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Asset Allocation : Hard Toronto Urban Reit Portfolio

Updated: Feb 4, 2022

We are more than halfway through 2021 and I have made some fairly large changes to the Hard Reit Portfolio that I posted about in January 2021.

This portfolio performed quite well with performance currently at +50% year to date. The return has been enhanced by 33% leverage.

I have made some significant changes to the design of the Hard Reit Portfolio

  1. Smartcenters Reit (SRU.UN) replaced with Dream Office Reit (D.UN)

  2. Gold and Silver replaced with Bitcoin

Introducing the new Portfolio:

Selling Smartcenters

I sold Smartcenters (SRU.UN) for $29.28/share vs an average cost of $17.79/share representing a 64.5% increase in the share price plus I collected an additional 10% in dividends for a total return of 74.5% in 12 months. This was an excellent contrarian investment made at a time when the retail sentiment was very negative during the beginning of the pandemic.

A few things impacted my decision to sell including:

The share price for SRU is approaching its fair value relative to its NAV and although I expect the stock to continue to rise and trade at a premium to NAV, both RioCan and Dream Office offer investors much larger value reversion potential with bigger discounts to net asset value. Smartcenters has maintained its dividend throughout the pandemic and offers a high 6% yield however it also has a high payout ratio at 89%.

Smartcenters had negative leasing spreads -8.8% in Q1 2021 vs. positive leasing spreads for both Riocan and Dream Office Reit.

Given the aggressive global central bank balance sheet/monetary expansion, I am very focused on selecting investments that are able to effectively absorb inflation. REITS absorb inflation through both rents and asset prices. I believe positive leasing spreads and cap rate compression help you identify which real estate investment trusts are able to absorb inflation effectively.

Leasing spreads measure the real estate portfolio's ability to charge higher rents on both lease renewals and new leases. Cap rates are a function of asset prices with compressing rates signaling asset price increases.

REITS outperform the S&P 500 in both moderate inflation (2.5% - 6.9%) and high inflation (7%+) environments.

I believe urban real estate will be able to absorb inflation through rental rate increases and asset values increases more effectively than suburban real estate due to land scarcity and land use density.

It is relatively easy to build a new retail development adjacent to the highway in the suburbs (Smartcenters) but hard to build a new office building in the financial district (Dream Office) or develop a mixed used development in the heart of Yonge and Eglington or Yonge and Sheppard (RioCan).

Dream Office reported on its Q2 earnings call that cap rates in downtown Toronto have not adjusted since the beginning of the pandemic. This means the valuation of downtown Toronto real estate has not been significantly impacted by a pandemic with complete shutdowns. This is a strong example of the durability of the downtown core.

Real Estate Value = Scarcity + Demand + Utility + Transferability

(Scarcity) Very limited supply of land in Toronto 630 km2 with an even smaller supply of prime locations

(Demand) Largest city in Canada, 2nd largest financial center in North America, Tech Hub, high immigration rates/high immigration targets, strong population growth, talented diverse labour force.

(Utility) Toronto Has High Land Use Density, Excellent Transportation Infrastructure, and 3 Million residents

(Transferability) Real estate investment trusts are liquid and have insignificant transaction costs

Buying Dream Office Reit

I posted about Dream Office Reit on May 24th, 2021 and purchased the stock for an average price of $21.75. I expect a few short-term catalysts (office reopening, share buy backs, positive leasing spreads) to propel this company towards its $29 net asset value and beyond. I am thankful for the opportunity to invest into the heart of the Toronto financial district at such a significant discount.

The consensus view right now is that the Office market will be weaker going forward with many employees/employers embracing work from home. This has created a contrarian investment opportunity in Dream Office Reit similar to the retail reit environment at the beginning of the pandemic.

My personal view is that high quality office space in prime downtown Toronto locations will always be in demand. The positive long term trends downtown Toronto Office Real Estate experienced for last 10 years will continue post-covid.

Dream Office Reit also holds a large investment in Dream Industrial Reit that has been very profitable on it's balance sheet. This means that about 37% of any investment in Dream Office is truly an investment in Dream Industrial Reit.

Real Estate Sector Diversification

Despite the Hard Toronto Urban REIT portfolio being heavily concentrated in two real estate businesses: Dream Office Reit and RioCan Reit, the portfolio has exposure to four different real estate sectors.

Retail - RioCan's amazing portfolio of prime retail locations

Residential - RioCan's robust development pipeline (RioCan Living Residential Division)

Office - Dream Office's financial district office building portfolio

Industrial - Dream Office's large investment in Dream Industrial that represents approximately 37% of the dream office market cap.

The Hard Toronto Urban REIT portfolio focuses on scarce, undervalued, high quality real estate assets in prime urban locations. It has exposure to four real estate sectors, offers a 4%+ yield, and has a 10% bitcoin kicker for extra inflation protection.

I will keep posting updates as the portfolio evolves. Thanks for reading.

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