H&R Real Estate Investment Trust (TSX: HR.UN) is one of Canada’s largest real estate investment trusts with total assets of approximately $13.3 billion on September 30, 2020. H&R REIT has ownership interests in a North American portfolio of high-quality office, retail, industrial and residential properties comprising over 40 million square feet. Since its inception in 1996, H&R has executed a disciplined and proven strategy that has provided stable cash flow from a high-quality portfolio.

Source: Company Presentation

Investment Rationale

• An Income Play: H&R’s current monthly distribution is CAD 0.0575 per Unit, which equates to an annual distribution of CAD 0.69 per Unit with an approximate yield of 5.2%. The company’s current dividend yield is significantly higher compared to the S&P/TSX Composite Index dividend yield of 3.3% and Canada 10-Year Government Bond Yield of 1.21%. Given the higher dividend yield and consistency in dividend payment, H&R REIT shares are likely to remain under the investors’ radar.

Dividend Payment History: Source: Refinitiv (Thomson Reuters) 

• All Properties are Fully Operational: In the fourth quarter, the company reported that all the properties are currently open and fully operational, including all retail properties, some of which were impacted by mandated closures during Q2 2020. Management has been working closely with all of the REIT's tenants, and particularly retailers at H&R's enclosed shopping centres, where same-store sales volume recovered in Q4 2020 to 86% of prior-year levels, up from the low 31% average in Q2 2020. The tenants that have been impacted the most by the COVID-19 pandemic have been retailers. By the end of June, all properties, including most stores at enclosed shopping centres, were re-opened, which is reflected in the retail rent collections trending upwards from 75% in Q2 2020 to 86% in Q3 2020. Q4 2020 collections from the retail portfolio stood at 88% without any CECRA subsidies.

• Strong Rent Collection Despite COVID-19 Led Difficulties: Rent collection has been a key focus during the pandemic and one area where H&R believes it has performed well while also accommodating the needs of its tenants. H&R's high-quality, long-term leased office portfolio delivered strong rent collection consistent with the profile of the tenant base, with 85.5% of revenues coming from investment-grade rated tenants. Rent collection was also strong in H&R's industrial and residential portfolios, reflecting the stronger-than-average credit profile of the REIT's tenant base across both of these portfolios. H&R's rent collections since the onset of COVID-19 are as follows:

Source: Company Filing

• Strong Balance Sheet: H&R REIT has a strong balance sheet and further strengthened its financial position in the Q4FY20, with CAD 1.1 billion of undrawn credit facilities available under its lines of credit, CAD 62.9 million of cash on hand, and an unencumbered asset pool of approximately CAD 3.7 billion, as on December 31, 2021. Further, the REIT’s total asset as of December 31, 2021, stood at CAD 13,355.44 million against the total liabilities of CAD 7,284.05 million. However, as of December 31, 2020, the Debt to Total Assets ratio was 47.7% compared to 44.4% as of December 31, 2019. This is primarily due to the negative fair value adjustment of certain office and retail properties of approximately CAD 1.2 billion. The weighted average interest rate of H&R’s debt as of December 31, 2020, was 3.6%, with an average term to maturity of 3.5 years.

Source: Company Presentation

• Technical Breakout on Daily Price Chart: On the daily price chart, the stock registered a breakout as the shares moved above the crucial short-term resistance and managed to trade above it for the past three trading sessions. Moreover, the Moving Average Convergence Divergence (MACD), the leading momentum indicator, is moving higher with the difference between 12-day EMA and 26-day EMA is positive and traded above the 9-day SMA signal line, a bullish indicator. Moreover, the stock continued to hover in the long-term bullish zone, as its shares traded approximately 19% above the 200-day SMA support level, which implies that the stock is trading well above its long-term support level and indicates a bullish trend in the stock. A technical breakout above the short-term crucial support level along with continued long-term bullish trend and bullish momentum indicator indicates a potential upside in the stocks from the current trading level.

Technical Chart (as on February 22^nd, 2021). Source: Refinitiv (Thomson Reuters).

• Risk Associated with the Investment: The COVID-19 pandemic has dramatically disrupted society and the economy and significantly impacted the commercial property industry. A new wave of this contagious virus could further dampen the REIT’s occupancy and lower down assets valuations. Further, the company is exposed to rentals default in the wake of a challenging condition in its tenant’s sectors.

