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Dream Office Reit : High Quality Value, Short Term Catalysts



Dream office is a high-quality real estate investment trust focused on AA office buildings in downtown Toronto, primarily in the financial district. The financial district is the heart of Canada’s finance and banking industries and includes Union Station, multiple subway stops and the PATH underground network (30KM of underground walkways and 1200 shops.)


This location is the bullseye in the centre of Canada’s largest city and provides Dream Office REIT with a durable competitive advantage and defensive moat over alternative office space outside the downtown core.

Development height restriction info: https://dailyhive.com/toronto/downtown-toronto-tall-buildings-ban


Dream Office REIT has been going through a strategic transformational process from 2016 – 2021 selling properties that are not located in the Toronto downtown core and using the proceeds to buyback shares of the business.


This plan has resulted in the company becoming leaner and meaner with a portfolio of higher quality assets that attract higher quality tenants, premium rents and better capitalization rates. The share buybacks have been consistent and significant, reducing the share float from 114 Million shares in 2016 down to 55.9 Million shares in 2021. The company also has plans to initiate a normal course issuer bid in August 2021 to buy back up to an additional 10% of shares for 2021. Michael Cooper, CEO has indicated the company intends to continue to buyback shares as they are at a significant discount to NAV.


The strategic transformational process has also resulted in a consistent increase to the net asset value of each share over the last five years. Just prior to COVID in 2019 the price of Dream Office was trading at a premium to NAV as the market was recognizing the strategic transformation and improved business model.


At one point, Dream Office traded at $35 a share implying a 31% premium to the Net Asset Value for 2019. I believe, in the near future, the market will recognize this value again and Dream Office will trade at a premium to its net asset value. We will likely see this repricing occur once we are on the other side of vaccinations, the covid impact starts to dissipate and market sentiment towards office real estate improves.


The strategic transformation has resulted in a steady increase to the average rent/sqft Dream Office REIT reports. This is because a higher concentration in downtown properties generates a higher average rent/sqft and is evidence of the stronger business model.



Office Rental Rates/SQFT for Downtown Toronto AA office space have increased dramatically from 2013-2021 going from $26/SQFT to $35/SQFT. Dream Office’s current average in place rent is $26/SQFT which results in significant upside as leases renew and the rents are marked to market. Dream Office estimates the current market rent conservatively at $31.23 which generates a 20% renewal spread premium for downtown office lease renewals.


The rental rates in the non-core portfolio have declined and current market rents are 15% below current rents. When you combine +20% Toronto renewal spread premium relative to its share of the portfolio and the -15% decline in non-core portfolio it results in an 8% overall lease renewal spread premium. As the trust continues to execute its transformational plan it may reduce the impact of the non-core portfolio through further liquidation. These positive lease renewal spreads will continue to increase revenues consistently over the next five years as the leases are renewed and provides a built-in growth engine.




The downtown buildings are also currently valued at $613/SQFT, however, comparable properties in the downtown core are selling between $900-$1000+/SQFT. $900/$613 = 46% Undervalued

During COVID and the pandemic lockdowns Dream Office has reliably collected the majority (97.7%) of the office rent through the pandemic and boasts a five-year weighted average lease term. The tenant profile consists primarily of professional services/management, finance and insurance, and government agencies.


Source: Dream Office REIT Q1 2021 Quarterly Report


Dream Office also has a significant investment in Dream Industrial REIT worth approximately $372 million dollars and representing 30% of the value of Dream Office REIT. This investment has been very profitable for Dream Office REIT and has benefited from the strong e-commerce trends supporting the industrial real estate market. This investment also generates dividends at a current yield of 5%.


Dream Office is led by CEO/Chairman, Michael Cooper, who is the founder of Dream Asset Management, Dynamic Real Estate Fund and Dundee Real Estate Asset Management. He has been the head of 7 different public real estate companies and is a hall of fame worthy Canadian real estate entrepreneur. Previously I invested in Dream Global REIT, also founded by Michael Cooper, for years until it was acquired by Blackstone in 2019 at a premium. His experience, leadership, strategy and financial commitment (33% Ownership) to dream office inspires me with confidence in the company.


