Our view: With a focus on mid-tier, value-add apartments located in the suburban markets of Canada's three largest cities—Toronto, Montreal, and Vancouver—CAPREIT continues to deliver steady growth amid improving operating conditions. Encouragingly, leasing demand in the under-30 segment has started to come back and the return of international migration is likely to drive the next leg up in 2022. At the same time, homeownership continues to become less affordable, supporting growing rental demand in CAPREIT's markets. We increase our price target by $3 to $68 on rising apartment values and reiterate our high-conviction Outperform rating.
Key points:
Delivering steady growth and a 5% distribution increase. As detailed herein, CAPREIT: 1) delivered an in-line print with NFFOPU of $0.58 (+4% YoY); and, 2) announced a 5% distribution hike to $1.45 annualized effective Aug-2021. SP-Revenue growth decelerated to 0.8% (from 1.8% in Q1), while SP-NOI growth improved 50 bps sequentially to 2.9%—in line with the 3.1% TTM average—on good cost control. In 2021–23, we see steady SP-NOI growth of 3–4%, with potential upside as immigration returns.
Leases signed increased 75% sequentially to 4,200 in Q2. With turnover increasing to 20% annualized in Q2/21, from 16% in Q2/20, CAPREIT sees increasing demand supporting higher re-leasing spreads in H2/21. For context, re-leasing spreads of 5% in Q2 were up from 3% in Q1, yet down from 8% in Q2/20 and 13–14% in 2019. Notably, we see future demand supported by international study/work permits issued in Q2/21 that were 4%/57% above Q2/19 levels—with further backlog to catch up on in H2/21.
TMV is the place to be. CAPREIT derives 51% of its NOI from Toronto (31%), Montreal (11%), and Vancouver (8%). Since Q4/19, home prices in these markets are up 23%, 26%, and 18%, respectively. As a result, ownership costs account for 68%, 45%, and 75% of household income—up 210 bps, +20 bps, and -240 bps since Q4/19, compared with +130 bps nationally. We think demand will further strengthen in 2022 as TMV collectively accounts for 57% of Canada's net immigration (but just 35% of its population).
Cap rate compression continues; NOI growth set to drive next leg in valuations. In Q2, cap rates compressed 10–15 bps and ~5 bps in Toronto and Vancouver to ~3.3% and ~3.3%, respectively, while Montreal was steady at ~4.1%, according to Colliers. Looking ahead, CAPREIT sees further fair value gains in H2/21, but expects NOI growth will become more of a contributing factor going forward.
Raising our NAVPU estimate by 4%; FFOPU largely unchanged. Post Q2, our NAVPU estimate increases by $2 to $58, with our 1Y forward NAVPU reflecting 6% growth to $62 (+$3). Our target remains based on a 10% premium to our 1Y forward NAVPU. Our 2021–22E FFOPU are largely unchanged at $2.32 (+/-0%) and $2.42 (+2%), reflecting growth of 2% and 5% year-over-year. Our inaugural 2023E of $2.51, reflects 3% growth and a 2019A–23E CAGR of 4%