Growth-by-acquisition strategy can come with drawbacks for REITS, RBC report shows

As expected there are a lot of gems in the recently published 377-page report by RBC Capital Markets on the sector outlook for REITs, a group with a market capitalization of about $75 billion.

One of the more interesting observations — in what is the bank’s 80th such quarterly outlook — was that 2018 will be a busy year for asset dispositions: $5.4 billion of “intended or announced property dispositions” are expected to be completed in this year and beyond.

To put that number, which has risen for four years in a row, in perspective: there were only $2.4 billion of such dispositions in 2015; $3.7 billion in 2016; and $5.3 billion last year. (According to CBRE, there were about $40 billion of commercial property transactions last year.)

Based on what’s happened already, we are more than 20 per cent of the way to that 2018 estimate, in part because some of the “grander plans” announced by three REITs have already been achieved.

Downgrade

Cominar REIT, which had a year to forget with a credit rating downgrade (the first for the sector) and a cut in distributions, has already made good on its plan, announced last August, to divest $1.2 billion of non-core assets, via the recent sale to Slate Acquisitions. It plans to sell another $1 billion – $1.5 billion of properties.

But there’s more to come given that RioCan REIT wants to sell $2 billion of smaller market properties by 2020, while H&R REIT has announced plans to sell 91 properties valued at US$895 million.

The RBC report gives another perspective to asset dispositions: over the period 2004-2007, or three years before the global financial crisis, the levels were low with just one REIT, Dream Office, engaged in any major sales. Over those years, REITs sold $3.118 billion of properties, of which Dream accounted for $2.375 billion.

But over the 2014 to 2017 period, almost $10 billion of assets were sold. As with the prior period, the recent numbers are skewed by DREAM’s activity: after its re-entry to the REIT world, it has now made $3.415 billion of dispositions with another $100 million targeted.

As for the reasons for the increase, the report posits that it’s related to “normal-course portfolio pruning and capital recycling,” a “heightened” focus on core markets and properties and “a path to correcting past strategy missteps.”

In this way, the report said it sees capital recycling via non-core asset sales as “a means towards achieving the goal of continuous quality improvement. As capital is a precious resource, we also believe the process instills asset-management discipline.”

It may be precious but it seems that it’s always available. All the properties that are now targeted for sale were financed, often with a healthy does of equity, by investors who were generally told that the acquisitions were accretive.

Growth-by-acquisition programs

As for the missteps, RBC said generally they were rooted in “very aggressive growth-by-acquisition programs through which we believe the affected enterprises aggregated assets on a non-strategic basis, and/or in conjunction with higher financial leverage.”

For those cases where the REIT is managed externally often there are incentives (the receipt of fees) for doing transactions — all of which can encourage growth by acquisition.

It’s worth noting that three REITs now planning the largest asset dispositions — Cominar, H&R and RioCan — have all underperformed the S&P composite real estate sector index on a total return basis over the past seven years. In Cominar’s case, the return has been negative over the period.

The report makes SmartCentres REIT its top pick. In 2017, the REIT posted a 1.13 per cent total return.

Financial Post

bcritchley@nationalpost.com

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