I only acquired positions in a handful commercial REITs during the COVID-19 pandemic, and Plaza Retail REIT (OTC:PAZRF) was one of them. My main reason for buying the stock (and its debentures) was the strong tenant mix with a substantial portion of the tenants remaining open for business as an essential store. This, combined with an acceptable valuation of the properties and LTV ratio, made me go long the stock. The moment of truth was earlier this month when Plaza reported its Q2 results and I’m glad things turned out in line with expectations.
The average daily volume of Plaza on the OTC exchange is very low and I recommend to trade in the REIT’s shares through the facilities of the Toronto Stock Exchange where Plaza is trading with PLZ.UN as its ticker symbol. The average daily volume in Canada is closer to 100,000 shares.
Plaza Retail REIT: not just any retail REIT
While commercial REITs aren’t the most popular idea right now, there’s a big difference between the larger commercial REITs that own and operate malls and the REITs owning smaller assets with usually a single tenant and multi-tenant assets with one dominant anchor tenant. Those types of assets can be riskier, but in Plaza Retail’s case I believe the risk actually is reduced as in excess of 50% of the rental income is generated by large chains that remained open and should be strong enough to continue to pay their rent.
Source: Company presentation
I bought the stock in April at around C$2.85 as the REIT was yielding almost 10% at that point and I believed the lower than average rent collection risk was not appreciated by the market. I also calculated that as long as half of the rental revenue was collected, Plaza would be able to stay current on all its interest payments and cover the G&A expenses as well as the normal maintenance expenses for the real estate assets. So around 50% was the breakeven point and any rent that was collected above that percentage would help toward covering the dividend.
Source: Q2 update
In its Q2 update, Plaza confirmed 98% of its stores were opened again and 92% of the July rent had been collected. Not only is that sufficient to cover all overhead expenses (and then some), it also protected the generous dividend and Plaza Retail REIT continued to pay its monthly C$0.0233 dividend throughout the crisis.
Yes, Q2 wasn’t great, but the situation appears to be under control
I was looking forward to the financial results of Plaza to see how the performance was impacted by the lower rent collection rates. Plaza collected only 80% of the April and May rents but this already increased to 86% in June for an average if 82% in Q2. That still isn’t a great result, but thanks to a high percentage of strong tenants, Plaza did better than other retail REITs. Additionally, the bump to 92% in July is very encouraging and perhaps we can aim for a 95% rent collection rate by the end of the quarter which would put Plaza completely back on track. The rental income deemed “lost” (as part of the subsidy plan of the Canadian government, landlords were also asked to forgive a small portion of the rent, and Plaza seems to have recorded this as a non-recoverable expense which explains why the operating expenses are higher).
Source: financial statements
As you can see above, the weak result was predominantly caused by the lower net property operating income and the C$3.9M loss related to the contribution of associates. These two elements explain singlehandedly the lower income before finance costs and taxes. And as Plaza’s interest expenses decreased YoY, the REIT actually was on track to post a higher underlying result, but given the special circumstances, the company recorded an additional C$28.6M decrease in the book value of its properties. This reduced the value by C$48.5M in the first semester, compared to an increase of C$18.1M in H1 2019.
Keep in mind that although the deferred rent was included in the revenue, the amount of rent receivable increased by C$4.15M and Plaza should be able to collect the cash in the next few months and quarters. So accounting wise, Plaza recorded the revenue as if nothing happened, but of the C$23M in pure rental income, C$1.4M (4% of the gross rent) was recorded as an expense as Plaza won’t collect it while an additional C$4.15M was added to the balance sheet as a receivable.
Source: Financial statements
An important element for retail REITs will be the occupancy rate, and Plaza was able to keep this one relatively stable at 96.2%.
Another aspect of Plaza I do like is the mortgage repayment schedule. 55% of the mortgages only have to be refinanced from 2025 on and the amount of near-term maturities is very limited.
Source: quarterly report
Additionally, only 3.7% of the leases will have to be renewed in 2020. 2021 is a more important year as 11.8% of the square footage will have to be renewed followed by 9.9% in 2022 and 14.9% in 2023.
My own NAV calculations
Although Plaza Retail REIT already valued its properties using very reasonable metrics, the REIT reduced the book value of the assets by almost C$50M in H1 2020 and this appears to be a very conservative move. After all, if we would annualize the normalized rent of C$23M per quarter to C$92M per year, the current book value of the properties of C$1.05B doesn’t appear to be unreasonably high as this implies a gross rental yield of over 9% once we take the occupancy into account.
That’s why I wanted to run the numbers myself, just to figure out what Plaza Retail REIT could reasonably be worth. I will use the starting point of the C$23M in quarterly rental income and apply a required gross rental yield of 8.5% which I think is more than reasonable. This results in the calculation below:
Source: Author calculation, based on publicly-available data
Based on my assumptions, I end up with a fair value of C$5.47/share. This doesn’t mean we will get there overnight as I expect the retail REIT sector will need some time to get the investor confidence back. But in any case, I think Plaza Retail REIT is quite cheap.
The current dividend is C$0.2333/month which works out to be C$0.28/year for a yield of approximately 8%. This yield is fully covered by the FFO (C$0.165 in H1 2020) and AFFO (C$0.143 in H1 2020) and is thus sustainable. The Q2 dividend payments were not fully covered (as the AFFO payout ratio came in at 102%) but given the strong rent collection improvement from 82% to 92%, I’m not too worried and the Q3 AFFO payout ratio will drop to the 91%-93% again according to my calculations (and excluding negative surprises). Plaza currently is also buying back its own shares on the open market and repurchased almost 0.4M shares in Q2 2020. The lower share count also will help reduce the AFFO payout ratio.
I own both the common stock (at C$2.85 for a dividend yield of almost 10%) as well as the convertible debentures that are trading on the Toronto Stock Exchange. I’m not expecting the debentures to be converted, but with a YTM of 10.6% (a coupon of 5.10%, I bought the debentures in April) I’m a perfectly happy creditor and shareholder of Plaza Retail REIT and will be looking to add to my position on dips. Ideally, I’d be very interested if the share price dips back down toward C$3.
Long story short, the current 8% dividend yield will be more than fully covered thanks to the increased rent collection rate in July. Plaza’s main focus should now be on extending the existing lease agreements to create visibility and keep the occupancy rate high.
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Disclosure: I am/we are long PAZRF. 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: I have a long position in the common shares/units and the debentures, trading on the TSX.