An interesting financial gamble just commenced yesterday evening.
Dream Office REIT (TSX: D.UN) owns 28 properties (2 under construction), and currently about 63% of the square feet is lease-able in downtown Toronto. The consolidated portfolio is 80% occupied (84% with commitments), with the Toronto segment at 88%.
Just like other office REITs, D.UN’s unit prices have gotten killed over the past year for well-known reasons.
On D.UN’s balance sheet, their primary assets are $2.39 billion in investment properties, and about 26 million (effective) units of Dream Industrial REIT (TSX: DIR.UN) (fair market value: $383 million at March 31, 2023). There is also about $1.27 billion in debt. Some of the debt is secured with the DIR.UN equity. The net equity is $1.5 billion, and with 52.2 million diluted units outstanding, gives a net asset value of about $29/unit.
They announced they will be selling about half (12.5 million units) of their DIR.un for $14.20 a piece ($177.5 million gross) and then commence a SIB for 12.5 million of their own REIT (24% of diluted units outstanding) for $15.50/unit. This is $194 million gross.
A typical bought deal would cost about 4% of the gross, so D.UN is paying about $7 million for this transaction, plus another amount for the legal fees for the SIB, so let’s round it to a $200 million dollar transaction.
D.UN shot up from $12.61 to around $15.00 per unit today in response – clearly some arbitrage potential being priced in.
The $200 million dollar question is (and this applies to all of these office REITs) whether the $2.4 billion in properties on their balance sheet is actually worth $2.4 billion.
If so, Dream is trying to buy dollars for half-dollars.
If the properties are worth 71% of the stated value, then the proposition is break-even at best (not factoring in the leverage factor and lost income from the ownership of DIR.un).
If the properties are worth less than 71% of the stated value, then this is a value-destroying proposition.
Another interesting factoid is that Artis REIT (TSX: AX.UN) and related entity Sandpiper jointly own about 6.8 million units of Dream Office REIT. Will they tender?
This will be interesting to watch. I have no skin in the game here – in general, I am adverse to deeply leveraged entities in our existing macroeconomic environment.
“The $200 million dollar question is (and this applies to all of these office REITs) whether the $2.4 billion in properties on their balance sheet is actually worth $2.4 billion.”
The follow up question is “when?”. Office buildings have lives measured in many decades. Valuations vary dramatically over their natural lives. If Dream maintains the ability to hold for the long run, this is probably a good bet by them.
Think it’s also interesting that the parent Dream Unlimited (owns ~18.5 million units) intends to participate in the SIB, though the number of units tendered are to be determined. Not sure if that’s another sign of what the properties are worth.
Couple of things I noticed in the last 2-3 months (view from core Toronto downtown):
Something tells me that offices are going to be fine…
“Something tells me that offices are going to be fine”
I lean that way also. It’s fine to debate how efficient/inefficient WFH is or ought to be but we are about to see over the next 3 months to 2 years the real world impacts in company financials. Company A embracing WFH vs Company B not so much should begin to diverge in performance. If not, then WFH or not isn’t a big deal.
Personally, my career spanned 35 years, all in the private sector. I worked from home (efficiently I think) for some of it and in the office for most. I think COVID pushed us well past the maximum % of folks who can work from home without negatively impacting the important attributes of great companies (mentoring, cross-pollination, innovation, efficiency, etc.). We will probably shrink back towards more than pre-Covid but less than now.