May 28, 2021
Canadian REITs and REOCs – Q1/21 recap
Earnings ahead of forecast; plenty of reasons to remain constructive
Recommendations: Our Outperform-rated REITs include Allied Properties REIT, Boardwalk REIT, BSR REIT, CAPREIT, European Residential REIT, First Capital REIT, Granite REIT, InterRent REIT, Minto Apartment REIT, SmartCentres REIT, and WPT Industrial REIT. Also on our roster of Outperform-rated securities: Chartwell Retirement Residences and Colliers International Group. For further details, see Exhibits 15 and 16 – "REIT valuation table" on pages 17-18 and "NAV summary" on pages 19-20.
Earnings erosion continues to slow...Q1/21 FFOPU declined 1% YoY for our coverage universe, ahead of our -3% estimate and the -2% posted in Q4/20. Among reporting entities in our universe, 51% (20 of 39) posted earnings that were in line with our forecast, below the long-term average of 65%. In contrast, 31% (12 of 39) exceeded our expectations, while 18% (7 of 39) fell short. Acknowledging sample sets within subsectors are in some cases limited, seniors housing had the highest proportion of entities that exceeded our forecasts, while office had the largest proportion that were short (Exhibit 2).
...as weight of pandemic gradually abates. Q1/21 same-property NOI declined 1% YoY, an improvement relative to the -2% in Q4/20, but nonetheless still well below the sector’s +2% long-term average. Similar drivers remained at work in Q1, including lower occupancy across most property types, higher bad debts and rent abatements, and pandemic related costs. Not surprisingly, industrial REITs registered the strongest organic growth (+3% YoY SP NOI), whereas diversifieds were the weakest (-6%). Notably, the -1% SP NOI growth from rental residential REITs marked the first decline since Q3/17.
Earnings forecasts reflect recovery to pre-pandemic levels for most by 2022. Our 2021E FFOPU growth slipped fractionally to 3% from 4%, partly from extended lockdowns. Still, the pace is substantially better than last year’s record low (-5%). Our 2022E FFOPU growth is unchanged at 6%. Notably, our estimates for most of our universe reflect FFOPU recovering to 2019 levels in 2022 (Exhibit 5). In some cases, however, we believe the recovery will take longer, particularly in instances where fundamentals may lag or where capital recycling may weigh on near-term growth (e.g., select retail and diversified REITs).
Our NAVs have moved up, but room for upside remains. Our post-Q1 NAVPU estimates increased an average 4%, with the largest gains in seniors housing (+7%), retail (+6%), and industrial (+5%). Positive revisions were mostly driven by higher forecast NOI and/or lower cap rates, with the latter partly reflecting reversals of our 2020 cap rate increases amid the depths of the pandemic. Still, our NAVPU estimates remain on average 3% below pre-COVID levels (Exhibit 6). The largest gaps are among diversifieds, seniors housing, and retail, suggesting room for upside remains as re-opening traction builds. As well, further cap rate compression could push industrial and rental residential NAVs higher.
Valuation remains fair to favourable across our preferred gauges. The TSX REIT Index has registered a strong 17% YTD total return, modestly ahead of the TSX Composite (15%). Diversified, retail, and seniors housing REITs/REOCs have posted particularly strong returns (averaging >20%), aided by improving views on fundamentals and a narrowing of heavily discounted valuations. The YTD recovery has brought valuations to more reasonable levels, with the sector trading at a 5.2% AFFO yield (19.3x NTM AFFO), a 372 bps earnings yield premium over the 10Y GoC yield of 1.46%. This spread is in line with the long term average of 369 bps, and sits within "fair" value parameters. Yet relative to corporate bonds (Moody’s BAA Index), the AFFO yield spread (161 bps) remains well above historical levels (100 bps). On an NAV basis, our universe is trading at an average 1% discount (Exhibit 11), marginally below the 1% long-term average premium. Bottom line, with reasonable valuations, an improving line of sight on the recovery of fundamentals, and a strong appetite for real assets amid still depressed rates, we see plenty of reasons to remain constructive on the sector.