A Day Dreaming
September 6th
Early on my ears perked up when Michael Cooper, speaking as Dream Unlimited's CRO (CEO) announced a future educational event (Teach in) where they'd talk about "how we think we're going to continue making money at the rate we've been making over the last 10 years." Now that's pretty interesting when you consider where NAV/book have gone over the last 10 years compared to the current discount to try to figure out an IRR for today. If one were to use NAV growth as a surrogate for expected return, the numbers get pretty interesting, pretty quickly at a decent range of assumptions on what both of those numbers would be.
It was also said that FFO was shown because some would appreciate it but the company has always and will always focus of growing Net Asset Value. My humble opinion is this is the best way to run and think about real estate companies. It is the gravity which the company will orbit long term. Amounts of leverage, distributions, uses and prices of capital will change over time focusing on growing the terminal value of assets makes the most sense when you can do it as well as Dream.
Infinite Money Glitch
Unlimited spoke about their development activities saying they essentially end up building to 6% cap rates in western Canada... And 10 years debt was available near 4% (3.8%). Now that doesn't sound like much of a clip.
It isn't, strictly speaking but it's also infinite. Making 2% is very little but it's not really making 2% in that scenario... It's an inflate % because you'd keep the 2% on someone else's incremental capital. Similar to asset management fees.
Use assets + credibility to get capital, use capital to create asset, use asset to pay off the capital... Keep asset + credibility.
Sure, it might not make sense to use 100% debt to finance development at a 2% spread but there's a lot of room for good returns between the infinite % of using all debt and the 6% of using all equity capital. Given however the incremental WC unit being a relatively small cost and portion of the companies' NAV, they can effectively use outside capital for the majority of the development. Also, if you have access to asset specific debt that can be locked in for a long time you can use a significant amount. If those assets become gifts that keep giving the returns can be ridiculous... If not, it consumed less capital.
I'm sure they won't take this idea as far as I suggested above and will have some level of equity backing assets. On the other hand, when looking at incremental capital needs & if we assume they own the land unlevered...
Developing at 6 or in the 6s and having access to term debt closer to 4 also means that the interest on the higher cost construction loan (6s or 7s) are somewhat misleading when it comes to interest cost modeling. As the assets are completed, the cost of debt decreases as the revenue kicks in to pay off the development.
I took the scenic route to saying: $8 of unproductive land on the BS... Weighing down book value CAGR... Or $15-20 of land in NAV yielding nothing can easily blossom into its own company there without requiring the rest of the business to subsidize it. WC dev is a potentially significant business.
We Prefer Apartments
Cooper made an offhand comment that was interesting to me when he said, "We prefer apartments because they keep on giving." It's interesting because... They don't really have many rental apartments. Most of what they do have on the platform are small stakes via funds and JVs not what they developed. Hopefully this means dream will develop and keep some awesome properties that keep adding value for years and decades to come.
Hundred Baggers
Cooper spoke about some of dream's best performing investments. They bought assets that nobody wanted for very cheap... A cast-off ski hill. An old distillery. And turned them into great desirable, niche places. They develop a culture around them and add to the region. Grow the assets with more vision than math. Long into the future you have assets who yield 100s of % of the companies' cost. Assets worth much... Much more.
I quite liked the story about the investor who told them they 'better not buy that middle of nowhere asset in one of their funds.'
With all the respect in the world for Cooper this does make me wonder about the affordability arm of MPCT. What dream has done fantastically was prove out the ability to visualize and materialize a wonderful experience. Think, Distillery District, A-Basin, Forma. What's completely different is dealing with affordable side of the market and those associated challenges.
Office.
Office remains excessively noisy. The most interesting Cooper remark on Office was around zoning. They provided an example, using their head office building as an example... Of how an office building is worth about $240M whereas if it were empty land with residential zoning, it would probably be worth $300M. Meaning: office zoning essentially has negative value. The implicit suggestion here is that there's a more drastic manner of balancing the currently oversupplied office market. If cities would remove need to replace office space, plenty of residential development would be possible.
This would work towards balancing both markets (resi and office) much quicker and provide cities with more vibrancy and tax revenues. The main problem with this scenario which seems ideal for all parties is it hinges on wise political governance... In other words, it's probably dead on arrival.
