The Morguard Complex: Dirt Cheap Real Estate Trading at 50-70% Off
How I'm playing this uniquely interesting situation
I’ve been promising to take a closer look at the whole Morguard complex for a while now, so let’s do it. No time for more preamble.
Morguard has a long diverse history. It was founded in 1905 as D. Ackland and Son, which, by the way, is a company naming structure that needs to make a comeback. Mr. Ackland and his son originally made carriage parts, which wasn’t exactly a growth industry in 1905. It eventually moved into making automotive parts, eventually transforming into a distributor of auto and other industrial parts in the 1960s.
Now is a good time to introduce y’all to K. Rai Sahi, Morguard’s CEO and largest shareholder, who came to Canada as a 24-year-old in 1971. He got a job unloading boxcars as he worked to improve his English. After a few months of that, Sahi moved from Montreal to Kingston and started selling life insurance, studying accounting on the side. He completed his CGA and started a five year stint with Bank of Montreal dealing with real estate loans.
He took the entrepreneurship plunge in 1982 and bought Advanced Extrusion Ltd., which made toothpaste tubes. He — along with partners — spent approximately $7M for the company, which had profits in the neighbourhood of $1M. They made investments in the business, including modernizing equipment, and took advantage of a weak Canadian Dollar to increase exports to the United States. Revenues more than doubled, and Sahi sold his part of the business a few years later.
Sahi got involved with a few other businesses, including trucking and a conglomerate called Federal Industries after it bought out the trucking business. Federal was involved in everything from bookstores to steel pipes. It would eventually sell off most of the moving parts — partly due to Sahi’s insistence — with the metals part of the business forming the basis of today’s Russel Metals.
Sahi’s big win was his investment in Ackland. He took control of the company with a 23% stake in 1990 and immediately went to work expanding the company. He went on an acquisition spree for a few years, buying other Canadian industrial distributors and consolidating the sector. By 1996 the company pivoted and sold off the distribution business, leaving it was more than $300M in cash. Ackland started buying real estate, including the assets of Morguard REIT. The company rechristened itself as Morguard Corp, and kept buying.
A couple decades later and Morguard is a true powerhouse. It owns more than $10B worth of real estate with another $4B worth of real estate under management. It also has a portfolio of nearly $4B worth of publicly traded real estate assets, mixed in with some debt.
This is when things get a little complicated. There are three Morguard entities, including Morguard Corporation (TSX:MRC), Morguard REIT (TSX:MRT.un), and Morguard North American Residential REIT (TSX:MRG.un) . We’ll refer to them as the Corporation, REIT, and Residential respectively for the rest of this post.
Corporation is the holding company. It has large stakes in each of the REIT and residential subsidiaries. As of February 23rd, 2023, Corporation owns 61.6% of the REIT and 44.7% of Residential. The structure looks a little something like this:
Let’s take a closer look at all three Morguard entities, starting with the Corporation. I’ll then compare the various entities and let you know how I’m playing this. There’s opportunity here, even if it is a little complicated.
Join 1,100+ skilled investors, professional money managers, and CEOs who read Uproar Capital. Straight to your inbox Tuesdays and Fridays. Completely free!
As outlined in the graphic above, Morguard Corp is more than just real estate. It also has a robust asset management business.
The portfolio consists of nearly $15B in both owned and managed real estate. It includes 15M square feet of retail space, some 12M square feet of office space, a little over 7M square feet in industrial space, nearly 18,000 residential units, and, for good measure, some 2,900 hotel rooms. This is enough to make Morguard one of North America’s largest real estate holders.
The portfolio is spread across North America, with the majority of assets being held in Canada, and more specifically, Ontario. I was recently in Toronto and noticed a bunch of Morguard buildings on Bloor Street. Things seemed busy, FWIW. Much of the U.S. assets are in residential, which we’ll look at more closely when we analyze the Residential REIT, but it also owns certain retail and office assets south of the border.
Like any real estate company, there’s essentially two ways to value Morguard Corp. We can look at net asset value (NAV) or an earnings multiple. It doesn’t matter which way you look at it, the Corporation is cheap.
Let’s start with NAV. Morguard released its various 4th quarter reports a few weeks ago. The Corporation calculated NAV at a hair over $350 per share. As I type this, the stock trades at approximately $110 per share. That’s a price-to-NAV ratio of about 30%, or a 70% discount to NAV. That’s a massive spread between market value and fair value.
It’s similarly cheap from a price-to-earnings perspective. The Corporation earned $19.10 per share in funds from operations (FFO) in 2022. That puts us at a little under 6x trailing FFO.
It gets better. Morguard isn’t just a real estate holding company. It’s also an asset manager.
