Choice Properties: Invest in Real Estate With One of Canada's Richest Families

The Westons invest for the long term and I'm happy to invest alongside them

The Weston family doesn’t need much of an introduction. They’re among Canada’s richest people, and, depending on your perspective, are either to be admired for their business acumen or hated for needlessly jacking up the price of groceries for our most vulnerable citizens.

The family’s success started with George Weston’s foray into the bakery business. After completing public school at age 12 in 1876, Weston took an apprenticeship with G.H. Bowen, learning everything about the business. He became a salesman and his first foray into entrepreneurship was buying a bread route from Bowen. A few years later he purchased the entire bakery from his mentor and by the mid-1890s he was well established in the bakery business.

After merging with a competitor in 1901 — a move he convinced consumers would lead to lower prices — the newly expanded Weston bakery empire started moving into cookies, since they offered higher margins compared to bread. By 1911 Weston was all-in on cookies after selling the bread operations to a consortium called the Canada Bread Company. Part of the conditions of the sale was Weston’s agreement not to compete with the new company for 10 years.

After World War I George’s son Garfield took over the family business, using equipment imported from England to undercut English imported biscuits, a big growth market at the time. The company also got back in the bread business.

By the Great Depression Weston’s biscuits had begun expanding across Canada. It purchased the Independent Biscuit Company of Calgary in 1931 and the bankrupt Ontario Bakeries a couple years later. Weston’s was profitable throughout the depression, and was able to get financing when other potential suitors could not. It also took advantage of the turmoil in Great Britain to acquire various biscuit and bread plants there.

After the 1930s buying spree was completed, Garfield Weston owned cookie plants in Canada, the United States, and Britain. The British part of the business was so important he eventually moved his family there.

The company finally moved into the grocery business after WWII, including a large stake in Loblaw Companies in Canada in 1947-48, a high-end grocer in England in 1951, a discount grocery chain in England in the mid-1950s, and even expansions into France and West Germany. It also purchased a large stake in Chicago Tea, a chain of 700 supermarkets in the United States.

Garfield’s son Galen was asked to turn around Loblaws in the early 1970s, after the chain suffered from poor sales growth and slowing profitability. Galen took a machete to the business, eventually closing hundreds of too small and outdated stores. He also sold off large parts of the chain’s U.S. operations.

Eventually, after consolidating operations in the 1980s and 90s, George Weston — the company, not the person — would grow to own two things. The first one was a large stake in Loblaw Companies and the second was the bakery business. By the early 2010s George Weston (TSX:WN) and Loblaw Companies (TSX:L) decided to spin out the real estate into a third company, a REIT called Choice Properties (TSX:CHP.un). George Weston still owns a big stake of Choice Properties today. George Weston then sold off the bakery business, meaning all it owns today is large stakes in Loblaw and Choice Properties stocks.

George Weston is one of those holding companies that probably shouldn’t exist. It persistently trades at a discount to a sum of its parts because you can easily replicate it yourself. If you want exposure to Loblaw or Choice Properties, just buy them yourself.

Anyway.

I highlight the history of the Weston family for a couple reasons. Firstly, it’s interesting. If someone put all this into a book I’d read the hell out of it. And secondly, I’m trying to give you all a glimpse into the thinking of the Weston family. These guys are long-term investors who have been in business for 150 years now. It’s a big part of why I’m bullish on Choice Properties.

Let’s take a closer look at the company itself.

The skinny

Choice Properties was spun off from Loblaws and George Weston in July, 2013, with the two companies selling a portion of their holdings in a $10 per share IPO on the Toronto Stock Exchange. Loblaw exited Choice completely in 2018, selling its shares to George Weston.

The real estate was spun into its own unit for a few reasons. It would allow Loblaw to focus on its grocery business. It also allowed Loblaw to crystalize the value of its real estate, and for the real estate to take advantage of the REIT structure. When real estate is tucked inside of Loblaws, any profits get taxed twice — once at the corporate structure and once again when distributed to shareholders. REIT profits are only taxed when distributed to shareholders.

There’s another advantage. When Choice properties was part of Loblaw, it was essentially a retail landlord. Which is fine, there’s nothing wrong with that business. But now that it has been separated from its former parent, Choice can go ahead and act like any other REIT, including launching a development program and expanding into industrial and residential real estate. Which it has done, as you’ll see.

First, a look at Choice’s portfolio. It is one of Canada’s largest REITs, owning more than 64 million square feet worth of space spanning 701 properties.

As you can see, it’s still retail dominated, and much of the industrial space is warehouses rented to various Loblaw entities. You can also see they’re just starting to expand into mixed-use and residential properties. They have big plans there, more on that later.

Choice’s largest tenant is, by far, Loblaw. Loblaw may have sold out of its stake in Choice, but they’re still intertwined.

Sure, 50%+ exposure to one tenant looks like a lot, but the company has actually done a nice job diversifying since its 2013 IPO. Loblaw represented more than 90% of the REIT’s total income at the time.

Choice has expanded a few ways since the IPO, which included a little over 400 properties. It has purchased assets from Loblaws as it looked to get completely out of owning its own real estate. It also purchased properties from third parties. It made a big acquisition in 2018, purchasing CREIT for $6B, including debt. And it has used its large land holdings to start a development program, which includes getting into mixed-use and residential property.

After the CREIT deal especially, Choice started an active capital recycling program. It Sold more than $2.3B worth of property from 2017-22, while adding an additional $1.4B worth.

Another interesting move made by Choice Properties was its 2022 decision to sell a bunch of office space. It sold six office properties to Allied for $794M. Allied paid in stock, giving Choice approximately 11.8M shares valued at just over $50 each. Choice also holds a promissory note of $200M.

