Land Lord: Calgary’s Mainstreet Equity gambles on Edmonton
How a Calgary real estate company plans to take over downtown Edmonton
by Eric Blair
On its own, it was a simple real estate transaction between buyer and seller. But the purchase of City Square Tower, a 28-storey residential building on 104 Avenue in downtown Edmonton, by Calgary’s Mainstreet Equity for $40 million in early June, wasn’t on its own. Instead, it was the culmination of a strategy that the company has been pursuing since 2007– one that saw it scoop up 77 properties containing 2,218 units in an area bounded by the airport lands to the north, Jasper Avenue to the south, 124 Street to the west and 97 Street to the east. And it’s about to pay off in a big, big way.
V250 Rank: 214 | Revenue: $66.8 million | Number of Employees: 230
Chief Executive Officer: Bob Dhillon
Illustration Dave Webber
In retrospect, the strategy looks fairly straightforward. With the construction of new LRT lines, the development of the former downtown airport and the construction of a new arena, not to mention a rapid gentrification process along 124 Street and the expanding campuses at NAIT and Grant MacEwan, the neighbourhood is about as sure a bet as you can find in the city when it comes to property-value appreciation. Indeed, as a recent paper by University of Alberta economics professor Brad Humphreys noted, properties within a 1.6-kilometre radius of Edmonton’s new arena can expect to see their value increase by “tens of millions of dollars.”
Jimmy Shan, an analyst with GMP Securities who covers Mainstreet Equity, says the package of real estate assets in the area the company has acquired – one that comprises 35 per cent of its overall portfolio – is “a significant long-term positive.” And while it hasn’t been priced into the stock yet, he thinks that’s only a matter of time. “The capital markets are very short-term minded,” he says, “and this is more of a longer-term play.” That disconnect between Bay Street’s attention span and Mainstreet’s strategic plans isn’t new to the company, or to its founder and CEO, Bob Dhillon. “On Bay Street, a lot of the investors and portfolio managers are very short-term thinkers,” Dhillon says. “They don’t want to look three years down the road – they want to look three quarters. I’ve taken a long-term approach towards Mainstreet.”
Has he ever. Wind the clock back a few years, before the provincial funding for the LRT lines was secured, before the debate over the airport had been concluded, before the torturous negotiations over the downtown arena were put to an end, and the strategy to build up land in the less-developed and more downtrodden portions of downtown Edmonton doesn’t look nearly so obvious. “We said that if we hit one of them, we’d be happy,” Dhillon says. “We hit all of them. Even if the arena didn’t happen it was a home run. But this was a grand slam.” He’s not exaggerating, either. Just look at the numbers: Mainstreet’s first deal, back in 2007, came in at $20,000 per door (a standard metric when valuing residential properties). Lately, buildings in the area have been trading at closer to $90,000 per door.
And while Mainstreet will almost certainly do well on its investments in the neighbourhood, Dhillon’s interest in it is beyond monetary. He thinks it can become a showcase for both the city and his company, a chance for Mainstreet to shed its reputation as a purveyor of low-cost, low-quality housing. “One of the negative comments we get is that ‘You guys are slum landlords,’” Dhillon says. “But what they don’t understand is that we buy slum properties and transform them. Per capita, we’ve spent more money on [capital expenditures] than anyone else. They see the old – they don’t see the new. And there’s always a lot of old coming through the pipe, so they stereotype all these buildings. But I’ve made this area our benchmark – we’re going to transform this area into, like, Yaletown. Mainstreet’s going to do it.”
Dhillon founded Mainstreet Equity in 1998 with 272 units of mid-market housing that were worth approximately $17 million at the time. Today, his ever-expanding empire of mid-market housing stands at 8,432 units, with a market value of $1.1 billion, and while that’s in part a product of some favourable conditions – interest rates have been on a one-way ride to zero, while the company’s key markets have been the economic engines of the country – Dhillon deserves much of the credit. He’s built a model that works. Essentially, Mainstreet buys residential assets that are too small for the big REITs like Boardwalk and CAP to take an interest in, but too big for a mom-and-pop investor to run efficiently. And he’s been relentless in his dedication to that strategy. He demonstrated that dedication in 2008, when, during the depths of the economic crisis and with his company’s shares trading around $6, he decided to buy back 40 per cent of the company’s float. Today, they trade above $32. “Now, I look brilliant,” he says. “At that time, I looked like an idiot.”
