Boardwalk REIT (BEI.UN) recently announced a normal course issuer bid, since accepted by the Toronto Stock Exchange, to repurchase up to 10 per cent of its public float.
The issuer bid, which could account for up to 3.8 million trust units (or ultimately zero units should the value of the REIT’s units bounce back), has been made because the REIT “believes that the current market prices of its Trust Units do not reflect their underlying value.”
In a nutshell, the REIT`s management sees a big gap between the current prices for multi-family assets in private markets and the implied value of its portfolio based on the current price of its trust units.
The main factor behind Boardwalk’s initiative is the rising interest rate environment and its impact on unit values on REITs.
“Valuations of our company based on our public market valuation has come down drastically, in other words the implied cap rate on our stock is more like a six per cent cap rate,” James Ha, head of investor relations at Boardwalk, said in a mid-August interview.
The Calgary-based REIT, when it was trading in the $65-per-unit range prior to the May hit caused by falling interest rates, had an implied cap rate in “the low five per cent” range. Today, it is trading in the $56-per-unit range. The REIT also has a about $2.70 per trust unit in cash, which brings the value of the trust units to the $53-$54 range, giving it an implied cap rate of about six per cent based on its IFRS fair value, said Ha.
Sell high, buy low
With the normal course issuer bid in place, Boardwalk could sell non-core assets at a high point in the market and use those funds to buy back trust units in an accretive transaction for unit holders.
It is a strategy that the REIT has employed in the past. Between 2007 and 2010, Boardwalk bought back about 4.5 million trust units for approximately $170 million. That three-year repurchase program was made at an average price of about $37 per trust unit, said Ha, which looks smart based on the REIT`s recent trading range of between $56 and $65.
Boardwalk’s cap rate arbitrage essentially would see it sell well-located institutional grade apartment buildings in well-located areas with cap rates as low as four per cent in markets such as Vancouver or five per cent in Edmonton compared with trust units with an implied cap rate of six per cent.
Those relative high prices for good multi-res assets means it makes more sense to hold off buying any new properties, selling what doesn’t make sense long term, and ploughing the proceeds into stock repurchases.
Ha terms it “equity for equity” arbitrage, selling non-core assets to buy back trust units.
Boardwalk has one non-core property up for sale currently. “We will see how this goes but this is going to be a slow process. If we sold $100 million worth of assets, it is not like we could buy back $100 million worth of trust units overnight.”
Boardwalk has about $140 million of cash on its balance sheet but that capital would not be used for stock buybacks.
Others considering it, too
“You have seen a number of other REITs as well over the past few weeks issue normal course issuer bids,” Ha said. “That is just purely driven by the increase we have seen in public market valuations.”
In a recent report, RBC Capital Markets managing director Neil Downey identified four other unit buyback programs (Northern Property REIT, Killam Properties Inc., Canadian REIT, and RioCan). All five, Downey noted, see the possibility to get a better deal through buying their stock than they could by purchasing real estate.
“Thematically, the tie that binds most of these entities is that they have bottom-quartile financial leverage and therefore, latent ‘fire power’ to repurchase units, should valuations become excessively discounted,” the analyst wrote in his Aug. 21 report.