Toronto-based H&R is a diversified real estate investment trust, owning everything from industrial properties to apartment buildings, but with a heavy weighting toward office towers - such as the Bow in Calgary - and enclosed malls. The REIT’s market performance has suffered more than many of its peers’ since the pandemic erupted, with its units currently trading at a 30-per-cent to 35-per-cent discount to their net asset value.
To fix this, the company is considering a wholesale change that could narrow its focus, so that investors can better appreciate what its owns. Apartment buildings, for instance, are trading at record values in private markets, but H&R’s may be overlooked because its mall portfolio is too distracting.
Management “will advance opportunities to simplify its business, including the potential for the creation of new public entities with more narrowly defined mandates consistent with investor preferences, which could also result in a more narrowly focused H&R REIT,” the company wrote in its latest annual letter to unitholders.
H&R isn’t saying much else about its plans, but the expectation is that it will spin out individual sectors into their own public companies. If so, it could result in a round trip of sorts for the REIT’s mall division, which was acquired by winning a nearly $3-billion takeover battle for publicly-traded Primaris Retail REIT in 2013.
H&R did not return a request for comment.
The structure of any spinout is to be determined, but it could result in existing unitholders getting new units in any new standalone division. H&R could also take a unit public, selling some of it to new investors while also retaining a stake. The benefit would be that it makes the holdings of each company easier to discern, but it could also hurt some divisions whose troubles are somewhat masked by other types of properties at the moment.
“While the opportunity to unlock value in the smaller industrial and residential segments is abundantly clear, the outlook for a smaller-cap retail and office standalone [company] with a potentially lower level of liquidity remains to be seen,” CIBC World Markets Dean Wilkinson wrote in a research note to clients.
In H&R’s current structure, office and retail comprised 48 per cent and 29 per cent of the REIT’s net operating income last year, respectively, but they are also the sectors real estate investors are most worried about. At the moment, most office towers are sitting empty, or close to it, because white-collar workers are largely working from home, while retail is suffering from continuing shutdowns. Complicating matters, many malls were losing value before COVID-19 hit.
Retail-focused REITs have been cutting their distributions lately, with both RioCan REIT and First Capital REIT slashing theirs in January. H&R was ahead of the curve and cut its own by 50 per cent last May.
H&R has been diversifying over the past few years by building a residential property division, which now comprises 21 per cent of the REIT’s asset value, according to BMO Nesbitt Burns. However, one of its most promising assets, the Jackson Park development in Long Island City across the East River from Manhattan, is currently sitting at 60-per-cent occupancy, partly because many foreign students did not return to New York when the new academic year started in September.
Despite the current woes, BMO analyst Jenny Ma called H&R’s units “unjustifiably cheap” in a note to clients, adding that she is encouraged by management’s commitment to changing the status quo in a bid to drive the unit price higher.
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