What is your take on H&R Real Estate Investment Trust HR-UN-T? The unit price has been extremely volatile over the past several years. It fell by more than half at the start of the COVID-19 pandemic, rebounded over the next 18 months, but since late 2021 it’s been pretty much downhill. What is going on here?
Like many REITs, H&R has been hurt by a combination of high interest rates and negative investor sentiment toward commercial real estate, particularly office and retail properties. H&R is in the midst of a multiyear repositioning aimed at reducing its exposure to those two sectors while beefing up its faster-growing industrial and residential holdings.
The strategic overhaul, launched in 2021, has already begun to reshape the Toronto-based REIT. At the end of 2023, residential and industrial properties accounted for about 61 per cent of H&R’s assets, up from about 35 per cent when the plan was announced. The proportion of office and retail assets, meanwhile, has dropped to 32 per cent from 65 per cent, with another 7 per cent being rezoned for primarily residential use. Eventually, H&R aims to exit office and retail entirely.
Judging by the sluggish unit price, however, many investors would prefer not to have their money tied up in a lengthy turnaround story.
“H&R … is trading like an office REIT. What’s clear to us is that it is not,” said Jimmy Shan, an analyst with RBC Dominion Securities Inc., in a note after the release of H&R’s fourth-quarter results in February. “What’s unclear is how and when sentiment changes on the stock to more accurately reflect its underlying portfolio value.”
For investors who can be patient, H&R’s weak unit price could present an opportunity, for a couple of reasons.
Let’s start with H&R’s yield. Shortly after the pandemic began, H&R slashed its distribution in half. It later trimmed its payout again. However, it has since raised its regular monthly distribution twice and is now paying five cents a month or 60 cents annually. That works out to a yield of about 6.9 per cent based on H&R’s current unit price, which closed at $8.70 Friday.
H&R’s payout ratio also seems manageable. For 2023, the REIT distributed a conservative 63 per cent of adjusted funds from operations (AFFO), a widely used cash flow measure in real estate. Analysts expect the payout ratio to fall to 60 per cent this year, assuming the distribution remains constant. This indicates that H&R’s distribution is well covered by the cash the REIT generates.
The stock market is also not giving H&R full credit for the value of its real estate, analysts say. In a Feb. 14 note, Sumayya Syed of CIBC Capital Markets said the units were trading at a 42-per-cent discount to CIBC’s estimated net asset value (NAV) per unit of $16.50, which is essentially the value of H&R’s properties minus debt. With the units losing more ground in recent weeks, the discount has widened to about 47 per cent. Many REITs trade at a discount to NAV, but in H&R’s case the gap is substantial.
“Belying the progress made [on the repositioning], units consistently trade at a wide discount to NAV, indicating to us that investors are in wait-and-see mode until the repositioning program is closer to completion,” Ms. Syed said. She has an “outperformer” rating and a price target of $12 on the shares. Two other analysts also rate the stock a buy, with three holds, and an average price target of $11, according to Refinitiv.
H&R isn’t without risks. Given the soft market for office and retail assets, and the long lead times for new residential and industrial real estate developments, H&R’s transformation will likely take many years. Although the REIT stands to benefit from lower interest rates, it’s not clear when rates will begin to fall meaningfully or how low they will go.
“H&R is attractive for the benefits that will stem from its long-term strategy to focus exclusively on multiresidential and industrial properties. This is offset by near-term industry supply headwinds in the residential business, the multiyear time frame to transition holdings and the dampening effect of higher interest rates,” said Jim Marrone, an analyst with Accountability Research, in a note after the release of H&R’s third-quarter results in November. Accountability Research rates the units a buy with a price target of $11.
Such risks notwithstanding, H&R does seem to be on the right path, and the units offer attractive value for investors who are content to get paid an above-average yield while they wait for the repositioning to bear fruit. Remember to do your own due diligence before investing in any security.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.
John Heinzl