Published by Nick McCullum on June 21st, 2017
Real estate investment trusts (REITs, for short) give investors a hands-off method to participate in the economic upside of owning and operating real assets.
REITs have grown in popularity over time as yield-starved investors seek alternative strategies to generate portfolio income.
On side effect of the growing popularity of REITs is the emergence of specialized REITs, focusing on only one subsector of the real estate industry.
Dream Office REIT (DRETF) is one example of this trend. As the largest pure-play office REIT in the Canadian market, this trust has a dominant position in the office property space.
At the security level, Dream makes a highly compelling investment proposition for high income investors. There are two reasons for this.
First, the company has a 7.8% dividend yield. This is more than four times as high as the average dividend yield in the S&P 500 and makes Dream one of the few companies with a 5%+ dividend yield.
The second reason why Dream is attractive is that its dividends are paid monthly. Monthly dividends are ideal for retirees and other investors that require stable, predictable income from their investment portfolio. There are very few companies that pay monthly, rather than quarterly, dividends.
Dream Office REIT’s high dividend yield and monthly dividend payments will catch the eye of high income investors.
However, some due diligence reveals that the trust recently cut its dividend and it is undergoing a seismic shift to its fundamental business.
This article will analyze the investment prospects of Dream Office REIT in detail.
Dream Office REIT is Canada’s largest pure-play office REIT. The trust has a market capitalization of $2.0 billion at current market prices. It is part of the Dream Unlimited family of real estate trusts, which also includes:
- Dream Industrial REIT (DIR.UN.TO)
- Dream Global REIT (DRG.UN.TO)
Dream Office REIT and Dream Global REIT share a Chief Executive Officer, P. Jane Gavan. Dream Industrial REIT has a separate Chief Executive named Brent Chapman.
Dream Office REIT trades on the Toronto Stock Exchange under the ticker D.UN and is listed in U.S.-based stock databases under the ticker D.UN.TO or sometimes DRETF.
Dream Office REIT’s Strategic Plan
At the beginning of 2016, Dream Office REIT announced a Strategic Plan that was expected to transform its business and return the trust to fundamental business growth.
The Plan’s announcement came at an opportune time, as the trust’s stock had languished for some time. The Strategic Plan’s announcement saw a noticeable stock price increase from below $16 to ~$20, circled in the diagram below.
For income investors, the key takeaway from this strategic plan was its dividend cut.
The trust had held its dividend steady for roughly a decade before a minor dividend increase in 2013. The Strategic Plan saw a decrease in Dream’s monthly dividend payment from $0.18666 to $0.1250 per unit (shown below).
Dream Office REIT’s Strategic Plan also contained a large asset divestiture plan which categorized the trust’s existing properties into three buckets: Core, Private Market, and Value-Add.
The Core assets are self-explanatory – assets that are essential to the trust’s strategy and financial success.
Private Market Assets are defined as “fairly liquid, but not strategic to the longer-term objectives of the trust”.
The Value-Add Assets are where Dream’s strategic plan begins to get interesting.
These assets, located primarily in Alberta (the ‘Canadian Texas’) and Yellowknife (the remote capital city of Canada’s Northwest Territories), are characterized as “requiring active asset management or the passage of time prior to improving their demand profile and/or liquidity in the Private Market.”
The goal of the trust’s Strategic Plan was to systematically increase the quality of Dream’s real estate portfolio while divesting non-core assets in order to shore up its balance sheet. More specifically:
“The Trust intends to advance the Strategic Plan until the Core Assets represent substantially all of the Trust’s portfolio, with the goal of stabilizing the business by 2019. The proeeds from dispositions will be targeted to making the balance sheet stronger, investing in our buildings and opportunistically repurchasing our units, until such time as we see more attractive investment opportunities in the marketplace to redeploy the capital.” – Dream Office REIT 2016 Annual Report, page 7
While Dream Office REIT’s Strategic Plan appears encouraging, many investors have found it hard to forgive the trust’s substantial dividend cut.
Certainly, there exist many other monthly dividend companies with superior track records of generating stable and growing dividend income. Realty Income (O) comes to mind.
