Marvin Samuel Tolentino Pineda/iStock Editorial via Getty Images
Please note all $ figures in $CAD, not $USD, unless otherwise stated.
Introduction
Choice Properties REIT (TSX:CHP.UN:CA) is a real estate investment trust that focuses on large, retail properties for major tenants. In the most recent quarter, the REIT reported a strong Q2'24 that came in line with expectations. While the year is shaping up nicely for Choice Properties REIT and the company is certainly a high quality name, I think the valuation is a bit too high right now which is why I'm avoiding buying shares.
Overview
Choice Properties REIT is a real estate investment trust that specializes retail and properties across Canada. The company also has some industrial and residential exposure, but it’s comparatively small to the retail exposure (77% retail, 19% industrial, and 4% mixed-use and residential). About 46% of NOI is generated from Ontario, the REIT’s largest market, but it also has a presence in Alberta (19%), Quebec (12%), BC (10%), and the rest of the Canadian provinces.
Choice Properties REIT focuses primarily on retail properties, including supermarket-anchored shopping centers. Many of its tenants are high quality tenants with multiple locations. At quarter end, the REIT had a 98% occupancy ratio and 65.9 million square feet of income producing properties across 702 locations worth over $16 billion.
Investor Presentation
Historically, Choice Properties REIT has been a solid performer, outperforming the rest of the REIT market in Canada. Looking at the company’s performance since IPO, the REIT has delivered an annualized return of 8.5% compared to the REIT index of 4.3%. While that’s lower than the overall market’s return (S&P500) over the same period, the REIT has been a great place for investors to rely on consistent distributions and dividends. Since the IPO, it's never missed a payment, having raised it in each of 2017, 2023, and 2024. The current payout ratio of 88.8% of AFFO looks strong enough to cover the company's 5.5% dividend yield.
One of the reasons to invest in Choice Properties REIT is for its high quality tenant base. This generally includes strong, necessity-based retail anchor tenants who stay in those locations for the long-term. After all, how often do you see your local grocery store switch locations just to save a few bucks on rent?
Choice Properties has some of the largest retail companies in Canada as its long time tenants. This includes companies like Loblaw (L:CA), Canadian Tire (CTC.A:CA), TJX Companies (TJX), and Dollarama (DOL:CA). Most notably is Loblaw, who makes up over half of the company’s rental revenue (57%). As I mentioned in my article on Slate Grocery REIT (SGR.UN:CA), there are several reasons why grocery REITs are attractive. This includes long-term leases, necessity of real estate, low turnover and historically strong performance relative to the rest of retail real estate.
Q2’24 Results
When looking at the latest Q2’24 results for Choice Properties REIT, FFO for the quarter clocked in at $0.255 which was down 1.5% quarter over quarter but up 0.4% compared to last year. On a same-asset NOI cash basis, Q2’24 came in at $241.7 million, 1.9% higher sequentially over last quarter and 4.4%compared to last year. Leverage also fell compared to last year’s quarter, down 0.4 turns to 6.9x.
Company Filings
Overall, I’d say these were pretty solid results for the quarter, despite not much price action in the stock post-Q2 announcement. FFO/unit of $0.255 seemed to be in line with estimates, with a few unusual items offsetting each other to get there. This included $1.2 million in LTF income, $1.7 million BDE reversal, and $3.3 million restructuring costs due to the REIT outsourcing of property accounting).
Adjusting for last year's LTF income, FFO/unit increased 5.7% on a year over year basis. Same property NOI growth (ex-BDE) climbed 3.7%.
In terms of some key highlights, post-Q2’24, Loblaw renewed 46 (3.1 million square feet) of a tranche of 48 Loblaw leases expiring in 2025 (including one industrial lease) for a weighted average term of 5.0 years, continuing the theme of high-quality tenants who look to stay long-term. Choice Properties REIT achieved an 8.4% renewal spread on the leases versus 7.5% for the 2024 Loblaw renewals due to a more favorable geographic mix. The two leases not renewed include a property held for redevelopment in B.C. and a property expected to be sold, so in my view, we can infer this wasn’t on Loblaw for why they didn’t want to renew.
While the REIT generally holds its properties for the long-run, Choice Properties REIT is continuously acquiring and selling to optimize the portfolio and create value for unitholders. During the quarter, the REIT acquired the remaining 50% ownership interest in a 102k square feet retail property in Alberta for $21.1 million. It also acquired a 13.3k square feet retail property in Toronto for $12.0 million and subsequently leased the property to Loblaw. To me, this highlights the strong partnership relationship between Choice Properties and its major tenants, ensuring strategic alignment in property acquisition and management. In terms of selling assets, Choice Properties also sold 4 retail properties for $80.4 million, where consideration included vendor take-back mortgages totaling $11.1 million at 6.81%.