The Corporation reported revenue of $916M and net operating income (NOI) of a hair over $500M in 2022. Asset management revenue was $41M, a decent decline from $49M a year earlier. But it’s still a legitimate business. Slap a 12x valuation on that and we get an asset management business worth $500M, which is actually a pretty big chunk of the current $1.2B market cap.
In other words:
Asset management: Worth $500M
Real estate: Paying $700M, getting $4.4B worth of NAV. Or 16% of NAV once we strip out the value of the asset management biz
Yeah, that’s right kids. Morguard is even cheaper than it appears at first glance.
Except it really isn’t. The thesis is full of holes if you drill down a little. First, a closer look at the Corporation’s portfolio reveals a bunch of lackluster office towers. People don’t even want good office space in 2023, never mind mediocre space. It also owns a bunch of hotel rooms in places like Fort McMurray and London. Not the good London, either. There’s also a portfolio of publicly traded securities, which isn’t readily disclosed. I couldn’t find it after a few minutes of searching, anyway.
There’s a lot of stuff here. There’s no focus.
Another reason for the big gap between NAV and the share price is the market doesn’t believe the NAV of the subsidiaries for one second. It’s pretty easy to argue both the REIT and Residental’s NAV are overstated.
The REIT is loaded with office towers (bad) and malls in such bustling metropolises as Grande Prairie, Prince George, and Saskatoon (not great). It has a small industrial portfolio, but occupancy recently took a dive. Residential has assets in Toronto renting for far lower than market rents because they’re on rent control. Despite major issues with both portfolios, Morguard continues to insist they’re worth more than they were in 2019.
Another issue is capital allocation. Both REITs trade at a huge discount to book value. There are plenty of shares available in the open market. Rather than buy them and slowly take both REITs private, Morguard continues to buy buildings from third parties. This tells me even Morguard doesn’t believe the published NAV values of its two subsidiaries. If they did, it would be an absolute no-brainer to buy shares in either subsidiary.
Yes, such a strategy would mean Morguard would lose property management fees. But the gain would be massive. Morguard REIT has a NAV of $1.05B. It has a market cap of $350M. Meanwhile, the REIT reported paying property management fees of a little over $8M to the parent. Once we factor in the 61.6% ownership interest Morguard already has, every share purchased would be the equivalent of paying $134M for $403M in assets. What would you rather have — $8M per year forever or $269M right now?
If Morguard believed its NAV calculations, taking the REIT private would be an absolute no-brainer today. K. Rai Sahi is no idiot; he got rich buying undervalued assets. Therefore, I have no choice but to assume the calculated NAV for each is bunk.
Two more reasons why I don’t like the Corporation, and I’ll move onto each REIT. Firstly, the parent pays a grand total of $0.60 per year in dividends, good enough for a 0.54% yield. It’s a token dividend designed to get the company included in dividend mutual funds and ETFs. I’d be fine with this, assuming I can trust Sahi’s capital allocation skills. I’m not sure I can do that.
Remember, Sahi was one of Canada’s original capital raiders. He was the one who pushed for change at Federated Industries after seeing what a cluster that business was. Even Prem Watsa warned him not to do it. Why isn’t he keen to do the same thing at his own company?
Secondly, Sahi was born in 1946. He’ll be 77 this year and is comfortably a billionaire, at least according to Forbes. I’m not even sure how much he’s involved in the business anymore. I know I sure wouldn’t be. His daughter is on the board of directors and seems to be the company’s voice on conference calls, which tells me Sahi views Morguard as a family business. That could be good or bad, depending on your perspective.
Since this edition is basically three stocks in one, feel free to take a little break right now. Stretch. Breathe. Grab a beverage. Do what you gotta do. I’ll be waiting here until you get back.
Okay, onto the REIT. Morguard REIT owns office, retail, and industrial space across B.C., Alberta, Saskatchewan, Manitoba, Ontario, and a single property in Quebec. The portfolio consists of 23 office properties, 19 retail locations, and four industrial properties, spanning a total of 8.2M square feet.
Occupancy was 91% at the end of 2022, which is actually fairly consistent with the last few years. Many office-focused REITs have seen occupancy dive after the pandemic, but the REIT has been able to keep its office space rented. Approximately a third of total office space — and about 15% of the entire portfolio — is in downtown Calgary, rented to medium-sized oil producers like Obsidian and Athabasca. This was a very bad thing in 2016. It’s not great in 2023, but at least oil is strong.
The office portfolio features various levels of governments as top tenants, followed by Obsidian and Bombardier, for some reason. The average length of lease is just 4.0 years.
