April 8, 2021
Real Estate Investment Trusts Quarterly Review and Sector Outlook – Q2 2021
Recommendations
From the universe of 38 TSX-listed REITs, we have 14 Outperforms: Allied Properties REIT, Artis REIT, Boardwalk REIT, BSR REIT, CAPREIT, Dream Industrial REIT, European Residential REIT, First Capital REIT, Granite REIT, InterRent REIT, Killam Apartment REIT, Minto Apartment REIT, SmartCentres REIT, and WPT Industrial REIT. Also rated Outperform are Chartwell Retirement Residences, Colliers International Group, and Tricon Residential. On balance, we remain overweight multi-res & industrial.
Highlights
A new year, a better tone: listed real estate staging a respectable comeback. The TSX REIT Index delivered a 9% total return in Q1/21, pushing modestly ahead of the TSX Composite (8%) and S&P500 (6%), and well ahead of 10Y GoC bonds (-7%). The rebound marks a solid start after a year of record underperformance in 2020. Looking across global listed real estate markets, returns were mostly positive, as vaccinations advanced and economic prospects improved. In Q1, TSX REITs outperformed the Global Index (6%) and Europe (flat), but trailed Asia (14%) and the US (10%).
Plenty of reasons to remain optimistic. The road to recovery is rarely smooth, and setbacks are to be expected. Yet, while the resurgence of the pandemic and reinstated lockdowns in various regions will likely put some speed bumps on the path to normalcy, we see ample support for a year of strong 2021 returns, including: 1) upward revisions to GDP growth forecasts, 2) improving traction in property fundamentals, 3) recovering NAVs (+5% 2021E) and earnings (+4% 2021E), 4) a favourable outlook for interest rates, 5) discounted valuations (even if not as steep), and 6) record levels of corporate liquidity. Indeed, we’re particularly encouraged by stronger than expected Q4/20 results and have raised our NAVPU estimates by 2% YTD. Yet, as discussed in more detail herein, our NAVPU estimates remain on average 7% below pre-COVID levels, with opportunities for further positive revisions as traction builds.
Discounts have compressed, but value is still on offer. The sector’s rebound has narrowed the sizeable valuation discounts across several of our preferred gauges. On a P/NAV basis, our universe is trading at a 5% discount, a marked improvement from the 11% discount at the start of the year. This larger than typical margin of safety may very well persist, but in our view, provides good downside support. While the AFFO yield spread to the 10Y GoC has returned to fair value range, the AFFO yield spread to the Moody’s BAA Index (167 bps) remains well above historical levels.
Good start points to potential upside to our base-case 13% total return call for 2021. We’re encouraged by the Q1 start, but acknowledge improved visibility on fundamentals will likely remain a pre-requisite for the next leg up in valuation. The sector has managed to shrug off yield curve steepening thus far this year, although a further sharp move-up in the curve could slow the momentum. Against this backdrop, our preferred property types on fundamentals remain industrial and multi-residential.