Analysis of Canadian REITs: Allied Properties vs SmartCentres

In the dynamic landscape of Canadian Real Estate Investment Trusts (REITs), two firms – Allied Properties vs SmartCentres – have drawn significant investor attention. Allied Properties, with its unique portfolio of urban workspaces including many “brick and beam” buildings in major cities, is seen as a purveyor of creativity and connectivity. On the other hand, SmartCentres, with its robust retail portfolio, has over 180 properties across the vast expanse of Canada, many of them featuring a Walmart as an anchor store. These two REITs are different in their offerings but both present attractive investment opportunities in unique ways.

This post will compare Allied Properties to SmartCentres to shed light on which might be a better investment.

The challenge lies in comprehending the valuation and future growth potential of these entities. A financial comparison reveals Allied Properties to be more favourably valued at present, with lower leverage and payout ratios coupled with a higher yield. However, a sense of bearish sentiment around office space tempers this initial analysis.

Understanding the redevelopment potential of these REITs is also crucial to envisioning their growth trajectory. SmartCentres has an edge over Allied Properties due to its expansive land footprint and capability to convert its existing properties to higher density uses. Yet, the strategic locations of Allied Properties in the urban cores bring their own advantage.

One of the fundamental considerations that investors must factor into their analysis is the future of interest rates. As REITs typically carry some level of debt, changes in interest rates could significantly impact the cost of this debt and the overall value of the trust.

Both entities also grapple with existential threats, such as the trend towards working from home affecting Allied Properties and the rise of e-commerce impacting SmartCentres. In this evolving scenario, deciding on the superior investment between Allied Properties and SmartCentres hinges on an individual’s investment goals and risk tolerance, as well as their perspective on the future of office work and retail spaces.

Join us as we delve into these aspects and more, offering insights and perspectives to help you navigate the complex world of REITs.

Allied Properties Real Estate Investment Trust

Allied Properties holds a leading portfolio of unique urban workspaces in major Canadian cities. The company offers unique office environments including many in historic “brick and beam” buildings. Allied’s office portfolio is focused on the highest-grade urban core offices.

SmartCentres Real Estate Investment Trust

SmartCentres holds a diverse retail portfolio that spans Canada including over 180 properties sitting on more than 3,500 acres of land. Many of SmartCentres properties are anchored by a Walmart. The company is actively diversifying its portfolio to include more work-live spaces including residential developments.

Financial Comparison

	Allied Properties	SmartCentres
Leverage Ratio*	55%	73%
AFFO Yield	9.93%	7.74%
AFFO Payout Ratio	84%	98%
Distribution Yield	8.36%	7.75%

*Leverage Ratio was calculated by dividing the market cap of the REIT by the debt outstanding. In this way, a higher value means a lower level of leverage and more capital compared to debt outstanding.

The table above shows that the valuation of Allied Properties is currently more favourable compared to SmartCentres. This is evidenced by a lower payout ratio, and a higher yield. However, the market cap of Allied is currently quite low compared to its assets and debt outstanding. These valuations incorporate sentiment about the future, which is currently quite bearish on office buildings as will be explained further.

Redevelopment Potential

A REIT’s ability to re-develop their property portfolio is a key factor to determining their ability to grow over time. Especially as times change, real estate trusts need to adapt to new trends.

SmartCentres has the edge compared to Allied Properties when it comes to re-development potential. One benefit for SmartCentres is their large land footprint. Many of their current shopping centres are suburban and include vacant land and large parking lots. These properties can be more easily converted to higher density uses including residential. In fact, investors in the GTA may have noticed towers spouting up at highway 7 and the 400 in Vaughan where SmartCentres is in a multi-year process of redeveloping land surrounding the Vaughan TTC subway extension.

Allied Properties on the other hand does not has as much redevelopment potential. The land Allied owns is smaller in size but located in downtown cores. This makes re-development tougher from a regulatory perspective. But, when Allied Properties can re-develop, their properties are situated on more valuable locations that will likely have higher density.

Expertise is another factor to consider about a REIT’s ability to re-develop their portfolio. SmartCentres is building a greater expertise in residential development. However, Allied Properties lacks the same capacity internally when it comes to residential developments.

