November 26, 2021
Canadian REITs and REOCs – Q3/21 recap Results ahead of forecasts, as recovery continues to unfold
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 is Chartwell Retirement Residences. For further details, see Exhibits 16 and 17 – "REIT valuation table" on pages 14-16 and “NAV summary” on pages 17-19. While we remain cognizant of potential macro headwinds ahead and the ongoing pandemic, our sector outlook remains constructive supported by reasonable valuations, recovering fundamentals, an attractive growth outlook, and strong appetite for real assets.
Q3 results ahead of forecast on another solid earnings rebound. Q3/21 FFOPU increased 5% YoY for our coverage universe, ahead of our 3% estimate, but below the 10% growth in Q2/21 which lapped the sector’s low water mark last year. Among reporting entities in our universe, 68% (23 of 34) delivered earnings that were in line with our forecasts, consistent with the long-term average (65%). In contrast, 24% (8 of 34) exceeded our expectations, while 9% (3 of 34) were short. Acknowledging that sample sets within subsectors are in some cases limited, diversified had the highest proportion of entities that exceeded our forecasts, while seniors housing had the largest proportion that were short (Exhibit 2).
Repair work in fundamentals continues as pandemic pressures fade. Same-property NOI rose 4% YoY in Q3/21, accelerating from the 3% YoY advance posted last quarter, and above the sector’s long-term average (2%). Growth was aided by lower bad debts and rent abatements, lower pandemic costs, higher rents, and higher occupancy. Notably, organic growth was positive across all but one property type. Industrial REITs led (SP NOI +6% YoY), followed by diversified (+5%), seniors housing (+5%, but entirely driven by SIA’s +15%), retail (+4%), and multi-family (+3%), whereas office lagged (-1%).
Earnings outlook edges higher, with pace set to ramp-up next year. Post Q3 results, our 2021E FFOPU growth is intact at 3%, with our 2022E growth rising to 8% (from 7%), aided by a full year of re-opening. The uptick in next year’s forecast was mainly attributable to more positive earnings revisions among the diversified and multi-family REITs. Our 2023E FFOPU growth is unchanged at 5%. In short, our calls for the next two years reflect growth that exceeds the sector’s 3% long-term average. Notably, estimates for most of our universe reflect FFOPU recovering to 2019 levels in 2022 (Exhibit 5).
Another quarter of solid NAV growth. Our post-Q3 NAVPU estimates increased an average 4%, with the largest gains in multi-family (+7%), industrial (+4%), and retail (+4%). Positive revisions were mostly driven by higher forecast NOI and/or lower cap rates, with the latter reflecting upward pressure on pricing as significant dry powder looks to raise exposure to real assets. Notably, our NAVPU estimates are up 16% YTD and, on average, are 9% above pre-COVID levels (Exhibit 6), albeit with diversified and seniors housing lagging. Looking ahead, our one-year forward NAVs reflect 6% growth.
A strong rally, yet valuation gauges still screen quite reasonable. The S&P/TSX REIT Index has posted a solid recovery, with a 33% YTD total return, ahead of the S&P/TSX Composite (27%). Underpinned by strong fundamentals and M&A, industrial REITs (+52%) have outperformed by a sizeable gap, followed by multi-family (+35%) and retail (+32%). While heavily discounted valuations are mostly in the rear view mirror, our preferred gauges still screen fair to favourable. Indeed, the sector’s current 5% discount to NAV remains below the long-term average 1% premium (Exhibit 12). The current 4.8% AFFO yield (21x NTM AFFO) reflects a 304 bps premium over the 10Y GoC yield of 1.8%. The spread is tighter than average (368 bps), but still within "fair" value range. Yet relative to corporate bonds (Moody’s BAA Index), the AFFO yield spread (147 bps) remains well above historical levels (101 bps)