Aedifica: A 7.3% Yield From A Triple Net Lease REIT (OTCMKTS:AEDFF)

Introduction

Aedifica (OTCPK:AEDFF) is a Belgian REIT focusing on healthcare real estate, with a very specific focus on nursing homes and other facilities for the aging population.

The REIT is active in multiple countries and as you can see below, there aren’t any major differences between the four largest markets of Aedifica as Germany, Belgium, the UK, and Finland are all accounting for approximately 20% of the portfolio.

Aedifica’s primary listing is on Euronext Brussels, where the company is listed with AED as its ticker symbol. The average daily volume in Brussels is 64,000 shares, and one of the advantages of the main listing is that there are options available. There are currently 47.55M shares outstanding, resulting in a market capitalization of just over 2.5B EUR based on the current share price of just over 53 EUR.

The 2023 results indicate the dividend is fully covered

One of the reasons I like Aedifica the most is its CPI-linked indexation. This allows the REIT to gradually increase its rental income and means Aedifica is generally not too exposed to the impact of inflation other than a ‘timing’ issue: it usually hikes its rent just once per year. A second reason I’m charmed by Aedifica is the fact that its leases are triple net leases, which greatly reduces the capital expenditures required to keep the properties in shape.

As you can see below, Aedifica generated a total rental income of 314M EUR resulting in a net rental income of 313M EUR. The EPRA earnings came in at almost 220M EUR, which resulted in an EPRA EPS of 5.02 EUR per share using the weighted average share count throughout the year.

A robust set of earnings (although the per-share result will decrease in 2024) while keeping the balance sheet safe: at the end of 2023, the debt to assets ratio came in just under 40%. This will help the REIT to complete its investment program

And looking at the fair value of the real estate asset base, Aedifica’s assets are valued at 5.59B EUR, using a rental yield of 5.8%.

Aedifica is guiding for a rental income of 330M EUR this year, and even if you would apply a cap rate of 6.5% the fair value would decrease by just over 500M EUR which would result in an update NAV/share of approximately 62-63 EUR.

Aedifica also continues to advance its pipeline and about 294M EUR of development assets should be completed in 2024. The entire investment portfolio will add 23M EUR to the rental income basis, representing a yield on cost of 5.6%. I think Aedifica would not like to see higher returns before committing to new projects.

Important: the REIT only has to invest 245M EUR in 2024-2026 to complete these assets. As the REIT will retain approximately 50M EUR per year in earnings (the difference between the EPRA earnings and the dividends payable to its shareholders), it should have no issues to secure funding to complete the development pipeline.

Although the results will be weaker in 2024, Aedifica will increase the dividend

I have the utmost respect for management teams who let a dividend fluctuate based on earnings. After all, that’s exactly what a dividend is supposed to be: a distribution of (a portion of) the earnings of a company to its shareholders.

When it comes to 2023, there is no issue whatsoever: the REIT reported earnings of 5.02 EUR per share and will pay a dividend of 3.80 EUR, for a payout ratio of approximately 76%. That’s fine. However, for 2024, the REIT is already guiding for a dividend of 3.90 EUR per share (+2.5%) although the earnings will decrease by 6% to 4.70 EUR per share. Based on the guidance for 2024, the payout ratio will increase to 83%. The lower earnings result is predominantly caused by the higher share count. During 2023, the share count increased from 39.9M shares to 47.5M shares, but the weighted average share count was 43.7M shares, and that was the number used to calculate the EPRA earnings of 5.02 EUR per share.

While that indeed means the dividend is still well-covered by the earnings, 2024 may not be the last year Aedifica will have to deal with pressure on the earnings. As of the end of 2023, Aedifica’s average cost of debt was 1.9%. Fortunately, the REIT has hedged the vast majority of its interest rate exposure and as you can see below, there also is a substantial portion of fixed rate debt.

However, the interest rate hedging obviously only takes the hedging into account until the maturity date has been reached. As you can see below, Aedifica may face some headwinds going into 2026. The 211M EUR of maturing debt in 2024 and 2025 can easily be refinanced, and the expected increase in the cost of debt will likely be fully compensated for by higher rental income.

The real test will be in 2026 and 2027 wherein a combined 820M EUR of debt will have to be refinanced. Fortunately, there are two things working in Aedifica’s favor. The first element is the anticipated interest rate decreases over the next few years. I like the odds of Aedifica’s cost of debt to be lower in 2026 than where they are at today. Secondly, 2026 is still two years away, which gives Aedifica plenty of time to ‘right-size’ the portfolio and push through a few rent hikes by then and to complete its investment portfolio which will add just over 20M EUR to the rental income (a portion of the full run rate of 23M EUR is already included in the 2024 guidance).

In theory, and this is just a theory and assuming all other costs and expenses remain unchanged, an average increase in the net rental income of 2% per year would cover a refinancing at 4.5%. An interest rate, which I think is definitely achievable if the ECB indeed starts to reduce its benchmark interest rates later this year.

Investment thesis

I have a decent sized long position in Aedifica, and I was waiting for the annual results before deciding if I should add to this position (which currently is slightly underwater). I wasn’t quite sure how the REIT would navigate through the volatile waters, but my fears have been put to rest by the transparent 2023 update. While the earnings will decrease in 2024, this is mainly due to the full impact of a capital raise in 2023, and odds are we will see an earnings increase again in 2025 as the REIT should be able to continue to increase its rental income while the impact of debt refinancings should remain relatively limited.

An added bonus is that Aedifica’s dividends are subject to a withholding tax of just 15% instead of 30% (although this benefit may disappear in a few years as the UK portfolio will no longer count as European residential healthcare real estate. Aedifica could decide to reduce the size of its UK portfolio while investing in other European assets to meet the requirement to have 80% of its assets as European residential real estate. It all depends on how important the reduced dividend tax is to the REIT.

Aedifica is trading at a discount of 25% to its NAV based on a 5.8% cap rate and a discount of 15% based on a 6.5% cap rate. Additionally, the well-covered dividend yield of 7.3% is very attractive as well.

I have a long position and will continue to add to this position.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.