD 118.5 million in the previous corresponding period. The decrease in the rental revenue was mainly due to the impact of dispositions, as it disposed of one industrial, eight office and three retail properties in 2020.
• Total revenue increased by 1.9% to CAD 120.8 million, against CAD 118.5 million. The marginal increase was primarily due to the inclusion of condominium sales worth CAD 13.8 million.
• Total operating expenses surged to CAD 56.6 million, against CAD 49.3 million. The rise in the operating expenses was mainly due to cost related to the sale of condominium at CAD 12.9 million, partially offset by lower property operating cost, which stood at CAD 25.5 million V/s CAD 29.5 million in pcp.
• The net operating income posted by the REIT stood at CAD 64.2 million V/s CAD 69.1 million in pcp. The prime reason for the drop in operating income was lower rental revenue from investment properties.
• Lower interest expenses and higher fair value gain on investment properties, higher net income from equity investments, and fair value gain on derivative instruments helped the company transform its losses into a positive EBT of CAD 71.9 million.
• The company posted a net income of CAD 71.8 million against a loss of CAD 111.3 million in the previous corresponding period.
• FFO per unit in the reported period stood at CAD 0.35, compared to CAD 0.33 in the previous corresponding period, while AFFO per unit was CAD 0.25, compared to CAD 0.24 in Q1 2020.
• Rent collection has been a key focus during challenging time, and it collected 98.6% of rent charges for the three months ended March 31, 2021.
• The REIT Improved its total long-term debt and credit facilities to Adjusted EBITDA to 9.0x on March 31, 2021, compared to 9.4x on December 31, 2020.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which forms around 51.17% of the total shareholding. Joyce (Steven) and Sandpiper Group hold the company's maximum interests at 13.47% and 12.57%, respectively. The ownership of the strategic entities stands at 39.44%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock recommendation

The company started FY2021 with strong Q1 2021 numbers with quarter-over-quarter increases in FFO per unit, AFFO per unit and overall portfolio occupancy. Despite physical constraints, it persevered through the global pandemic and have performed on many key operating fronts, including leasing – both for renewals and new tenancies across North America. This has generated net positive growth on the committed occupancy at quarter-end while also achieving a positive increase in the weighted-average rental rate on renewals.

The company further improved its liquidity by disposing of its few of its retail and office property for an aggregate sale price of CAD 62.0 million. Moreover, it has a healthy development pipeline, which we believe would open new avenues for fresh cash flows in the near term.

The REIT has an excellent track record of dividend distribution, and recently it increased the distribution by almost 11.1%, which is encouraging from an income investor's point of view. Moreover, the stock was offering a dividend yield of 5.55%, which is decent amid a low-interest rate environment.

Therefore, based on the above rationale and valuation, we suggest a "Buy" recommendation on the stock at the closing price of CAD 10.81 on May 10, 2021. We have considered Dream Office REIT, InterRent REIT and Allied Properties REIT etc., as a peer group for comparison purpose.

1-Year Price Chart (as on May 10, 2021). Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at May 11, 2021 price as well.

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