The remainder of this article will discuss the trust’s growth prospects, competitive advantages, and valuation in more detail.
For the foreseeable future, the single largest influence on Dream Office REIT’s growth and financial performance will be the execution of the trust’s Strategic Plan.
Indeed, the company has already made significant headway on this initiative since it was announced in February of 2016.
At the time of the announcement, Dream Office REIT owned 166 properties totaling 23 million square feet of property with a portfolio occupancy of roughly 90%.
Today, the trust owns 106 properties totaling 15.4 million square feet.
Notice that the trust has divested from 36% of its properties (based on the number of properties owned) but only 33% of its total square footage. While this difference is small, it is significant because it suggests that Dream is selling smaller, non-core properties (as planned).
Dream’s business transformation can also be seen by looking at the company’s balance sheet.
In December of 2015 (the most recent financial reporting period at the time of the Strategic Plan’s announcement), the trust reported total assets of $7.3 billion and total debt of $3.5 billion with a weighted average interest rate of 4.1%.
As of March of 2017 (today’s most recent financial reporting period), Dream Office REIT has $5.1 billion of assets (a decrease of 30.1%) and total debt of $2.5 billion (a decrease of 28.5%).
The difference in changes between the trust’s assets and debt is likely due to the company earmarking some capital for share repurchases.
Investors should also note that Dream’s weighted average interest rate has ticked downwards slightly, to 3.8% from 4.1%.
Dream’s Strategic Plan calls for the divestiture of assets and the elimination of debt. While this might not be a significant contributor to growth in funds from operations (the REIT equivalent of earnings-per-share), it de-risks the trust’s business model and positions it for a future without additional dividend cuts.
Competitive Advantage & Recession Performance
Dream Office REIT’s competitive advantage comes from owning some of the most iconic real estate in the Canadian market.
These properties include:
- Scotia Plaza in Toronto (the headquarters of the Bank of Nova Scotia)
- State Street Financial Center in Toronto
- Adelaide Place in Toronto
- 5001 Yonge Street in Toronto (a major RBC hub)
- IBM Corporate Park in Calgary
- Station Tower in Surrey, B.C.
As an office REIT, Dream Office REIT is likely somewhat isolated from the effects of recessions. The company’s real estate (office centers) are in demand through all but the worst recessions.
With that said, Dream Office may feel a slight negative effect from the increasing number of workers electing to participate in the remote workplace economy. This is unlikely to have a meaningful effect on the REIT in the near-term.
Valuation & Expected Total Returns
Dream Office REIT’s future shareholder returns will be composed of its current dividend yield, valuation changes, and growth in its per-share funds from operations.
Dream Office REIT currently pays a monthly dividend of CAD$0.1250, equivalent to total annual dividend payments of CAD$1.50.
The company’s current stock price of CAD$19.14 is trading at a dividend yield of 7.8%. Investors should keep in mind that since Dream’s dividend payments are delivered in Canadian dollars, they are prone to fluctuations in the USD-CAD exchange rate.
To assess a REIT’s valuation, the traditional price-to-earnings ratio cannot be used because these real estate investment vehicles incur significant amortization and depreciation charges that artificially impair GAAP earnings-per-share.
Instead, alternative valuation metrics must be used. These include price-to-FFO, price-to-book, and price-to-NAV, among others.
However, the most practical valuation metric for REITs is to compare their current dividend yield to their long-term historical dividend yields.
Dream Office REIT’s current dividend yield of 7.8% is compared to its long-term average below.
Dream Office REIT’s current dividend yield is 7.8% and its average dividend yield since 2004 is 8.3%.
The trust’s dividend yield is actually lower than average, meaning that it may be moderately overvalued at current prices.
For high income investors, there are better alternatives in today’s market, although high-single-digit returns are possible based on Dream’s dividend yield alone.
Related: The 10 Best MLPs For High Income
Dream Office REIT’s exceptionally high dividend yield and monthly dividend payments make it very appealing at the security level.
However, some due diligence reveals that the trust recently experienced a dividend cut (which would trigger an automatic sell using The 8 Rules of Dividend Investing) and also is trading at a lower dividend yield than its historical average.