Desjardins Interest rates are likely to continue to dictate the performance of real estate investment trusts through 2024, according to Desjardins Securities analyst Kyle Stanley and Lorne Kalmar, recommending investors get their “tickets to the pivot party.”
“Despite historically being positively correlated, the [S&P/TSX Capped REIT Index] has trended in near-perfect negative correlation with bond yields in 2023, effectively frontrunning a recession, in our view,” they said. “We are increasingly confident that several rate cuts are likely in 2024 and that a soft landing can be achieved. This should set the stage for a recovery in REIT valuations in 2024. Since October 3, the 10-year GoC yield has declined 90 basis points while the SPRTRE has generated a total return of 8.8 per cent (7.6 per cent for SPTSX), providing a sneak preview of how we expect 2024 to play out.”
“We expect rate cuts and a corresponding decline at the short end of the curve to drive funds flows out of money market instruments and back into yield equities, including REITs. We also anticipate that increased visibility around rates and the economy will result in a pickup in transaction volumes, which should provide much-needed support for REIT valuations.”
The analysts say they are “taking a top-down approach” heading into 2024 They are now expecting total returns of 10-20 per cent in 2024, which is predicated on “(1) interest rate cuts; (2) funds flows out of money market instruments; (3) a soft landing/mild recession; (4) the relationship between REIT performance and 10-year Government of Canada yields this rate hiking cycle; and (5) a pickup in transaction activity.”
“Assuming Canada avoids a severe recession and inflation remains under control, we are optimistic that REITs should perform well in 2024,” they said.
“What else to look out for in 2024. Immigration continues to be an important tailwind for multifamily, retail and self-storage fundamentals. We believe REIT balance sheets within our coverage universe are generally well-positioned to withstand the impact of slowing economic growth, while strong top-line growth should absorb the impact of higher rates on refinancing. After several cuts/suspensions in 2023, the list of candidates for distribution cuts in the year ahead is very thin.”
In a report released Friday, the analysts said their sector pecking order is: “(1) multifamily; (2) retail; (3) industrial; and (4) office.”
Their “best ideas” are:
- InterRent REIT with a “buy” rating and $16 target. The average on the Street is $14.23.
- Killam Apartment REIT with a “buy” rating and $22 target. Average: $21.08.
- Primaris REIT with a “buy” rating and $16.50 target. Average: $16.84.
- RioCan REIT with a “buy” rating and $22 target. Average: $21.30.
Mr. Kalmar and Mr. Stanley explained: “IIP — with its concentration in key urban markets that have benefited from healthy market rent growth, IIP is poised to deliver sector-leading FFOPU growth in 2024. KMP — top-line growth should accelerate in 2024 which, in light of its deeply discounted relative valuation and healthy FFOPU outlook, offers an attractive entry point. PMZ — as our top pick in the retail space, we believe PMZ should continue to outperform in 2024 with its sector-leading balance sheet and the ongoing recovery of Canadian malls. REI — following relative underperformance in 2023, we believe REI is poised for a bounce-back year, particularly given our expectation for an increase in funds flows to the retail REITs.”