Outlook for Interest Rates

The outlook for interest rates plays a critical role when conducting financial analysis of a Real Estate Investment Trust (REIT) for several reasons. Many REITs carry some debt. So, as interest rates rise or fall, it will impact the cost of this debt. Also, real estate is valued based on capitalization rates. When interest rates rise, the value of many REITs will fall as investors adjust to alternatives. This dynamic is similar to how bond values fall as interest rates rise.

In summer 2023, investors expect interest rates to rise further. This is one reason why REIT values have been falling. The REITs with the highest debt levels are the most exposed to higher interest rates. Since Allied Properties carries less debt relative to assets & equity compared to SmartCentres, this will make SmartCentres more vulnerable to higher interest rates.

Existential Threats

Both Allied Properties and SmartCentres face existential threats to their business. For Allied Properties it’s the trend towards working from home (“WFH”). A greater portion of office workers are spending a greater share of their workday away from their office. This trend accelerated during the covid pandemic and looks like it will continue. The result is less demand for office space as vacancy rates for office has risen.

SmartCentres is also under threat from online shopping and e-commerce. This means that more shoppers will buy from retailers like Amazon who do not offer a “brick and mortar” shopping experience. The trend in retail is that online shopping continues to grow. This may mean less demand for retail shopping space in the future.

Allied Properties or SmartCentres: Which is a Better Investment?

To determine if Allied Properties or SmartCentre is a better investment, the first place to start is your investment goals and risk appetite. Both companies offer high yields and stable cashflows. But, each has also been challenged by threats. While SmartCentres has higher financial leverage, it also has a lower yield. On the surface, this could mean Allied Properties should be favoured. But, real estate investors are particularly bearish on office buildings.

The current market sentiment towards office buildings contributes to the undervaluation of Allied Properties. Granted, the trend towards work from home will continue. It may not mean the death of office work completely. There are lots of reasons why office workers and organizations may prefer working in offices compared to working from home. These include the nature of the work they do, the social benefits of working in the same location.

As the work from home trend gains pace, employers are finding it more difficult to motivate and evaluate their employees who are working remotely. It’s a lot easier to motivate workers and encourage feel loyalty when co-workers are “in real life” compared to meeting on Zoom.

So, at some point, the market for office buildings will find a bottom. This will come when supply and demand are more in balance. But for now, the power is tilting towards tenants who can receive concessions from office landlords who are desperate to lease empty space. By some estimates, 25% of the office buildings in Toronto Ontario are currently vacant. This is a main reason why the valuation of Allied Properties is at historic lows.

Investors who can stomach more risk, or who think the death of office work is overblown should take a chance on Allied Properties. But, for yield hungry investors who want a little more certainty, SmartCentres is a better investment.

Conclusion: Allied Properties vs SmartCentres

In conclusion, the choice between Allied Properties and SmartCentres as a potential investment depends on a multifaceted consideration of the current market dynamics, personal risk tolerance, and individual investment goals. The decision is not simply a matter of comparing numbers; it also includes reading into broader economic and social trends, from interest rates to shifting work patterns.

Allied Properties’ strong urban portfolio presents a unique value proposition, particularly for those who believe that the current bearish sentiment around office spaces is temporary. Their higher yield, lower debt, and prime locations make them a potentially lucrative option for those with a higher risk appetite or a long-term outlook.

SmartCentres, on the other hand, offers stability with its diverse retail portfolio, strong ties with retail giant Walmart, and a clear roadmap for expansion and redevelopment. Investors seeking steadier returns and less risk may find SmartCentres more appealing, despite the challenges posed by the rise of e-commerce. Navigating the ever-evolving landscape of REITs involves a delicate balance of careful financial analysis, keen market intuition, and understanding the socio-economic trends shaping our world. Both Allied Properties and SmartCentres offer intriguing prospects and their own sets of challenges. Ultimately, the superior investment will hinge on individual perspectives on the future of office work and retail spaces, as well as the ability to weather the uncertainties that lie ahead. Whatever your decision, the journey of investing in REITs promises to be as dynamic and fascinating as the market itsel