The REIT owns a single office tower in Downtown Toronto. It has eight other office towers in Ontario, focusing mainly in the Ottawa area. That’s where the large concentration of government tenants comes from. That could be an interesting transition, depending on what direction the government goes with working from home.
Let’s look closer at the retail assets next. Many are regional shopping centres, which I think are somewhat underrated. A mall in Red Deer, for example, consistently draws people from outside of Red Deer who want to spend a few hours window shopping or just walking the mall. There’s a certain amount of value there, and the 94.5% occupancy shows it. Here’s a list of the top retail tenants:
The industrial portfolio is quite small compared to the office and retail portions, and recently saw a couple vacancies that decreased occupancy from 100% to the 70% range. Industrial space is strong right now, so I assume this vacant space won’t stay empty for long.
Morguard REIT is cheap on a price-to -NAV basis. The NAV is $1.05B, or $16.34 per share. The stock trades at $5.70 per share. That’s a massive gap. And like the parent, it’s also cheap on a price-to-FFO perspective. 2022’s fully diluted FFO came in at $0.89 per share. That gives us a price-to-FFO ratio of 6.4x.
The REIT paid out $0.07 per unit each month for a very long time. That payout has been cut twice in the past few years. These days it pays out $0.02 per unit monthly, or $0.24 annually. AFFO net of improvements is in the $0.60 per share range. That’s a very sustainable payout and it works out to a 4.2% yield.
Like the parent, it’s perplexing why the REIT doesn’t use some of its excess cash to buyback undervalued shares. 2022’s share buyback program yielded a grand total of zero repurchased shares. The company should try an Artis strategy and take advantage in the spread between private and public valuations. Sell whatever you can get a decent price for and use the proceeds to gobble up undervalued shares. But they won’t, because the Corporation wants those sweet management fees.
I’ve saved the best for last. The residential side of Morguard is by far the most interesting.
Let’s talk about the portfolio first. Residential has property throughout the United States, as well as Canada. The Canadian portfolio is located primarily in Toronto and Mississauga, consisting of 5,335 units. Here’s a breakdown:
Rents on the Ontario properties are considerably less than average because they’re older buildings that fall under rent control. This translates into slower rent increases than the market will bear. I tweeted about this when researching the stock:
The company has had success jacking up rents when tenants leave these properties, and it has applied for special permission to increase rents by more than the 3.5% granted by government.
The Google reviews for Morguard’s Toronto properties are, shall we say, not great. Now keep in mind there’s zero incentive for anyone satisfied to post a good review, but still. That’s pretty low.
Here’s a quick look a the U.S. portion of the portfolio. What I like about it is there’s virtually zero rent control in the United States. Freedom, baby! This lets rents increase at more or less the market rate, which helped goose 2022 results.
Morguard’s interest in the U.S. portfolio consists of 6,548 units.
The difference in results from the two markets were well illustrated in the latest quarterly report. Average rent in 2022 went from $1,535 to $1,588 in Canada, or an increase of under 4%. In the United States, average rent increased from US$1,525 to US$1,771, an increase of 16%.
Residential is also buying more property in the U.S., including 350 units at Echelon in Chicago, the 50% interest in Rockville Town Square in the D.C. area it didn’t already own, and some retail space at the base of Town Square. These acquisitions should add to the bottom line in 2023, offset slightly by a couple smaller dispositions. Essentially, the residential REIT is recycling capital to buy newer and higher quality units. That’s exactly what I like to see.
The company has already stated its looking to purchase more property in the early part of 2023 to take advantage of IRS 1031 exchanges, which allow it to put the proceeds of previous sales back into real estate without paying taxes on the gains.
Overall, Morguard Residential REIT has really done a good job becoming a U.S.-focused residential play, and it has shown in its 2022 earnings. FFO came in at $1.47 per share, putting the stock at less than 13x trailing FFO. Minto, which I looked at a few weeks ago, has a trailing price-to-FFO ratio of approximately 18x. Earnings should increase next year too, as the company puts more of the sale proceeds to work.
Residential also recently announced a dividend increase, upping the payout from $0.70 to $0.72 per share on an annual basis. That works out to a pretty solid 3.9% yield.
The stock is also cheap on a price-to-NAV basis, with NAV checking in at $1.75B. The current market cap is $715M. It’s not quite as cheap as the REIT or the Corporation on a price-to-NAV basis, but it’s still trading at just over 40% NAV.
A 60% discount to NAV tells me NAV is too high. Just like with the other two NAV calculations Morguard has treated us to. But this one does feel a whole lot more reasonable. Here’s what the company is using as comps for each market.