From a balance sheet perspective, Debt to EBITDA net of cash was steady at 6.9x as was total liquidity at $1.5 billion. Choice Properties REIT is earning a 5.5% yield on the proceeds (invested in a GIC) from its recently issued 5.03% $500 million Series U debenture, which will eventually be used to repay most of its 3.56% $550 million Series K debenture in September (source: Bloomberg). Given that its cost of borrowing is essentially at GIC rates, bond holders look at Choice as having a very strong balance sheet and good credit metrics.
It also completed $243 million of mortgage financings (at share) on three industrial properties at 5.309% and assumed $45.2 million of mortgages from a partner (3.407%). According to Bloomberg, S&P upgraded Choice Properties REIT from BBB to BBB+, which highlights an improving credit profile. When looking at the company’s maturity profile, we can see that maturities are long and laddered, with about 50% beyond 2029.
Investor Presentation
Typically, Choice Properties REIT likes to match its lease term to its debt. At quarter end. The average lease term was 5.8 years and weighted average term to maturity on debt was 6.0 years. Given the number of bankruptcies in the REIT sector, it’s important for REITs like Choice Properties REIT to manage their lease terms and debt maturity carefully. Matching the lease term to the debt maturity helps in managing financial obligations effectively, particularly when it comes to refinancing debt or renegotiating leases in the future. With an average cost of debt of 4.12%, the REIT has a very low cost of capital so it can access debt capital markets at cheap rates.
In terms of the outlook for Choice Properties REIT, management expects a modest decline in occupancy for the balance of the year, from anticipated vacancies. Same property NOI growth is expected of 2.5% to 3% and FY’24 FFO is projected to be in the range of $1.02 to $1.03. The REIT is also targeting Adjusted Debt to EBITDAFV below 7.5x in its guidance to investors.
In my view, I think Choice Properties has a good chance to hit this guidance as evidenced by consistently meeting or exceeding EPS guidance since 2020. I wouldn’t be surprised to see low single digit same property NOI over the next few years, particularly as significant embedded growth through with the average in place rent per square foot at $9.32 compared to the market average rent of $15.95. In markets like Vancouver and Toronto, that gap can be sometimes double in market rents versus in-place rents. As that gap closes as leases mature, I believe Choice Properties REIT should be able to increase NOI faster than inflation in the medium term.
In terms of the risks to the investment thesis, company-specific risks include high tenant concentration and credit exposure to Loblaw, interest rate risk on debt refinancing; potential non-renewals of leases by Loblaw upon lease expiries, and a potential inability to achieve economically viable rents (including anticipated increases in rents). Other more general risks include the potential for an unanticipated increase in interest rates.
Valuation and Wrap Up
Based on the 8 sellside analysts who cover the stock, there are 6 'buy' ratings and 2 'hold' ratings on Choice Properties REIT with an average price target of $15.00. From the current price to the average price target one year out, this implies approximately 8.3% upside, not including the 5.5% dividend yield. With 13.8% total return potential over the next year, analysts are moderately bullish on Choice Properties REIT's near-term outlook.
Seeking Alpha
To value REITs, my preferred method is to use P/FFO and P/AFFO as they provide a clearer picture of the REIT's operational cash flow and distribution potential. Comparing Choice Properties REIT's valuation to the rest of the Canadian retail REIT space, the company trades at 13x P/FFO and 12x P/FFO on a forward basis. On AFFO, the company's trailing twelve month and forward multiples are 15x and 14x, respectively (source: S&P Capital IQ).
Author, based on data from S&P Capital IQ
Compared to the peer group, these are 3-turns higher on a current basis and 2-turns higher than the peer group on a forward basis. While Choice Properties REIT has slightly lower debt (shown below through low LTV and D/EV), the REIT has a lower dividend yield despite the same AFFO payout ratio as the group. Given this, I'd say that shares of Choice Properties REIT look expensive on relative valuation.
If I were considering a Canadian retail REIT today, my preference would be Slate Grocery REIT. I find SGR to be more attractive given a dividend nearly twice the size and at a significant discount to the peer group. While investors have to contend with slightly more elevated debt, I'm willing to trade Choice for SGR because their maturities and tenant profiles are so similar. Like Choice Properties, SGR has grocery anchored tenants as well, so I don't find there to be a whole lot of difference in quality to justify the valuation gap. As such, with a preference for SGR, I rate shares of Choice Properties REIT as a 'hold' and would consider added if the valuation became more in line peers in the space.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
