I’ve been watching SmartCentres REIT (OTCPK:CWYUF) for about two years as the REIT was a good buy just as the COVID pandemic drove the stock price higher less than just C$21/share. The REIT’s share price has hovered around C$30 for almost a year now, but recently fell below C$29 due to rising interest rates, causing REIT investors to reduce their positions. I think the REIT is still quite attractively priced at current levels. Walmart is the largest tenant, occupying nearly 41% of gross leasable area and accounting for just over 25% of gross rental income.
As you can see above, there are a lot of Tier 1 names in the list of tenants, but having Walmart as the anchor tenant is what got me so interested in SmartCentres REIT. Not only does this provide a reliable revenue stream from a Tier 1 tenant, but I was also attracted to SmartCentres’ development pipeline, which includes residential unit development.
SmartCentres has its primary listing on the Toronto Stock Exchange, where it trades with SRU (or in some cases SRU-UN or SRU.UN) as its ticker symbol. Average daily volume exceeds 300,000 shares and the current market capitalization is just under C$5 billion. I will be using the Canadian dollar as my base currency throughout this article, as SmartCentres reports all of its financial results in CAD.
The REIT continues to post strong results in the first quarter of the year
In the first quarter of this year, SmartCentres was able to increase its net rental income by almost 4%, as the REIT saw its revenues increase from C$199 million to C$202.5 million while operating costs of the building decreased slightly.
Looking at the breakdown of rental income received, we see the gross base rent increase by approximately 2.5%, but we also see the depreciation expense related to tenant incentives decrease by a few hundred thousand Canadian dollars, which which helped increase net base rent by approximately 4%.
You can also clearly see that the REIT was able to recover approximately C$0.6 million in additional operating expenses in the first quarter of 2022 compared to the same quarter of the previous year and the combination of this net income plus high and slightly lower operating expenses boosted net rental income.
Thanks to this strong performance, SmartCentres was able to increase its FFO by approximately 10%, to CA$93.2 million on an adjusted basis (the adjustment of CA$0.9 million is related to COVID-19 vaccination centers) which had a slightly negative but (hopefully!) non-recurring impact on the FFO result.
SmartCentres REIT does not publish an official AFFO, but adheres to Canadian Accounting Principles for Real Estate Investment Trusts and provides an ACFO: Adjusted Operating Cash Flow. And as you can see below, the ACFO hit almost exactly C$86 million on an adjusted basis.
The FFO and ACFO per unit were C$0.52 and C$0.48, respectively. This means that the current payout rate is still fully covered by FFO and ACFO, as the monthly dividend currently stands at CA$0.15417 per share (for an annualized dividend of CA$1.85). While it is commendable that SmartCentres continues to provide a healthy return to its investors, we must remember that the REIT is in full development mode and will need more cash to fund this pipeline. And SmartCentres looks beyond commercial real estate.
The development pipeline still seems robust
So, if the ACFO-based payout ratio is in the mid-90s, how will SmartCentres be able to fund the completion of its development pipeline. The answer should probably be found in the mix of the development pipeline, containing projects in the “complete to own” and “complete to sell” categories. Take a look below at SmartVMC (Condos), number 3 in the preview.
Within the next two years, Transit City 4 and 5, in which SmartCentres has a 25% stake, are expected to be completed and ready for sale. As you can see, the required contribution from SmartCentres is approximately C$104 million with an expected profit margin of 20-25%, which means that SmartCentres will likely make a profit on these development investments.
But more important than making that profit is the ability to “recycle” capital. If the buildings are actually sold in 2023 (the only question is the actual delivery date, as the assets have already been pre-sold. SRU does NOT need to find a buyer), SmartCentres can immediately reinvest the $125-130 million Canadians. in the capital elsewhere. For example, in the Artwalk project which will require C$192 million in capital and is expected to generate similar profit margins when this project is completed in 2025-2026.
Yes, there will definitely be spikes in debt levels and working capital required to complete the development pipeline, but it comes and goes and as SmartCentres has a fairly comprehensive pipeline, it will always be able to recycle capital from one project to another while the “build to own” projects will further increase the ACFO and reduce the distribution rate. This year, for example, the 238-unit Mascouche Nord apartment building should be completed. It was a C$72 million development and SmartCentres contributed approximately C$57 million, as it has an 80% stake in the development. The estimated rental yield on this project is 4.5-5% and even if I applied the lower end of that range, the net rental income will increase by C$2.5 million per year. This will be followed by a further increase in net rental income of CA$1.25 million in 2023 when the Mirabel development is ready.
Thus, these two short-term apartment development projects require very little capital to complete, but will immediately increase ACFO per share by 1% or C$0.02 per year and allow SmartCentres to retain more money if it doesn’t increase the dividend.
And speaking of the development of Mirabel, the image above shows how this development is only the very first phase of the densification planned by SmartCentres. This Phase 1 building is likely just the very first step towards developing the entire land with a combination of residential, commercial and hotel assets.
SmartCentres is aggressive. Maybe a little too aggressive for my liking, but as the REIT is achieving its goals, I certainly shouldn’t complain (as long as the financial puzzle continues to match). The REIT has an impressive land reserve ready to be developed, and I like the diversification approach to slowly reduce the contribution of commercial real estate in the portfolio.
The current dividend yield is around 6.4% and is fully covered by the ACFO (although barely). More capital will be needed to complete all development projects, but with a relatively low debt ratio of 42.5%, SRU should have plenty of financial flexibility to use debt to finance the completion of development projects. while recycling the money invested in “build to sell”. projects.