Reviewing Debt/Liquidity Metrics for Our Coverage
Comparing the Canadian and U.S. CRE Credit Environments
Commercial real-estate ("CRE") credit has become a top-of-mind concern in the U.S., as evidenced by the flurry of media reports in recent weeks. We believe this negative sentiment has affected trading valuations of Canadian REITs, despite what, in our view, is a more stable lending/credit environment. CRE lending in Canada is dominated by large banks, pension funds, lifecos (and some other lenders). These lenders are well-capitalized, though some undoubtedly may tighten their underwriting standards in the current environment. The U.S. market, in contrast, is more reliant on second-tier regional banks and the CMBS market. The use of recourse debt is also far more prevalent in Canada, meaning borrowers are far less likely (or able) to "walk away" from their assets. Furthermore, Canada's much- smaller CRE and lending community also means long-term stable relationships and reputation are far more important than in the U.S. This proved to be the case during the GFC, where the vast majority of the larger Canadian REITs did not have any refinancing issues, although spreads did widen. Debt markets have remained open to Canadian REITs thus far in 2023, with unsecured debentures totalling $1.4bln being issued YTD (Exhibit 3) including $650mm since mid-March.
Although we do not believe there will be many issues with REITs being able to refinance maturing debt, some are better positioned than others entering what is likely to be a tighter lending environment. In this report, we rank the REITs in our coverage universe based on Debt/EBITDA and the ratio of liquidity vs. total debt. We have separated residential/seniors' housing REITs from commercial property REITs (retail, office, and industrial) as most of the former have access to government- backed, CMHC-insured mortgages. As such, they are able to (and generally do) carry higher levels of debt.
Overall liquidity, in our view, is ample. Except for the residential and office REITs, each sector averages ~25%+ with individual standouts being Extendicare, Dream Residential, and Primaris. The best-positioned commercial property REITs regarding leverage are Primaris, CT REIT, and Granite REIT. Among names with CMHC insurance availability, the best-positioned are Chartwell, Morguard N.A. Residential REIT, and CAPREIT. (exhibits 1 and 2).
Our sector stance remains overweight. In our view, Canadian REITs look attractive from a long-term-value perspective, trading at a 21% discount to our NAV estimates. On a yield spread basis, the sector is trading at a 5.4% FFO yield spread to the GoC 10-year bond yield, which is +120bps since February and compares with the adjusted historical average of 4.9% (Exhibit 4). However, versus short-term bond yields, the current 4.5% FFO yield spread versus the 2-year GoC bond yield remains tighter versus the adjusted historical average spread of 5.8%.