Justin Paget
Introduction
In my previous analysis covering True North Commercial Real Estate Investment Trust (TSX:TSX:TNT.UN:CA, OTC:TUERF) (“True North”), I discussed why the market overreacted significantly to True North’s situation in terms of its complete cut of distributions, the decline in revenue and net operating income, the decline in FFO and AFFO amid the general weak outlook on office real estate.
After reviewing 2024 Q1’s financial results for True North, I continue recommending True North with a “Buy” rating to capitalize on this market overreaction. Although I am still optimistic about True North’s outlook and business fundamentals, caution is certainly warranted given some risk factors at an elevated level. Let’s dive into some details.
Distributions
Although True North has paused its distribution completely in 2023 Q4, it has been using the saved funds to repurchase its own units at an inferred distribution yield.
In 2024 Q1, True North repurchased and canceled 624,860 units in total with a total cash cost of $5.8 million. The weighted average price paid per unit was $9.23. Although $9.23 per unit is significantly lower than True North’s NAV of $29.47 (a 70% discount), it is unfortunately lower than the current unit price of $8.76 as of May 24, 2024.
Since my previous analysis, True North’s stock price declined slightly by 1.5% from $8.89 to $8.76 despite the inferred distribution yield of about 18% mentioned by the management team.
The disconnect between reality and perception for True North is widening.
So, where do True North’s fundamentals stand?
Occupancy Rate Deep Dive
Although True North’s occupancy rate declined from 93% in 2023 Q1 to 90% in 2024 Q1, it increased slightly compared to 89% in 2023 Q4.
Below is a detailed analysis of the occupancy rates in the past five quarters.
Although it appears that 2023 Q4 was the worst, the occupancy rate actually has been trending better prior to 2023 Q4. Ontario is the most critical province for True North with 25 properties in total making up over 60% of its total leasing revenue. The occupancy rate in Ontario has been steadily recovering in the past five quarters back to over 95%. The decline in occupancy rate in 2023 Q4 and 2024 Q1 was primarily a result of 1 property being vacant in Alberta (1020 68th Avenue NE)and 1 property with some space being vacant in Nova Scotia that True North has not found a new tenant. Although the 70% occupancy rate in Alberta looks terrible, it is actually in line with the average vacancy rate in the province. Calgary office vacancy rate is still at about 30%. However, Alberta’s commercial activities and population are increasing significantly in the past couple of years helping to bring down the average vacancy rate to 28% from 34% in 2022. True North should be able to find a new tenant for the vacant property soon.
Even though True North’s average occupancy rate is much lower than in 2022, it is still higher than the national average of 82%.
| Q1-24 | Q4-23 | Q3-23 | Q2-23 | Q1-23 | |
| Occupancy | 90% | 89% | 93% | 93% | 93% |
| Alberta | 70.30% | 70.30% | 94.80% | 94.40% | 94.40% |
| British Columbia | 100% | 100% | 100.00% | 100.00% | 97.80% |
| New Brunswick | 86.70% | 86.70% | 85.80% | 85.00% | 85.50% |
| Nova Scotia | 81.00% | 76.50% | 89.50% | 96.20% | 96.20% |
| Ontario | 95.80% | 94.70% | 94.20% | 93.30% | 93.20% |
truenorthreit.com/index.php?preview=1&option=com_dropfiles&format=&task=frontfile.download&catid=55&id=279&Itemid=1000000000000
True North’s tenant client base is still unchanged. 77% of its leasing revenue is from the government (41%) and credit-rated clients (36%).
The federal government of Canada has announced that its employees that are eligible for hybrid work will come back to the office 3 days per week from 2 days per week starting September 2024. Provincial, and municipal governments as well as credit-rated employers have been following suit. The trend to bring employees back to the office is continuing. In the U.S., some major banks went as far as asking employees to return to the office 5 days a week.
In addition, the public sector in Canada has continued to add more jobs leading the charge. On a year-over-year basis, the public sector in Canada added 208,000 jobs in April 2024 compared to April 2023, a 4.9% growth. Although the private sector added some 190,000 jobs in the same period, it was only a 1.9% growth, of which self-employed made up a significant portion.
True North is well-positioned to capture the growth of jobs in the public sector given its strategic focus.
Now that we see True North’s strong fundamentals in terms of occupancy rate, let’s take a look at its financial results in 2024 Q1.
2024 Q1 Financial Results
Its revenue in 2024 Q1 was relatively flat compared to 2023 Q4. However, True North’s revenue is expected to fall slightly in subsequent quarters as it sold 4 non-core properties in April 2024 from its portfolio raising cash proceeds (after paying off mortgages) of over $19 million in total.