As of today, those Allied shares are worth about $25 each. Whoops. Choice still maintains an 8.5% ownership interest in Allied.

Note that Choice still owns a little bit of office space, but most of it is either leased to George Weston, Loblaw, or is used internally. It has no plans to sell this space.

Let’s talk about the development program next. Choice has been busy developing properties over the past few years, adding more than 100 locations to the portfolio.

Most of these are really simple additions to current retail property. There are many Loblaw properties across Canada with huge parking lots that sit empty most of the time. So they develop property in those parking lots, simple things like bank branches, fast food restaurants, or other ancillary businesses. I love these deals. They’re easy and do add value. But at an average cost of less than $5M per deal you have to do a lot of them to scale.

I’ll quickly say Choice has told investors it still has potential to do hundreds of these retail bolt-on developments over time. The development program is just focused on bigger projects today.

The industrial and mixed use development programs are more interesting. Let’s start with industrial. Choice has some 7 million square feet of industrial space either in the active construction or zoned and ready stages. Much of this is in the Caledon Business Park, which has a total of 380 acres that can potentially be developed, located just a short drive from the GTA.

Choice has been actively developing some of its grocery property into mixed-use locations over the last few years too, as well as getting into residential real estate with partners. Completed projects are currently focused in Toronto, but there are residential properties in various stages of development in Ottawa and Brampton as well. Upcoming projects include a bunch of Toronto properties all located close to (or inside) downtown, with transit links nearby, with plans to develop in Montreal and Vancouver long-term as well.

Here’s a snapshot of Choice’s 18 million square foot development pipeline.

Return potential

I really like Choice’s pivot away from Loblaws property and into industrial, mixed-use, and residential. All of those are higher quality assets than retail.

Still, I like the retail assets too. They provide plenty of steady income as Choice diversifies. Much of the land being used in the development program comes from these retail assets, too. And as places like Toronto, Vancouver, and Calgary get more dense these retail locations will turn into more attractive development land.

Additionally, I think Choice has one of the best balance sheets in the business. It has a debt-to-assets ratio of under 40%, below most of its peers. Much of that debt is unsecured, borrowed against the trust of the organization rather than against physical properties. This translates into more than $12B of unencumbered assets and a solid credit rating.

Choice has returned approximately 9.6% per year — including reinvested distributions — since its 2013 IPO. That’s quite close to my hurdle rate of 10%.

In a recent investor day Choice guided a 9% annual return target, including a 5% distribution yield, 2-3% growth in the existing portfolio, and a 1% growth rate from the development portfolio.

There are a couple of factors that I think could help push the total return to 10-11% annually, at least over the next 5-10 years. Firstly, this hasn’t considered any outside acquisitions at all, nor does it consider any property acquired from Loblaw. Choice still has right of first refusal on any real estate Loblaw is looking to sell. There’s also the potential to pick up retail assets sold off by REITs (or other real estate investors) who no longer want to be in the retail game. Acquiring an additional 1% growth is not outside the realm of possibility.

There’s also multiple expansion. Choice trades at approximately 14.5x 2023’s projected AFFO, which should check in around $1 per share. Granite REIT, meanwhile, trades at nearly 20x 2023’s projected AFFO. I’m not arguing Choice deserves a 20x AFFO multiple. I don’t even think Granite deserves a 20x AFFO multiple. But I easily see a world where Choice moves to 15x or 16x AFFO, enough to goose the total return another 1% each year. That moves us from a 9-10% return profile to an 11-12% profile.

What I really like about this one is the downside risk. I think there’s very little risk of shares collapsing from here, even if interest rates continue to go up. I see worse case returns of somewhere in the 7-8% range. I’ll take these decent upside with high floor return scenarios all day long.

The distribution

Choice has been a solid choice for income oriented investors ever since its IPO.

Oh, come on. You knew I was going to do that at least once.

Distribution growth hasn’t been spectacular, but investors were treated to raises in 2016, 2017, and then again at the end of last year.

The AFFO payout ratio is approximately 75%, and I think the company will strive to maintain that payout ratio over time. Meaning, investors should see small but steady increases in distributions. It might not happen every year, but it should go up over time.

There’s also virtually zero risk of a distribution cut anytime soon. A 75% payout ratio is solid. There’s plenty of wiggle room if something goes wrong.

As I type this, shares yield 5.2%. A good chunk of your return going forward will come from the distribution, but Choice retains enough income it can help fund the development portfolio.

The bottom line

Here’s why I spent a bunch of words talking about the Weston family at the beginning of this post. Because those guys are smart investors who put their money to work with a multi-decade timeline. They want to own the best real estate possible, not make next quarter’s numbers.

In short, these are the kinds of investors I want to invest alongside.

Everything about Choice screams high quality. It is taking a slow and measured approach to development. It owns some of Canada’s busiest retail locations, real estate that is only going to get more valuable over time. And it has the financial prudence to make sure it can easily survive rough patches.

This is a stock I’ve been slowly purchasing to the point where it is a top five REIT position for me. When I have a little bit of cash I buy 100 shares. I think anything under $15 per share is a good entry point, but at the same time I don’t think you’ll go too wrong even if you pay a little more.

I view Choice as having a really solid floor with the potential to be surprised on the upside. I’m thinking worse case scenario of 8-9% over time with upside in the 11-12% range. I’m happy to take that all day long, especially with an asset I feel good about tucking away and forgetting about. Certain stocks you have to keep an eye on. Choice isn’t one of them.

Disclosure: Author owns Choice Properties shares