More important, he says, is the fact that he’s grown the company without ever diluting its shareholders. “We’re the only company, I think, in the history of Canada that’s gone from 272 units to 8,432 as of the last quarter – it’s higher now – without any equity dilution. It’s all been done through internally generated cash flow.” It is, as one journalist covering the company quipped, “a car that runs without gas.” And the car still has a long way to travel, Dhillon says, given the likelihood that low interest rates are here to stay for at least a little while longer. “What business in the world – in the world – has three per cent, 10-year term, 35-year amortizations? That’s cheaper than blue-chip financing on the bond market. Inflation is, what, two per cent? So the cost of financing is one per cent, but it’s amortized over 35 years, so I call it free money. And it’s a product where you’re never going to have competition from new supply because it trades below replacement cost.”
If there’s one secret to Mainstreet’s success, it’s that last part right there. It is, as anyone searching for an apartment in Alberta has discovered, nearly impossible to find newly built rental stock. That’s because it’s still cheaper for landlords like Mainstreet to buy an existing building and improve it than build a new one from scratch, and until that changes – and Dhillon doesn’t think it will for a while – that means no new supply coming on the market. “Replacement cost is a key driver of our business,” he says. “I think there’s going to be one more cycle until we hit replacement cost, and until then whoever owns apartment buildings is going to make a ton of money. It’s going to be a great ride.”
When that ride’s over, Dhillon says, it’ll be time for a different one to begin. He says that when the time comes – that is, when the properties he likes to buy aren’t trading at a discount to their replacement cost –he’ll explore the possibility of a major strategic shift, be it selling out to a REIT or getting into the land development game. Mainstreet, he notes, has a considerable portfolio of undeveloped land that adjoins and abuts many of its properties.
But that day still lies in the future. In the here and now, Dhillon still has an empire to build, one building at a time. “If I double the size of Mainstreet, I’ll still only be 18 per cent of the mid-market in my geographic location. Not the overall universe – mid-market in my geographic location. So consolidation hasn’t started.” His bet on downtown Edmonton, meanwhile, is about to start paying out. “It’s not going to end when the arena gets built,” he says. “There are going to be so many services and restaurants and bars and hotels – it’s going to be a destination. And we’re perfectly positioned.”
Much Ado About Nothing
If there’s one thing that separates Mainstreet Equity from virtually all other real estate companies, it’s the amount of money it pays out to its investors: nothing. And while analysts and investors alike have nagged the company – begged, practically – to start paying out a distribution, it has resisted the temptation. Why? Because, in short, CEO Bob Dhillon thinks he can get a better return for his shareholders by investing the money into new buildings than they would investing a cash dividend on their own. And the numbers back him up: Between May 2003 and May 2013, Mainstreet Equity outperformed every publicly traded real estate company in Canada. No, check that – it crushed them. Its total return over the 10-year period was 910 per cent. The nearest competitor was Morguard Corporation, at 634 per cent, with Boardwalk REIT close behind at 591 per cent. Large-cap REITs like Riocan, Dundee and H&R delivered between 306 per cent and 219 per cent – great returns, for sure, but nothing like Mainstreet’s. And those figures include the dividends they paid out and Dhillon didn’t. It’s no wonder he’s stuck to his guns.
That doesn’t mean Dhillon isn’t considering implementing a dividend at some point, though. “One of the negatives about not paying a dividend is that it closes 200 doors that could be open to me,” he says. “That could create more liquidity, more volume and more credibility for Mainstreet.” Would it move the stock? GMP’s Jimmy Shan isn’t so sure. “I don’t think it would be negative, but that’s not to say it would boost the stock. I think it will depend on the size of the distribution – if it’s a small token dividend, what it’ll do is increase the potential investor base, because there are some funds on the institutional side that have a yield mandate. If it paid a dividend, it would allow them to have a look at the name. But whether that will actually increase the stock’s price is unclear.”