Stocks Investment

Morguard North American Residential REIT – Still Inexpensive

Opportunities in Canadian REITs

Real Estate Investment Trusts (“REIT”) is one of the worst hit sectors under COVID-19 pandemic. REIT prices not only declined more deeply at the onset of the pandemic, but they also did not fully participate in the V-shaped stock market recovery which started in late-March. The reasons are quite obvious:

  • Most of the push towards e-commerce experienced under economic lock-downs is likely to be permanent which will accelerate the demise of shopping centers and malls owned by Retail REITs.
  • Work from home adopted during the pandemic will be sustained in some form by most corporates to achieve long-term operational savings reducing the demand for office space leased out by Office REITs.
  • Despite gradual opening up of economies, hotel stays are still a long way from making a comeback.

Source: Bloomberg

However, all is not lost for the future of real estate. Apartments and warehouses are two bright spots among the real estate sub-sectors. Rental apartments are likely to stay in fashion as they have no substitute other than outright ownership of the increasingly unaffordable real estate. Warehouse space is in high demand as e-commerce giants like Amazon (NASDAQ:AMZN) are leasing fulfillment centers as they replace the brick-and-mortar retail stores.

Despite an uptick in prices and valuations lately, we think there may be pockets of opportunity for diligent investors. This brings us to the Morguard North American Residential REIT (“MRG”) (OTC:MNARF) which owns a portfolio of multi-family rental apartments in Canada and the United States.

Source: Bloomberg

Why is MRG an attractive value call?

We like MRG for a number of reasons:

Defensive asset class

MRG is a pure-play, multi-family rental apartment owner. The ability of multi-family rental apartments to generate consistent cash flows with low levels of volatility gives them their defensive characteristic. This defensiveness is even more valued during economic recessions as rental demand increases from people on a budget looking for more affordable accommodation.

Valuation still inexpensive

MRG is a good, catch-up trade after the general rise in the market which has lifted the valuations of REITs as well as most stocks. While the discount to NAV on most of the other Canadian-listed apartment REITs has vanished, MRG still has some ways to go despite rallying 43% from its COVID-19 bottom. The reason for further re-rating potential in MRG is that it continues to trade at a steep 46% discount to Net Asset Value (“NAV”) compared to a pre-COVID-19 discount of 25%. Using the latest NAV of C$29.4 per unit and a target discount of 25%, the implied target price for MRG is C$22/share (USD16.60/share) or 42% upside from current levels.

Source: Author Estimates

Attractive and sustainable dividend yield

For readers afflicted with the dividend bug, MRG is not a bad deal as it offers a pretty safe 4.5% yield. I consider this yield to be safe due to MRG’s low payout ratio reflective of a management keen on plowing back cash into the business for future growth rather than paying out as dividend. MRG’s dividend payout is around 55% of its Fund Flow from Operations (“FFO”) which is slightly lower than its peers which pay out 60%+.

Source: Author Estimates

Geographic diversification

MRG offers exposure to a well-diversified portfolio of multi-family rental real estate. It has a 40/60 Canada/US split which gives geographic and currency diversification. In Canada, its properties are primarily in southern Ontario, while in the US, its properties are spread across the sun belt states, mainly Florida. Both of these geographies are attractive as southern Ontario and US sun belt are experiencing population growth.

Source: Company Quarterly Report, June 2020

What we don’t like about MRG ?

MRG has been historically shunned by many investors which has caused it to persistently trade at cheaper valuations compared to its peers. To dispel any confusion on this account, my investment case is not based on this historical discount going away. Rather, I am arguing that the prevailing 46% discount to NAV is way above the 25% discount at which MRG was trading prior to COVID-19 and is not warranted by any problems in the business.

Based on my research, the persistent dislike for MRG is due to the following reasons:

  • In Canadian apartment REITs space, shareholders have benefited from take-over/take-private transactions at a premium to market prices in the past few years. MRG is unlikely to be a take-over/take-private candidate due to its closely held nature. The largest shareholder of MRG is Morguard Corporation (OTC:MRCBF) (44.8% effective ownership) which is the flagship holding company of notable Canadian real estate investor, Mr. K. Rai Sahi. Mr. Sahi serves as the Chairman/CEO of Morguard Corp. and two REITs including MRG.
  • Unlike many of its peers, MRG is externally managed by an affiliate (presumably its parent, Morguard Corp.) which is paid fees for services like a property management fee equal to 3.5% of the gross property revenue and asset management fee equal to 0.25% of the gross book value of properties. These fees are a significant cost which ate up 32% of the FFO and 16% of the net operating income in 2019. In my view, shareholders get to keep more of the rental income in an internally managed REIT vs. an externally managed one.

Final words

To recap, MRG offers a nice, catch-up trade for valuation to rise towards pre-COVID-19 levels. It offers exposure to a defensive asset class with its portfolio of Canadian and US sun belt properties. To top it all, it has a safe dividend distribution for yield investors. There is still time to accumulate this inexpensive REIT.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Additional disclosure: This report is a personal opinion only and should not be considered as an “investment advice” or as a “recommendation” regarding a course of action. Only registered investment advisers can provide personalized investment advice. Investors should get personal advice from their investment adviser and should make independent investigations before acting on any information published here.

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