D-UN focused the bulk of their presentation on the quality of their assets. Core assets, market leading rent and rent growth. Strong renewals and significant spreads over past leases. Highly in demand restaurants. They're certainly holding up better than many... But I'm sure the toxicity of the asset class weighs on all.
It remained unclear what DRM would be doing with their stake. Cooper didn't sound tremendously bullish even on what the rest of the crew were discussing as tremendous properties. The asset collector in me doesn't really want them to sell any. I have various conflicting thoughts on this whole thing so instead of more back and forth, I'll just wait and see.
US Real Estate
I can't remember which call it was in but Cooper mentioned that 3000 buildings in the US were given back due to changed market fundamentals and credit availability in the country. He also suggested that's going higher. It sounds like RE credit markets aren't going well where it comes to availability.
This plugs in to two other points.
1: Their entrance into the US credit markets with the Aviro partnership. Perhaps there's space and opportunities in the US lending market. Given however that my hopes for that business are that it's an OPM asset management business, I guess the challenge would be convincing investors to step in with funding. I'm not sure how tied to a niche their initiative might me at this point vs broad enough to market the equity fear (on lack of credit availability) as an opportunity.
2: A Basin
A-Basin
They mentioned that it doesn't really make sense to sell A-Basin. Their cost basis is 0 and tax would eat too much of the value to justify. They also suggested they they don't have other US assets to offset the tax. They can however use pull capital from the asset while keeping the growing, strong asset.
No US assets, US capital available, people having to give back assets... Need I go on? I don't really know what kind of thing they'd have interest in. As much as I prefer the development side of the business particularly in Resi, the fundamentals in Canada seem far stronger than in the US. The distressed assets also aren't necessarily there. A-Basin, if that's also where the bulk of the capital were to come from, isn't tremendously huge either. They could buy an asset... Or two but couldn't acquire a portfolio. That said, they also suggested they wouldn't need to acquire much because of their current long runway of assets. I for one would love to see the legend of the $4M asset acquisition continue to expand in value across other assets in the country.
Canada Fundamentals
One point brought up in the Impact Trust Q&A I wanted to discuss because I emphatically agree with it. Last year Canada had this wonderful plan to help housing affordability... Build twice as many houses each year. No sarcasm here... It's a good idea. The "how" was a bit less though out. The capital needed to execute on the plan was to be a mere 2x GDP. So naturally they assumed it would just happen without much help. One thing that did brilliantly help is interest rates were raised ~tripling the price of that 2xGDP of capital. That one was sarcasm. Anyways housing starts fell because builders don't want to fight the central bank. So now we need to almost triple housing starts... Lovely.
It's slightly better (worse) than that. The reason we weren't building more before was labor constraints. Constraints which likely don't naturally improve as most of that labor force is far closer to retirement than day 1. Constraints which also mean that infrastructure improvements would consume the same productive capacity that would otherwise be building places to live.
Now imagine how screwed up the situation would be if 30% of construction costs were taxes...
Replacement Cost
The above point about labor flows into the point about apartments being the gift that keeps giving. Something that many people seem to miss but seems impossibly evident when coming from commodities is that cost of production is paramount. You can always have more of something if the price is high enough to cause people to profitably add capacity. Whereas you get no more of somethings if the price is too low to produce it. (There's of course a lag). It's much more expensive to build a building today than it was 50 years ago. It'll probably be much more dollars in 50 years to build than now. If we're talking about an apartment building... it'll house the same number of people... people who'll be earning much higher wages (in $). The economic value of this apartment will likely increase over time.
As long as you need to keep expanding capacity... ie growing an economy... prices will need to trace production cost. If you want to understand the main reason why Canada is more expensive than Japan... or Toronto is so much more expansive than Edmonton look no further than the continued need to develop in a constrained area. You can wreck the economy short term and disrupt the incentive to build... overcapacity or negative economic growth, population shrinkage etc. There are a few (Land and Tax) costs which are medium term questions and could in theory decline leading to lower prices... although offset on the developer side. When the need to grow supply returns it will cost money... and probably more money. Better or more in demand areas also contribute to how much people are willing to pay to live there. Higher wages, more entertainment...
