Allied Properties REIT, a prominent office landlord in downtown Toronto, is experiencing a sizable writedown, coupled with a soft earnings outlook. Office buildings and condominiums in the downtown core of Toronto on Sept. 20, 2020.CHRIS HELGREN/Reuters
A sizable writedown coupled with a soft earnings outlook sent units of Allied Properties REIT AP-UN-T, a once-beloved office landlord, back to 2009 prices as investors debate the office sector’s future amid higher interest rates and white-collar workers’ desire to continue working from home.
Allied, which is a prominent office landlord in downtown Toronto and Montreal, reported fourth-quarter earnings that included better rents on lease renewals, yet investors focused on management’s expectation that earnings this year could be flat to down 5 per cent, which dented any hope for a quick rebound in office building vacancies.
Allied also reported a $510-million writedown on its property portfolio, which management attributed to a tough economic environment as higher interest rates bite. The real estate investment trust said it is taking a long time to fill unleased space as tenants turn over, and new tenants now take 12 to 18 months to find compared to the prepandemic level of three months to six months.
Allied’s units slumped 8.9 per cent Thursday, falling to $17.78 apiece – the same price they traded for in November, 2009. The REIT’s units briefly fell below their current level last fall, but rebounded quickly because investors grew optimistic that central banks would start cutting rates over the next few quarters.
REITs are highly sensitive to interest rates because they fund their property acquisitions using mortgages. They are also popular investments for retail investors in Canada, who used to buy REITs for their hefty monthly distributions. When benchmark interest rates were hovering around 1 per cent annually, REITS often paid 5 to 6 per cent. But because benchmark rates have risen, REIT yields aren’t considered to be as lucrative as they once were.
Allied isn’t the first REIT to take a writedown – rental apartment owner Canadian Apartment Properties REIT also took a $507-million writedown last fall, for instance, owing to higher interest rates – but the impairment suggested management has accepted that internal valuations were out of line with current market fundamentals. This disconnect is prevalent across the commercial real estate sector, particularly with private real estate holders, such as pension funds, who have often refused to acknowledge lower public-market valuations.
Historically, Allied was considered a prestige landlord, with a portfolio of premium low-rise office buildings in downtown cores. However, working from home, coupled with higher interest rates, has hit the entire sector. Allied’s occupancy is currently 86.4 per cent, above the national average, according to brokerage CBRE, but its units are still down 70 per cent from their record high set in February, 2020.
Despite this drop, Allied’s market performance has fared better than a number of rival publicly-traded office landlords, including Dream Office REIT (down 78 per cent from its peak) and Slate Office REIT (which is now a penny stock). Some of this outperformance stems from a solid balance sheet, which was boosted by the $1.3-billion sale of three data centres last year. Proceeds from the sale were put toward debt repayment and helped Allied absorb development costs on new properties.
Because it has ample cash, Allied has not needed to slash its monthly payout. By contrast, Slate Office, which derives half of its operating income from the Greater Toronto Area and Atlantic Canada, cut its own by 70 per cent early in 2023. Around the same time, True North Commercial REIT, which owns office properties across Canada but focuses on Ontario, slashed its own distribution by 50 per cent.
Allied rejigged its management last year, moving long-time chief executive officer Michael Emory to the role of executive chair and naming Cecilia Williams as the new leader. On a conference call Thursday, Ms. Williams expressed optimism that occupancy levels would rebound once the economy settles. “I’m still feeling very confident that we will get back to a stabilized portfolio, which is in that 94-per-cent to 95-per-cent range. But I’m not going to be commenting on the exact timing of that,” she said.
In an e-mail to The Globe and Mail, Ms. Williams added that demand for office space “rebounded over most of 2023, and we expect this to continue through 2024. The uncertainty arises from the time required to finalize lease transactions, which is understandable in the current macroeconomic environment.”