Financial Highlights: Q4FY20

Source: Company Filing

• Rentals from Investment properties was 2% lower on a YoY basis. The primary reason for the decrease in rentals from investment properties is net disposition activity over the past two years. The REIT completed approximately CAD 1.0 billion of asset sales compared to CAD 218.1 million of acquisitions over the past two years, substantially repositioning its portfolio and enhancing its internal growth profile.
• On a sequential quarter basis, Rentals from investment properties increased by CAD 5.9 million in Q4 2020 compared to Q3 2020 primarily due to an increase in operating cost recoveries.
• H&R achieved an overall rent collection of 94% in January 2021, compared to 95% in Q4 2020, 95% in Q3 2020 and 91% in Q2 2020
• FFO per Unit in Q4 2020 was CAD 0.42 compared to CAD 0.41 in Q3 2020 and CAD 0.44 in Q4 2019. Excluding the Q4 2020 bad debt expense of CAD 3.9 million, Q4 2020 FFO would have been CAD 0.44 per Unit. AFFO per Unit was CAD 0.22 in Q4 2020 compared to CAD 0.35 in Q3 2020 and CAD 0.30 in Q4 2019.
• Same-Asset property operating income (cash basis) from office properties decreased by 3.4% and 1.6%, respectively, for the three months and year ended December 31, 2020 compared to the respective 2019 periods primarily due to the Hess Lease Amendment which included an initial seven month rent free period.
• Same-Asset property operating income (cash basis) from industrial properties increased by 5.7% and 5.8%, respectively, for the three months and year ended December 31, 2020 compared to the respective 2019 periods, primarily due to an increase in occupancy and increased rental rates on lease renewal.
• Same-Asset property operating income (cash basis) from residential properties in U.S. dollars decreased by 20.5% for the three months ended December 31, 2020 compared to the respective 2019 period, primarily due to Jackson Park in New York which has been negatively impacted by lower-than-average lease renewals and prospective tenant inquiries as a result of COVID-19.
• Same-Asset property operating income (cash basis) from retail properties decreased by 1.7% and 13.2%, respectively, for the three months and year ended December 31, 2020 compared to the respective 2019 periods, primarily due to bad debt expense as a result of the impact of COVID-19.
• As at December 31, 2020, debt to total assets was 47.7% compared to 44.4% as at December 31, 2019. This is primarily due to the negative fair value adjustment of certain office and retail properties of approximately CAD 1.2 billion.
• The REIT’s largest development project in 2020 was River Landing, an urban in-fill mixed use development site in Miami, FL, which is adjacent to the Health District with approximately 1,000 feet of waterfront on the Miami River, two miles from downtown Miami. River Landing includes approximately 347,000 square feet of retail space, approximately 149,000 square feet of office space and 528 residential rental units. In Q4 2020, the commercial portion of this project reached substantial completion and was transferred from properties under development to investment properties. The residential portion of River Landing is expected to be transferred from properties under development to investment properties in Q1 2021.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 16.06% of the total shareholding. The Vanguard Group, Inc is the entity holding maximum shares in the company at 3.27%. BlackRock Institutional Trust Company is the second-largest shareholder, with a holding of 2.89%.  The institutional ownership stood at 23.03% and strategic ownership stood at 1.9%, respectively.

Source: Refinitiv (Thomson Reuters) 

Valuation Methodology (Illustrative): EV to Sales Based Valuation Metrics

*(Note: All forecasted figures and peers have been taken from Thomson Reuters).

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The year has just gone by proved much more challenging than anyone expected a year ago. We believe that it could provide more opportunities than many might expect today. H&R spent much of 2020 focused on ensuring the stability and durability of the REIT’s portfolio and balance sheet. Further, H&R’s high-quality investment-grade clients, long-term leased office portfolio delivered strong rent collection consistent with the profile of the tenant base, with 85.5% of revenues coming from investment-grade rated tenants. Rent collection was also strong in H&R’s industrial and residential portfolios, reflecting the stronger-than-average credit profile of the REIT’s tenant base across both portfolios.

Further, the company is maintaining a strong balance sheet. The company has a decent track record of dividend distribution and offering a lucrative dividend yield amid a low-interest-rate environment. Also, technical indicators are indicating a potential upside in the stock, led by a recent breakout registered on the daily price chart.

Therefore, based on the above rationale and valuation, we recommend a “Buy” rating at the closing price of CAD 13.43 on February 22, 2021.

Source: Refinitiv (Thomson Reuters)

*Recommendation is valid at February 23, 2021 price as well.

Disclaimer

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