RBC Q2/21 Recap August 26, 2021
Canadian REITs and REOCs – Q2/21 recap Results ahead of forecasts, as earnings post a solid rebound
Recommendations: Our Outperform-rated REITs include Allied Properties, Boardwalk, BSR, CAPREIT, Dream Industrial, European Residential, First Capital, Granite, InterRent, Killam Apartment, Minto Apartment, and SmartCentres. Also on our roster of Outperform-rated securities: Chartwell Retirement Residences, Colliers International Group, and Tricon Residential. For further details, see Exhibits 16 and 17 – "REIT valuation table" on pages 16-18 and “NAV summary” on pages 19-21.
A solid rebound in earnings growth (albeit off a depressed base), as recovery takes hold. Q2/21 FFOPU increased 10% YoY for our coverage universe, ahead of our 6% estimate and the -1% posted in Q1/21. Among reporting entities in our universe, 63% (24 of 38) delivered earnings that were in line with our forecasts, consistent with the long-term average (65%). In contrast, 24% (9 of 38) exceeded our expectations, while 13% (5 of 38) were short. Acknowledging that sample sets within property subsectors are in some cases limited, retail had the highest proportion of entities that exceeded our forecasts, while seniors housing had the largest proportion that were short (Exhibit 2).
Organic growth turns the corner, as pandemic pressures ease. Q2/21 same-property NOI rose 3% YoY, marking the first positive print since Q1/20 and lapping the sector’s 17-year low (-5% Q2/20). Growth was aided by materially lower bad debts and rent abatements, lower pandemic costs, higher rents, and higher occupancy in select property types. Retail REITs registered the strongest recovery (SP NOI + 6% YoY), while strength in industrial continues (+4%), in contrast with seniors housing, which lagged well behind (-5%). Notably, rental residential was flat YoY, slightly better than last quarter’s 1% YoY slip.
Minor tweaks to our earnings outlook; momentum should build next year. Our 2021E FFOPU growth remains unchanged at 3%, partly weighed down by extended lockdowns in 1H/21, but nonetheless marks a solid recovery from last year’s low (-5%). Our 2022E FFOPU growth increased to 7% (from 6%), with our inaugural 2023 estimates reflecting a healthy 5% advance. Notably, estimates for most of our universe reflect FFOPU recovering to 2019 levels in 2022 (Exhibit 5).
NAVs on the rise amid firming fundamentals and rising appeal of real assets. Our post-Q2 NAVPU estimates increased an average 6% (+13% YTD), with the largest gains in industrial (+17% post-Q2), rental residential (+6%), and diversified (+4%). Positive revisions were mostly driven by higher forecast NOI and/or lower cap rates, with the latter partly aided by a growing appetite for real property amid depressed bond yields. Indeed, our universe booked ~$3B of IFRS fair value gains in Q2 (portfolio values +2% QoQ), with nearly all of the marks driven by the industrial, residential, and retail REITs/REOCs. Our NAVPU estimates are now, on average, 6% above pre-COVID levels (Exhibit 6), though diversified and seniors housing are still playing catch-up. Looking ahead, our forward NAVs reflect 6% growth.
A strong rally, yet valuation still screens quite reasonable. The TSX REIT Index has rebounded well, posting a 26% YTD total return, ahead of the TSX Composite (20%). Aided by exceptionally strong fundamentals and proposed M&A, industrial REITs (+43%) have led the way by a wide margin, followed by rental residential and retail (27% each). The sector’s recovery has restored valuations to reasonable levels on most of our preferred gauges. Specifically, the sector’s trading at a 4.8% AFFO yield (21x NTM AFFO), a 366 bps premium over the 10Y GoC yield of 1.2%. The spread is in line with long-term levels (369 bps) and sits within "fair" value parameters. Yet relative to corporate bonds (Moody’s BAA Index), the AFFO yield spread (162 bps) is well above the historical average (101 bps). On an NAV basis, our universe trades at a 2% discount (Exhibit 12), slightly below the 1% long-term premium. Net-net, with reasonable valuations, fundamentals on the mend, an attractive growth outlook, and a strong appetite for real assets, we see plenty of support to maintain our constructive view of the sector.