Dream Office : Quick Summary

Financial Snapshot

· $21.75 Share Price | $28.73 Net Asset Value (32% Undervalued)

· 4.6% Dividend Yield | 65% Payout Ratio (healthy/safe dividend)

· 5.0 year weighted average lease term

· 3.54% weighted average interest rate | 3.1 Interest Coverage Ratio

· 41.2% Net Debt to Net Assets

· 33% Owned by Dream Unlimited + Company Insiders (management aligned with shareholders)

· 10% Owned by Sandpiper (REIT value/activist fund)

High Quality Office Portfolio – Toronto Focused

· 30 Properties, 5.2M SQFT Gross leaseable area (3.4 million SQFT is in downtown Toronto)

· 87.2% occupancy overall (93.9% occupancy in downtown Toronto)

· 2.9 Billion total assets (2.1 billion in downtown Toronto)

· 97.7% Rent Collection

Valuation Net Asset Value vs. Share Price

Share Price $21.75 vs NAV per Unit $28.73 = 32% Undervalued

Price / FFO $21.75 / $1.54 (2020) = 14.1 P/FFO This 14.1 Price/FFO ratio is attractive despite being based on 2020 covid earnings. FFO Yield – 7.07% This is indicating an earnings yield of 7% which provides for the 4.5% Dividend Yield. The company has been spending the remaining earnings on share buy backs. This FFO Yield should increase as transient parking revenue return, positive leasing spreads generate new revenues and occupancies improve post-covid. I believe this FFO yield will continue to grow and eventually be 10-11%+ on the book cost of an investment made at today’s share price. Fundamental Trends are Strong

· Toronto is forecasted for strong employment and population growth

· In 2019 30% of all international immigrants to Canada à Toronto

· Pre-Covid Downtown Toronto Average $/SQFT Class A Office Rent have been increasing and vacancy rates were decreasing since 2013.

· Toronto Condo sales have spiked in 2021 as investors and end-users plan to get back into the city.

· Traffic trends in New York and Toronto have shown car usage recoveries to be stronger than public transit. New York has fully recovered to pre-covid vehicle traffic. This is a good sign for Parking Revenues as Toronto recovers. Commuters may be willing to pay a parking premium to avoid public transit.


Conclusion


Dream Office REIT is a significantly undervalued super bond with a 7% FFO Yield that will increase over time. The business has almost completed its transformation into a Toronto downtown core REIT and will benefit from positive leasing spreads, a return to normal occupancy levels, lower interest rates, the return of transient parking revenues and the continued liquidation of weaker non-core assets.


Management is very experienced, aligned with shareholders and have proven themselves with the successful execution of the transformation strategy. The 4.5% dividend yield rewards shareholders with cash while the remaining 2.5% of earnings yield is used towards share buybacks. The 2021 share buybacks targeted to commence in August for up to 10% of the current shareholders float combined with a successful vaccination implementation and an office reopening in the fall offer many short-term catalysts for this deep value investment.

I have taken a 32% long position in my portfolio and encourage all investors to do their own due diligence before any investment and remind readers that I am not an investment professional. Good luck to all and thanks for reading.



Breakdown of Dream Office Data (my comments in yellow)


Fundamental / Market Data


Source: Q1 2021 Investor Presentation, Dream Office. Data: cbre

Rent per square foot has remained elevated despite the increase in vacancies due to covid. Prior to covid vacancies had been declining since 2015 with rent per square foot increasing since 2010.


Source: cbre

Cap Rates for Office Downtown AA & A have been compressing since 2009 and are currently in the 4.25-4.5% range.



Source Q1 2021 Investor Presentation, Dream Office. Data: cbre



Source: cbre


Disclaimer: This article should not be taken as legal investing advice, I am wrong 100% of the time. The choice is yours whether to invest in any asset or not (Do your own research).


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