Originally posted 18 August 2016
Update of Dream Office REIT
The below news article from Andrew Willis of The Globe and Mail signals the expectation that contrarian investment fund Slate Asset management will purchase a significant portion or all of its Alberta properties. Dream last year wrote down a very significant portion of its 45 properties. As the report records, two very different views on Alberta real estate are destined to converge as Dream exits the market and Slate takes a much longer view.
On 10 August, Dream Office REIT reported its second quarter earnings to 30 June 2016. This Ontario-based real estate investment trust owns or is part-owner of 45 properties in Alberta with a total of 561 tenants. As reported in the media, the REIT took write-downs of $675 million in the June ending quarter and $748 million for the first six months of their fiscal year. According to its Management Discussion and Analysis (MD&A) document, “the decline was mainly driven by the continued downward pressure on market rents in the Alberta region where it contracted by $4.29 per square foot from $18.45 per square foot to $14.16 per square foot.” In contrast to the Toronto marketplace where expiring leases of $22.26 are lower than current market rents of $24.2 per square foot, in Alberta expiring leases are $18.92 a square foot vs.market rates of $14.64.
What is most newsworthy are some of the reasons given by the company for its write-down. “Since July of 2014, the oil and gas industry has been beset by significant financial deterioration. Throughout 2016, economic conditions have remained the same or deteriorated. The combination of vacancy increasing to over 20%, reduced office workers and increased supply of new office buildings indicates that the recovery of demand for office space and increase in occupancy rates and rental rates may be delayed. As at June 30, 2016, the Trust noted a significant and prolonged deterioration in leasing volume as well as key operating metrics such as market rents, leasing costs and vacancy rates relative to the Trust’s expectations over the past six months. These observations are consistent with external data points as at June 30, 2016. Based on the continued challenges in the Alberta office sector, the Trust revisited all assumptions used in the discounted cash flow model in valuing the Alberta investment properties to reflect the continued slump.”
Before concluding that Dream Office REIT’s 45 per cent write-down implies similar valuations across the province, one must understand the nature of the REIT’s underlying portfolio. Dream Office REIT’s Alberta properties are mainly older, smaller Class B buildings in Calgary threatened by new product entering the market. A occupancy rate (going from 88.5 per cent to 84.2 per cent year over year) is another factor informing REIT valuations. It is fair to say that sentiment towards Alberta has waned due to persistently low oil prices and rising unemployment.
According to the MD&A key drivers in the valuation of office real estate include: changes in GDP, employment and unemployment rates, vacancy rates, interest rates, and performance and/or sentiments of the stock market and commercial real estate.
On 9 August, HR REIT reported its quarterly June results. This REIT took a decrease of $136 million from December 31, 2015 on the stated value of its Calgary office portfolio. According to its MD&A, since 31 December 2014, H&R has recorded a decline in value of $340 million. This amount is roughly 10 per cent of the value of its Calgary properties. The Trust’s largest tenant is Encana which leases the Bow Tower. Adjusted same-asset property operating income for the REIT in Alberta fell to $53.9 million from $58.3 on a quarterly basis to 30 June 2016. Year-over-year declines for the first six months were 4.7 per cent.