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Allied Properties REIT's executive chair Michael Emory said his near-term focus is to complete the projects that are already under way, including The Well in Toronto.Tijana Martin/The Globe and Mail

Office property owner Allied Properties REIT AP-UN-T is selling its data centre portfolio in downtown Toronto for $1.35-billion, generating much-needed cash to pay down debt and fund its development portfolio.

Allied is selling three properties, the largest of which is 151 Front St. West., a major telecom hub, to Japanese telecommunications company KDDI Corp. KDDI owns and operates data centres in Asia, Europe and the United States through its Telehouse subsidiary, and the purchase adds its first batch of Canadian properties to its portfolio.

Allied announced in November that it was exploring a sale of its data centre properties, but at the time it wasn’t clear whether the REIT would unload the entire portfolio or bring in a joint-venture partner. Because the process took eight months, there were concerns that potential buyers either were not interested, or that they were not willing to pay as much as Allied wanted for the assets.

Ultimately, though, Allied was able to sell the entire portfolio for $1.35-billion, $118-million more than its combined net asset value on the REIT’s books. Allied’s units fell slightly in early Wednesday trading, down roughly 2 per cent to $21.45.

Allied is best known for its low-rise office buildings in downtown cores, and before the COVID-19 pandemic the REIT was adored by investors, with its units hitting a record high near $60 in February, 2020. Lately, though, slumping demand for office space, coupled with higher interest rates, which make mortgages more expensive, have hammered its units. Allied’s units are now down 64 per cent from the peak.

Although the office sector across North America is hurting, forcing many banks to rethink their loan exposures, Canadian REITs face a unique challenge. For more than a decade retail investors were major buyers of the sector’s units because they loved the income provided by monthly distributions when interest rates were ultralow. REIT distribution yields tended to hover around 5 per cent to 6 per cent annually.

Not only are these yields now rather close to what ultrasafe guaranteed investment certificates pay, but by holding onto REITs, and particularly office REITs, investors are exposed to volatile unit prices. On Tuesday units of Dream Office REIT dropped 12.5 per cent after the company disclosed results of a unit buyback that showed many investors wanted to sell their positions – even though the unit buyback program was priced at roughly half of the REIT’s net asset value.

Investors are also at risk of having their distributions cut. Earlier this year, Slate Office REIT slashed its monthly distribution by 70 per cent, and True North Commercial REIT slashed its own by 50 per cent.

Allied, however, has long argued that its portfolio is quite different from those of most office building owners. Slate and True North, for instance, predominately own “class B” buildings that are either in suburban areas or are older buildings in downtown cores that need upgrades.

Allied typically owns office buildings with character – older brick buildings that look more like loft spaces on the inside and usually fall into the “class A” category. The buildings are also mostly located in the heart of downtown cores in cities such as Toronto and Montreal.

Yet Allied has also been developing a number of large properties, including The Well in Toronto, and such developments require a lot of cash. Until recently most of it was funded either with debt or by raising cash from selling new units to investors. However, equity sales are now off limits to most REITs because so many of their unit prices have slumped, and debt is now much more expensive because of higher interest rates.

Allied will use the proceeds of the data centre sales to pay down its existing debt, and to fund its continuing developments. In an interview Wednesday, executive chair Michael Emory said his near-term focus is to complete the projects that are already under way, including The Well and a property they are developing for Google in Kitchener-Waterloo. The developments are expected to be completed in the next two to three years.

Allied is also exploring ways to intensify its existing portfolio. Many of its low-rise properties could be reworked to house much larger towers. While it is tough to build new office buildings at the moment, multi-use properties are an option, he said, which could include a mix of office, retail and multi-family apartments.

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