Monday, March 29, 2021

Thought Experiment: Canadian Apartment Properties REIT + Activist Investor

Having owned shares of Canadian Apartment Properties REIT (TSX: CAR.UN) since 2013, I have benefited from the long-term appreciation in their unit price. However, over the past two years, as the REIT has ceased growing their annual distribution (last increase was in March 2019), the share price has grown a paltry 5%. As a comparison, since March 2019, Granite REIT (TSX: GRT.UN) has increased their distribution twice for a total of 7.3%, and their unit price is up over 21%. 

One of the main differences between CAR.UN and GRT.UN is that in May 2017, two activist investors (Sandpiper Group and FrontFour Capital Group) effectively took control of the Board of Directors of Granite, on the platform of selling non-core assets, increasing leverage, and acting in a more shareholder friendly fashion (i.e. raising distributions). Lately, I have been thinking what a similar type of activist investor strategy might look like for CAR.UN and what results it might yield.

Could an Activist Take Control?
One of the reasons that Sandpiper and FrontFour were able to take control of Granite's board with only 6.2% ownership of outstanding units is the company's prior management team had very little skin in the game. A similar situation exists with Canadian Apartment Properties, with no current management or Directors appearing in the company's top five holders. In fact, CAR.UN insiders only hold a total of 1.2% of outstanding shares, making the company a relatively easy target for an activist investor. Based on the $9.3B market capitalization of CAR.UN, an activist could own more than all the insiders of the company combined for around $120M.

Could an Activist Repeat the FrontFour/Sandpiper Playbook at Canadian Apartment Properties?
An activist investor could easily make the argument that CAR.UN should divest their interest in European Residential REIT (TSX: ERE.UN), as it takes away the former company's focus on their domestic market. Canadian Apartment Properties' 11% interest in ERE.UN is worth about $45M based on the latter's market capitalization. Beyond the stake in ERE.UN, within CAR.UN's domestic portfolio, a case could be made to sell some buildings in certain Canadian cities whose appreciated values don't translate into higher projected cashflows.

There is also a straightforward case that CAR.UN could take on more leverage given their debt to gross book value ended 2020 at a modest 35%, and the REIT was easily able to cover their interest needs evidenced by their debt service ratio of 2.0X. For a quick comparison, Minto Apartment REIT, reported a debt to gross book value ratio of 39% at the end of 2020, and also had a debt service ratio of 2.0X. Taking on more debt in order to invest in buildings and development, at a time when apartment living becomes more appealing due to rising house prices in Canada could prove to be a very smart long-term strategic decision for Canadian Apartment Properties.

On the shareholder friendliness front, CAR.UN seems to take pride in showing off the decrease in their FFO payout ratio from 65% in 2019, to 61% in 2020. However, as a unitholder, I find it frustrating to see that ratio so low, compared to most REITs that payout closer to 80% of their FFO. Adding to this frustration for me is the fact that CAR.UN has kept their occupancy high throughout the pandemic (98% at year end 2020), and collected over 99% of their rents throughout the year. As a shareholder, I have to wonder why the current management team sees fit to not distribute any of the growing FFO as a distribution to loyal unitholders. 

Thanks for joining me on this thought experiment. It will be interesting to see if any larger REITs or activist investors start agitating Canadian Apartment REIT to change their rather static course.

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