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A Royal Bank of Canada (RBC) sign is seen in downtown Toronto.MARK BLINCH/Reuters

The debate over the break fee that Primaris Retail Real Estate Investment Trust agreed to pay H&R REIT as part of their takeover deal is heating up, with an RBC Dominion Securities analyst joining the chorus of critics, saying he is dubious of the size, makeup and stated rationale or the fee.

In a note entitled "the Anatomy of a Break Fee," analyst Neil Downey of RBC analyzed recent transactions and found that the fee of 3.8 per cent is higher than the average 2.9 per cent in 10 recent real estate merger deals. He said many investors he's talking to are not impressed with the size of the fee, especially considering the slim premium in the H&R offer over what was already on the table from hostile bidder KingSett Capital.

Moreover, he was critical of the hybrid nature of the fee, which includes cash and an option to buy two properties at a discount. H&R has argued it wanted something to do with the cash, rather than leaving it sitting on the balance sheet, so it sought the option as a use for the capital.

Mr. Downey is doubtful.

"H&R inferred that the receipt of a large cash break fee might somehow be dilutive to FFO/unit [funds from operations per unit]. We do not entirely understand this comment." In fact, he said that the contrary would likely be true should H&R take all cash as a break fee, as it would add to net asset value and be neutral to FFO/unit.

Mr. Downey suggested another explanation. He said he believes were "strategically selected to be a deterrent" to KingSett Capital. Primaris has argued that the two properties, a mall near downtown Toronto and a package of development properties on Yonge Street, are not key assets.

Mr. Downey isn't buying that, saying that he believes the mall is one of the key assets sought by RioCan REIT, one of the partners supporting KingSett, while KingSett wanted the Yonge Street parcels.

He also isn't sure on the valuation of the option to buy the properties at a discount. Primaris based the stated $37-million value of the option on the appraised value of the properties. But Mr. Downey argues that real estate has been rising, and the appraised values of properties may be a trailing indicator.

Because there is a lot of leverage inherent in the valuation of any option, any understatement of the overall value of the assets would dramatically be magnified in the value of the option. And that would vastly understate the size of the break fee.

His math works like this:

- If the valuation of the assets is 10 per cent too low, that adds $27-million to the value of the assets.

-That, in turn, adds much more to the value of the option. The economic value of the option jumps by 70 per cent beyond the $37-million value.

-That increases the value of the overall break fee package (consisting of $70-million in cash plus the option value) by 25 per cent.

-That would put the value of the break fee at 4.8 per cent of the equity value of the H&R offer, up from the 3.8 per cent it is currently at based on the stated value of the fee.

(Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)