Description

European Residential REIT (ERES) is a TSX listed REIT with multi-family and single family rental properties in the Netherlands. I believe there is a very low risk upside of 30-40% in the next nine months.

Investment Summary: ERES is in the midst of winding down operations and everything is for sale. It recently announced the conditional sale of ~50% of its assets above IFRS NAV value. CAPREIT (the largest Canadian Residential REIT) holds 66% of shares outstanding and is committed to selling the REIT on a piece by piece basis at/above IFRS NAV. IFRS NAV is ~C$4.30 (current price of $3.25). Given the decline in interest rates and re-ignited demand for investment properties, I think the most or all of remaining assets will be sold by Q1 2025. I believe CAPREIT will take private any remaining assets at NAV value to clean up the capital base. Total Return of C$4.30 (plus 5% dividend yield). Insiders have been buying ERES stock for first time post-sale announcement. If no subsequent asset sales occur, the remainco still trades at an unjustifiably large discount with a better balance sheet and 4% yield.

Background. ERES was your typical growth through acquisition REIT focused on the Netherlands, one of the shortest supplied property markets in the world. ERES enjoyed solid NOI growth and rock bottom financing (1.5% morgage rates). It was caught offside with too much debt as interest rates rose globally, and interest expense grew faster than NOI. At YE 2023, ERES was staring down the pipe at EUR$750M of mortgages coming up for renewal through 2026, with refi rates of 4.5% (this would add an additional EUSR$25M per year of interest costs). I believe EREs would have been able to maintain its dividend but the stock was cut in half anyway trading near C$2.20, despite IFRS NAV well north of C$4.00. After a strategic review failed to find a buyer, CAPREIT (owner of 66% and manager) decided to start seliing off assets piece meal indicating that it believe it could sell assets above NAV value, use proceeds to delever. CAPREIT is looking at all possible angles to surface value -

Here is CAPREIT CEO Mark Kenney (also acting CEO of ERES) on Q2 call in Aug 2024 on transaction market conditions in Netherlands.

When I met with management in February, they indicated CAPREIT and ERES shared common shareholders and many would be frustrated if CAPREIT used the weak equity market to force a sale of ERES signficaintly below NAV  (despite the fact the shares traded well below NAV). CAPREIT indicated the assets were not impaired (private market tranactions were inline with IFRS NAV carrying value) and committed to selling units at NAV.

After some early success selling individual suites in H1 2024, ERES announced the sale of C$160M of assets in July 2024 above IFRS value. Then in Sept 2024, ERES announced the sale of C$1.1B of assets above IFRS value. Together, these represent about half of its assets. Proforma the dispositions the REIT will:

1. Pay a special of C$1.13 (EUR$0.75)

2. Reduce its divdiend distirbution by half

3. Reduce total debt from EUR$0.96B to $EUR$0.30B

4. Since the assets have all been sold above NAV, IFRS NAV remains near or above C$4.40

Summary of the Deal Proforma - most of proceeds to debt and special distribution

Opportunity

Right now ERES is trading at C$3.25 with an IFRS NAV of C$4.40 about a 25% discount or a 38% upside to NAV. Not bad, until you consider that C$1.13 will be repaid in cash when above transaction closes (early 2025). Post-distribution if nothing changes, the share price should adjust lower to $2.12 and the IFRS NAV to $3.25. Now you're upside to NAV is 54%.

Now consider that a) remaining assets are in the Randstad region (urban/populated), b) are equivalent in quality (per management update post transaction) and c) increased buyer interest in recent months as rates/inflation falls. CAPREIT is highly motivated to clean up ERES from its books and will likely transact on more assets near NAV by Q1 2025 in my opinion. I believe if any properties are no saleable, CAPREIT will take out the remianing REIT assets to clean up its books/reduce expenses (public co, REIT structure) by June 2025. This should likely net close to $4.40 NAV.

My convction is strengthened by two recent insider purchases post announcement (and 40% move in share price in 3 months) - CFO Jenny Chou bought 8,400 shares at $3.27 on Sep 26 and Julian Schonfeldt, CAPREIT Director of Investments bought 49,600 at $3.20 on Sep 19. It appears they both see a low risk path to 30% as well.

The downside is no material transactions are announced and the REIT continues to chug along as a subscale REIT. Post special distribution and distribution cut, the shares will still yield 4% and the REITs balance sheet will be much stronger (debt/GBV of 33%, down from 55% pre-disposition). If the share price doesn't move higher, it will be trading at a 33% discount to NAV, among the highest in Canadian REIT land.

Hypothetical Return on C$10,000 purchase

3,075 shares at C$3.25

$3,477 special distirbution Jan 2025, share price of $3.25

Share price falls to $2.12 - use proceeds to buy 1,640 additional shares

Total position = 1,640+3,075 = 4,715 @ $2.12 (IFRS NAV = $3.25) *I would increase total exposure if price is ~$2.12 post-special distribution

Corporate acquisition at 10% discount to new IFRS NAV = $2.95 = 3,913 profit

=39% + ~4% return from dividends

Obviously, we don't know the path of future share price. I would expect the market to trade closer to NAV pre-distribution. Hypothetically, let's assume share price increases to $3.75 pre-distribution.

3,075 shares at C$3.25

$3,477 special distirbution Jan 2025, share price at $3.75

Share price falls to $2.62 - use proceeds to buy 1,327 additional shares

Total position = 1,327+3,075 = 4,402 @ $2.62 (IFRS NAV = $3.25)

Corporate acquisition at 10% discount to new IFRS NAV = $2.95 = 2,985 profit

=30% + ~4% return from dividends

Takeaway is the absolute return is lower the sooner share price responds - if market perks up before special distribution and takes price north of $3.75, return outlook gets much lower. 

Catalyst

Asset sales and Corporate Acquisition by CAPREIT if portfolio sale not possible.

Further insider share purchase transactions