I won’t pretend to be an expert in any of these markets, however I will say that the assumed cap rates do seem like they’re in the ballpark of reasonable. They might be a little aggressive, but overall not terrible. And remember, this is where the company values its portfolio. You’re buying for a substantial discount to that number. Even if these numbers are too high, it’s okay. We’ve already built in a decent margin of safety.
Here’s the interesting part of Residential. They’re actually buying back shares in the open market. I know. I can hardly believe it either.
The company repurchased some 56,000 units in the early part of the year, and has continued buying into March. It’s not a lot, with total repurchases a hair above $1M so far in 2023, but it’s at least a start.
Residential also just raised some capital with convertible debentures, which is something Morguard likes doing with both of their REITs. Proceeds will be used to pay back a previous issue of convertible debentures. Morguard purchased $5M of the $50M raised as well. Again, not much. But it’s a start.
The bottom line
I’m going to bold and italize this next statement, because after 3,000+ words the Morguard complex really comes down to this.
Morguard trades at a discount because it’s a confusing mishmash of real estate with no real focus. The corporation suffers from this, and so does the REIT. The residential REIT is much more focused.
The company could immediately create shareholder value by acquiring the rest of the REITs it already controls, or by a number of other methods I outlined in this post. Instead, they do nothing. This is bad because not only does it strongly show the NAV values are fiction, but it also shows an unwillingness to practice even basic capital allocation.
I’d understand it if the CEO (or his family) was hoovering up shares as fast as they could get their hands on them, buying when the stock was depressed. But they’re not. Sahi is content to hold. He’s not buying, but he’s not selling either. The Corporation is doing a token amount of share buybacks, but nothing very exciting. The inability to act is especially surprising considering how Sahi operated in the 1980s and 1990s. He was the king of stirring shit up.
I do think at some point the Corporation’s price-to-NAV does correct from its current 30% level. I can see a world where it trades for 40-50% of NAV. I don’t see any possible way it trades for 100% of NAV. There’s just too many layers, and a lot of them are filled with crap. I also think there will come a time when the company is forced to take its medicine and do an NAV write-down. So there’s upside potential, but not enough to get me excited.
Instead, I bought a small position in Morguard Residential. Yeah, there are warts there too, but not nearly as bad as the other parts of the business. I like the U.S. exposure, and I’m happy to take a 3.9% dividend while I wait for the price-to-NAV discount to narrow a bit. They’re buying back shares and I think they’re building a legitimate business there. It’s not a huge position to start with, but I could be persuaded to increase it. It could be a real winner if the parent gets serious about making it a winner. I’m not holding my breath.
Author owns Morguard North American Residential REIT shares
Thank you for your first Impression. Will keep looking for a knowledgeable comparative analysis of the corporations and sector prospective.
I love seeing me some Morguard discussion.
A while ago, I looked at Morguard Corp and figured that if you used public market valuations as comps for its various holdings (HOT.UN for the hotels, TNT.UN/SOT.UN for the offices, HOM.U/(now DRR.U)/MI.UN/KMP.UN for the apartments), and used the public market value of the REIT and Residential REIT, NAV was much more like $180, vs whatever Morguard said it was. Importantly, these comps weren't done with REITs trading at huge discounts to NAV, but instead were applying more accurate cap rates to Morguard's properties - keep in mind a 0.25% change in the cap rate used swings Morguard's NAV by like $50/share.
Since then, interest rates are way up, office valuations have only gotten worse (while I expect the apartment REITs and hotels are similar). I'd expect $180 was perhaps overly punitive before, but I bet it's accurate or close to it now. To me, $180-$200 is much more your upside than $300+ is.
And for the reasons you stated and more - questionable capital allocation, related party questions, Sahi's control and the possibilities of a takeunder, the asset management business being not great (while great ones like Dream and Tricon are not valued well by the market), the low yield and corporate structure being unloved by real estate investors, oil and gas exposure (specifically the Obsidian building), and a lot of lower quality properties (alongside a lot of very high quality properties that Morguard doesn't get credit for), it makes sense for Morguard Corp to trade at a discount.
Now there's a good argument to be made that the price should be more like $150 than $110 like it is now, but when looked at with clear eyes the Corporation isn't the screaming bargain many proclaim. You're right that Morguard Residential is the jewel. Its NAV is also too high, the cap rates in that table are too low, but NAv probably is like $22-$23. The valuation still provides a welcome opportunity.
Also, it's worth pointing out that the Corporation actually has been pretty active buying units of the REIT. Morguard just announced that the Corp bought 2.5% of the REIT in one fell swoop, and it isn't the only purchase it has made. I'd say at least that criticism, that Sahi isn't buying the REIT so he must think the NAV is too high, is exaggerated given the Corporation's purchases.