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November 23, 2020

SmartCentres REIT (TSE:SRU.UN): Get the Development Pipeline for Free

Disclaimer: The writer of this article may have positions in the securities mentioned in this article. The fact they hold positions in securities has had no impact on the production of this article

By Tyler Kirkpatrick

November 23, 2020

Smartcenters REIT

 

SmartCentres REIT (TSE:SRU.UN) is a Canadian REIT mostly known as a Walmart focused REIT, for good reason. It owns 168 properties and 73% of them have Walmart as the anchor tenant. 25% of SmartCentres’s rent comes from Walmart.

In fact, Mitch Goldhar, the Chairman of SmartCentres REIT, is the man who brought Walmart to Canada. Needless to say SmartCentres and Walmart are closely tied.

The core business of owning mostly Walmart anchored shopping centres is a good one, and a SmartCentres property is usually a core part of the neighbourhood they are in. Because so many people go to Walmart, any tenants on the same property as a Walmart will end up with more foot traffic, so SmartCentres has higher occupancy (97.4%) than most retail REITs.

SmartCentres REIT is cheap considering how good its properties are.

In 2019 SmartCentres earned $2.08 in AFFO (a REIT’s free cash flow). Profits and cash flow this year have been disrupted by COVID, just like every other retail REIT, but SmartCentres has actually increased AFFO because it completed sales of a condo building. For simplicity’s sake, SmartCentres is trading at 11.7x 2019’s AFFO.

The cap rate (a method of valuing real estate comparing the asset price vs a building’s income, lower equals more expensive) is also too high for assets of this caliber. The unit price of the REIT implies a cap rate of 5.9%. According to real estate research firm CBRE the average cap rate for retail real estate is between 5.5% and 6%.

Since SmartCentres REIT owns such strong properties, mostly concentrated in the country’s best markets, SmartCentres should trade at a lower cap rate than the national average.

Finally, SmartCentres yields 7.6% at today’s prices. That is very attractive at a time when most savings accounts pay less than 1%. The distribution is also safe. The payout is currently $1.84 per unit annually, so the AFFO payout ratio is 88%.

Development Potential

Since SmartCentres has cashflow left over after paying its distribution, what is it going to do with it? Well the REIT has one of the biggest development pipelines of any REIT in Canada.

There are a number of ways to look at just how much SmartCentres is going to go through developments.

It owns 2,775 acres of unbuilt land, on which it can add buildings to its existing properties, a process known as intensification.

Because a Walmart is a popular destination in a neighbourhood, any new buildings that get added to a Walmart anchored property will be in high demand. If an apartment building has a Walmart within a short walk, it can likely charge higher rents.

The management team of SmartCentres has identified 256 development projects to complete on 94 of its properties. In addition, they are reviewing another 72 properties that might be able to support intensification projects in the future.

Those 256 projects include apartments, condos and townhouses, office buildings, seniors’ housing, hotels, and storage units.

Perhaps the most impressive project is SmartVMC. The site is on 100 acres in the heart of Vaughan, with subway access making the trip to downtown Toronto take less than 45 minutes. The huge development is going to have almost 2800 condos, 451 rental apartments, and over 1 million square feet of office buildings, to go along with a new Walmart location and a 9 acre public park.

SmartVMC is set to be the new Vaughan city centre and it is an example of the great properties SmartCentres owns.

Management estimates these projects will create somewhere around $1.4 billion of value for the REIT, which is worth approximately $8 per unit. Almost $3 of that value is supposed to be realized over the next two years.

All of that value is going to get added to the net asset value (NAV) which currently stands around $28.

Over time, a REIT will usually trade around its NAV, so it would be reasonable to expect that SmartCentres will be $31 or more in the next couple years. After that, the development pipeline will keep growing NAV which will keep the capital gains coming.

The Bottom Line

SmartCentres REIT would be a great REIT to own even if it didn’t have all of the future developments. SmartCentres has stronger locations than most retail REITs as so many have a Walmart on the property, but it doesn’t trade at a meaningful premium to them. It trades at less than 12x AFFO with a safe 7.6% yield. The balance sheet is conservative, with net-debt-to-assets less than 43%. But the developments are going to drive growth. SmartCentres REIT is going to deliver a high yield and a lot of capital gains to unitholders. Not all REITs are so focused on specific industries, Cominar REIT (TSE:CUF.UN) is a diversified REIT that we reviewed, for example.

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Tyler Kirkpatrick


Tyler is an individual investor and has been investing in stocks, REITs, and private real estate for over 10 years. He focuses on companies with high quality assets that are trading with a margin of safety.

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