Rental properties can provide cashflow as that process works in the background... Location Location Location.
Sovereign Wealth Fund... Part 2?
It was hinted that Dream was trying to duplicate what they did with GIC & Summit. I'm of course all for that. A second deal could easily take NAV in that segment into the mid 20s from high teens. Not that anyone cares about such things. It's amazing really, the market apathy around dream's AM business. This is especially true after they landed their first Sovereign wealth fund partnership. Any catch of that size going forward is a step in value of relevant size for the company as a whole.
I compare an ideal Asset Managers' approach to that of fishing. To have the best chance of success, you want to have a bunch of lines cast and waiting for excitement. Having more funds, at least at a size that the market would accept, wants there are more scenarios for growth. A suspicion I had when they bought more of a stake in the distillery district was they may have been setting up a future Retail REIT.
Ideally someday they have a retail REIT, a Canadian residential REIT, more private Canadian funds, some US public stuff etc... that way there'd be more scenarios that could provide them with funds. The issue of course is that each needs it's own scale and liquidity not to mention their own management team... Associated costs etc.
I'm sure they'd love to have a second asset class with scale. Industrial has been the majority of their asset management success... It now makes up a disproportionately large portion of their fee bearing AUM. It's the only public field I could see able to make bite-sized additions and partnerships that would make significant jumps for DRM's AM growth.
Tax
I am one investor who wasn't the least bit surprised about the mention by DRM's CEO about the tremendous amount of time he spends on tax. I'm not just saying that to try to sound like a know it all jackass. I've been thinking a lot about it myself especially since tax season 2022.
Most of the excess returns on an asset purchase are front loaded... You see something differently, maybe you get it right or something changes. The value moves to where you expect... Then what. For an asset to get there... Say 5-10x the initial price, it probably needs to prove a lot of value, deleverage, grow, add stability, normalize the bargain price, etc. You then are left with a bigger asset with more average prospects and return profile at the asset level. You can sell it and reinvest the proceeds... After tax, losing a chunk of your gain in the swap. Or you can pull capital from that improved asset value (an asset with an average cashflow yield & average prospects) to invest in an asset with superior prospects.
Further, the mechanics when it comes to writing off interest vs the tax efficiency of certain income streams and nuance of different tax laws make it quite beneficial to put ample consideration of tax ramifications of virtually everything. Depreciation & amortization etc. Were I operating an asset collecting platform on any relevantly sized scale, I'm sure tax would be a huge part of most decisions.
The margin of alpha in many investments is so slim that it's hard to really benefit to an excess degree over time if you have to keep taking hits on tax every time you want to deploy capital. This is especially the case when you have perfectly good assets that should easily more than cover the cost of the capital you'd pull from them. Doubly so if you had an actual business with access reasonably priced fixed debt. Managing small things like D&A properly have a multiplied downstream impact on returns when operating cashflow can support new investments which offer high returns. Assets can have tons more value than what the taxable earnings they spit out might suggest. As I suggested much earlier, NAV or fair value of the assets is key... This isn't always the same thing as book value.
It's a bit of a relief to know that I haven't been the only one obcesing over the tax lens of investing. I feel a bit less crazy. I do find it a bit amusing given part of what's special about DRM, in my opinion vs the many cheap stocks out there and perhaps even slightly cheaper RE peers is that I think dream offers superior long term tax efficiency. I guess we'll see if that's the case.
Conclusion
I started this reflecting on some AGM thoughts. By this point however, I find myself looking at the company's intermediate future in a way I hadn't quite before. A billion dollar asset management business. A billion dollar western Canada homebuilding business. A billion dollar urban development business. A billion dollars worth of REIT unit holdings & other stabilized assets. That's four distinct categories which could all single handedly be worth more than the current market cap in a few years. All of which are both self sufficient and strengthened by their connection to the rest of the business. Dream will continue to work towards solving Canada's housing shortage to the degree they can. Rate hikes will continue to slow the industry and make the problem worse short term. I believe demand will be resilient based on supply and demand fundamentals, likely for years to come. As for me, I'll probably try to collect a few more shares over time if prices remain as discounted as I believe they are.