Net income for 2024 Q1 was $5.1 million compared to a loss of $5.9 million in 2023 Q4. Since 2022 Q2, True North has written down its portfolio with fair value adjustment in aggregate of $122 million because of higher discount rates and lower future cash flows. The write-down is largely complete as of 2024 Q1 (only $1.9 million fair value write-down). That is why 2024 Q1 reported a net income.
The cash flows from operations were at $14.9 million in 2024 Q1, relatively low compared to 2023 Q1 of $16 million or 2023 Q4 of $23.1 million, but still in line with Net Operating Income (“NOI”) of $16.5 million in 2024 Q1.
FFO and AFFO for 2024 Q1 were both slightly lower at $0.56 and $0.57 per unit compared to 2023 Q4 ($0.59 and $0.57 per unit). This decline was a result of several factors:
- expenses were higher due to inflation (property operating costs increased by about 2.3% and 4.3% respectively compared to 2023 Q4 or 2023 Q1).
- financing costs were higher as True North refinanced about $12.9 million mortgage at an average rate of 7.41% (compared to its existing mortgage’s average interest rate of 3.88%) for a one-year term anticipating the interest rate to fall before committing to a long-term mortgage with larger Canadian financial institutions.
Unitholders’ equity remained the same as of March 31, 2024, compared to December 31, 2023, at $452 million.
In general, True North’s 2024 Q1 financial results were fairly neutral as it navigates through the office real estate crisis, but its business fundamentals in terms of occupancy rates are still solid.
Elevated Risk Factors
True North’s Accounts Payable balance remained at an elevated level. As of March 31, 2024, True North’s Accounts Payable balance was $34.2 million. For 2024 Q1, its Accounts Payable Turnover in Days is about 730 days (it has been staying at this level since 2022 Q2), which means that on a FIFO basis, some suppliers need to wait 2 years before being paid. Essentially, many suppliers with outstanding balances as of 2022 Q2 still are not paid at all.
Although the amounts owed to regular suppliers usually are not secured, suppliers can start charging interest on the balance due, which can be quite high, or take legal action against True North, causing more professional fees incurred and time spent by True North.
Even though True North has been re-allocating the funds for dividend distributions to repurchase its units, in 2024 Q1, True North has not been able to allocate the exactly same amount of cash used in 2023 Q4 to repurchase its units.
In 2023 Q4, including dividends and repurchases, True North used $7.6 million cash while in 2024 Q1 True North only used $5.8 million cash to repurchase units indicating a more cautious approach on spending its cash.
$249.5 million of mortgages are to be renewed in the coming year and have been recognized as current liabilities as of March 31, 2024. It is hopeful that True North can successfully renew mortgages at relatively low rates with large Canadian financial institutions later this year as mentioned by its management team. However, it is possible that True North may be forced to take on short-term mortgages at extremely high rates such as the 7.41% interest rate it took in Q1 2024.
The interest rate swap that True North also will have a fairly minimal impact on controlling its interest rate as the notional amount is only $71.5 million (about 10% of its total liabilities) as of March 31, 2024.
The next two quarters are crucial on whether True North can negotiate reasonable interest rates upon mortgage renewal.
The current economic environment is not helping. The timeline for rate cuts by the Bank of Canada and The U.S. Federal Reserve keeps being pushed back due to the strong labor market and sticky inflation. While the Canadian economy is much weaker compared to the U.S., the Bank of Canada may be hesitant to start cutting rates too early to decouple with the U.S., which would cause the Canadian dollar to weaken significantly and cause Canada to start importing inflation from the U.S.
Valuation
True North’s market capitalization is at $130 million as of May 24, 2024, relatively lower than $144 million since my previous analysis.
The current market capitalization still represents about a 70% discount from the unitholders’ equity of $452 million.
Overall, there hasn’t been much change in terms of valuation metrics for True North. The thesis still holds true that True North trades at a significant discount to its NAV or unitholders’ equity and should see its stock price increase in the coming years to re-align.
Conclusion
Despite the challenging environment for office real estate, True North’s fundamentals remain relatively strong. The company’s solid occupancy rates above the national average and in each market have proven its resilience. True North’s significant tenant base in the public sector and the trend of employees returning to the office support an optimistic long-term outlook. While True North’s accounts payable balance remained very high and it is uncertain whether True North can successfully renew its mortgages this year at a reasonable interest rate, True North stock’s substantial discount to its NAV and unitholders’ equity presents a compelling investment opportunity. Therefore, I maintain a “Buy” rating while suggesting caution in the coming quarters.
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.
