RY H&R REIT
Price Target CAD 15.00 ↓ 15.75
Exercising prudence
Our View: Operating performance remains healthy driven primarily by growth (albeit decelerating) from its residential portfolio. We view H&R’s (“HR”) capital allocation activities positively, with its emphasis on NCIB funded by asset sale and prudence in its development activities. HR remains committed to focusing on growth asset classes. Execution will be choppy as asset sale environment is weak, especially for office. Having outperformed YTD, HR’s trading discount to our NAV estimate looks more in line with its various ‘sum-of-the-parts’ peers. Maintain SP.
Key points:
Healthy growth: Excluding a few lumpy items, SP NOI growth was +5% (headline +11.5%). This was driven by residential +11%, industrial +6.9%, office +0.6%, retail +4%. As with the broad US multi-res sector, pace of growth is decelerating y/y although move outs to buy homes have declined (12% from 20%) and combined with loss-to-lease of ~5-7%, a mid-to-high single revenue growth looks plausible next year for residential. Longer term, supply is being curtailed, which sets up well for H2 2024/2025.
No wavering in orienting the REIT to growth asset classes, but asset sale environment is weak: HR noted the market is weak, office prices “all over the map”, only getting done with VTBs and many deals are being dropped. Even core industrial assets are not achieving prices from a year ago. As such, asset sales will likely be choppy. HR remains committed to the plan, but won’t do so at any cost (read: less than IFRS value). Interestingly, HR’s CDN industrial portfolio (marked at 5.1% cap, ~$168 PSF) looks similar to Summit in terms of geography, rent and lease term but at this stage, it appears to be a keeper.
Prudent capital allocation: 1) Unit buyback remains its priority (3M units at $12.91 for $38M; YTD 23M @ $12.99 for $297M), 2) It has picked away at asset sales: $216M during and post quarter, 3) It postponed a couple of US multi-res developments given lack of visibility on market cap rate and higher cost of debt. Similarly, it is unlikely to buy more CDN industrial land for development and expects to only proceed with current projects.
Maintain Sector Perform: Our NAV estimate is $18.00 (+$0.25), based on 5.8% cap (+5bps), vs reported NAV of $22.58 (5.24% cap, +14 bps q/q). Our target of $15 (-$0.75) is based on 20% discount (vs. 15%) to forward NAV –lack of visibility on rates and asset pricing will likely result in higher than average discount trading multiples for the broad sector. We view positively its capital allocation activities including its prudence in development and emphasis on unit buyback. With the stock having outperformed YTD, HR’s 31% discount to our NAV estimate is closer to its various peers (US res 20-25%, US office 40-50%, US grocery 10-20%, CDN office 25-30%, CDN industrial 15-20%). We continue to believe that major office asset dispositions (hard to do today) that lead to meaningful transformation of the portfolio are a positive catalyst.