This High Quality 6.5% Yielding REIT Is A Good Investment Choice In 2018

| About: H & (HRUFF)

Summary

H&R REIT owns a portfolio of high-quality office, retail, industrial, and residential properties in North America.

The REIT has a healthy development pipeline with low debt ratio.

H&R currently trades at a price to AFFO multiple below the average of its Canadian peers.

Investment Thesis

H&R Real Estate Investment Trust (OTCPK:HRUFF) (TSX:HR.UN) owns a portfolio of high-quality office, retail, industrial, and residential properties in North America. It is the second largest REIT in Canada behind RioCan REIT (OTCPK:RIOCF) (TSX:REI.UN). The REIT has done an excellent job maintaining its occupancy ratio in the past two decades. In addition, it has also maintained an improving balance sheet. With a healthy development pipeline and an undervalued share price, I believe H&R Real Estate Investment Trust is a good investment choice for income investors.

Source: Company Presentation

Source: Company Website

Why H&R Real Estate Investment Trust is a Good REIT Investment Choice

I have listed six reasons why I believe H&R Real Estate Investment Trust is a good investment choice for income investors:

(1) High Occupancy Ratio and Long Lease Terms

A major reason I like H&R Real Estate Investment Trust is because the company has a very high occupancy ratio. In fact, in the past two decades, the company was able to maintain occupancy ratios above 95% even when there were two major recessions. The dip in 2015 and 2016 was due to the aftermath of Target's (TGT) retreat from Canadian market. Sears Canada's (NASDAQ:SRSC) recent decision to close its business is not expected to significantly impact its occupancy ratio as revenue from Sears Canada only accounts for about 0.4% of H&R Real Estate Investment Trust's total revenue.

Source: Company Presentation

In addition to H&R Real Estate Investment Trust's high occupancy ratio, I also like the fact that the REIT has a very long average remaining lease term to maturity of 9.2 years. This average remaining lease term is above the average of its Canadian peers. For example, Artis REIT's (OTCPK:ARESF) (TSX:AX.UN) average lease term of 4.2 years is five years lower than H&R Real Estate Investment Trust's terms (click here). In addition, H&R Real Estate Investment Trust's top 15 tenants have an average remaining lease term of 11.5 years as can be seen in the table below.

Source: Company Presentation

(2) Healthy Development Pipeline

What I like about H&R Real Estate Investment Trust is its healthy development pipeline. Below is the table of H&R Real Estate Investment Trust's development pipeline that I have summarized. Some items in the table are incomplete as H&R Real Estate Investment Trust did not disclose full detail on each project. Nevertheless, we have a glimpse of what the development pipeline looks like. H&R Real Estate Investment Trust's development pipeline will gradually contribute to its funds from operation ("FFO") in the next few years. For example, H&R Real Estate Investment Trust's Jackson project will begin to generate income in early 2018, and management expects that the income generated in the first year of operation will be about US$36.9 million or about C$0.16 per unit.

Name of Project

Description

Investment Capital

Progress

Jackson, Long Island City, NY

1871 luxury residential rental units; H&R expects to receive operating income of US $36.9 million in first year of operation

US$1.2 billion, H&R has 50% interest

Pre-Leasing: Late Nov. 2017, Occupancy Phase 1: Early 2018

Ambrosio, Austin, TX

370 multi-family units

US$52.8 million

Expected Completion in Q4 2017

River Landing, Miami, FL

420,000 sq. ft. of retail space, and 524 multi-family units

Mortgage Receivable outstanding of US$54.3 million

Occupancy in 2020

Bryan St., Dallas, TX

Redevelopment of a 93,000 sq. ft. of office space

Mortgage receivable outstanding of US$41.8 million

63% Pre-leased

Hercules, CA

38.4 acres of land, 172 multi-family units in Phase 1

Invested US$11.5 million at end of Q3 17. H&R has 31.7% interest

Construction begins in Q1 2018.

Koenig Project

5.0 acres of land, Phase 1: 391 multi-family units

Invested approx. US$5.3 million at the end of Q3 17.

Construction begins in mid-2018.

Source: Created by author, Company Report

(3) Balance Sheet Continues to Improve

H&R Real Estate Investment Trust's management has done an excellent job managing its debt. As can be seen from the graph below, its long-term debt to total assets has improved significantly from about 60% to about 40% at the end of the third quarter. With its recently announced strategic plan to dispose some properties, I expect this ratio to continue to decline.

Source: Created by author, Company Reports

Not only will the future dispositions help to reduce its debt, it will also help to improve its interest coverage. In its third quarter, H&R Real Estate Investment Trust's interest coverage ratio is 3.0x, an improvement from 2.4x back in 2013.

Source: Company Presentation

(4) Cost Savings from Interest Expense Expected in 2018

The two tables below show H&R Real Estate Investment Trust's mortgage ladder (top table) and debenture ladder (bottom table). As can be seen from the top table, the weighted average interest rate of its matured mortgage in 2018 is about 4.8%. At the current interest rate environment, the renewed mortgage rate will likely be at least below 4%. The same applies to some of H&R Real Estate Investment Trust's senior debentures whose terms are about to expire in 2018. For example, its Series E Senior Debentures which will expire on February 2, 2018, bears a contractual interest rate of 4.90%. This rate debenture can be renewed at an interest rate less than its current rate.

(5) A Good Track Record of Dividend Growth

H&R Real Estate Investment Trust currently pays a monthly distribution of C$0.115 per unit. At a trading price of C$21.36 per unit, its dividend is equivalent to a dividend yield of 6.5%. Its dividend yield currently only represents about 74.8% of its payout ratio based on its 2017 year-to-date funds from operations ("FFO"). Its monthly dividend has increased by 91.7% to C$0.115 per unit from C$0.06 per unit in 2010. Its most recent increase was back in December 2016 where the REIT increased it modestly by 2.2%. While I am slightly disappointed by the fact that the company did not announce a dividend increase this year, I can understand why management has announced its plan to dispose some properties which will bump up its payout ratio. I am confident that once the disposition is completed, with a healthy development pipeline and same property net operating income growth in 2018 and 2019, dividend increase will resume.

(6) Valuation at a Discount

H&R Real Estate Investment Trust currently trades at about 12.2x of its 2018 estimated adjusted funds from operations ("AFFO") as shown in the chart below. This value is below the average of its Canadian diversified REIT peers of 13.5x and significantly lower than Canadian REIT (OTC:CRXIF) (TSX:REF.UN). Its dividend yield of 6.5% is above the 6.3% average of its peers. Its price to net asset value ("NAV") ratio of 83% is significantly below its estimated NAV of C$25.40 per unit and lower than the 92% average of its peers. Given H&R Real Estate Investment Trust is currently only trading at C$21.36, its current unit price is very attractive.

Source: Created by author, Company Reports, TD Securities

Investor Takeaway

With both its price to AFFO and price to NAV below the average of its Canadian peers, H&R Real Estate Investment Trust continues to trade at a discount. Its 6.5% dividend yield remains attractive. In addition, the REIT has a healthy development pipeline that will contribute to its FFO in the next few years. I believe H&R Real Estate Investment Trust is a good investment choice for income investors in 2018.

Note: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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