Q1/22 Real Estate Earnings Preview
Impact of Rising Rates/Inflation Take Centre Stage Outlook on Fundamentals Remains Unchanged
For the real-estate sector's Q1/22 reporting season, which commences April 26, we are forecasting +5.3% average y/y AFFO/unit growth (weighted average) for Canadian REITs/REOCs in our coverage universe, driven by Industrial, Apartments, and Retail, partially offset by double-digit declines in the Seniors and Diversified sectors (Exhibit 3).
What to watch for
Impact of Rising Interest Rates on the Real Estate Sector: YTD, the Canadian 10- year bond yield has risen ~150bps and ~110bps since we published our 2022 outlook report on January 25 (link) to ~2.9% currently. In addition, the Bank of Canada has increased the overnight rate by 75bps, with further increases expected. As such, we expect some interest expense headwinds when we update our forecasts as companies report results. In most cases, we expect interest rates to negatively affect 2022/2023 forecasts by low- to mid-single digits, all else equal and depending on the amount of floating rate debt and near-term fixed-rate debt maturities, as shown inExhibit 2. CT REIT, Summit REIT, and Allied Properties appear to be the best- positioned names in our coverage universe.
Cap Rate Changes. Although interest-rate assumptions are a key factor in defining value for real-estate assets, they are not the only ones, with medium- and long- term growth assumptions being at least equally important (cap rate/interest rate spreads can narrow significantly in periods where strong NOI growth is expected). With current inflation running north of 6%, we believe investors are currently underwriting higher growth assumptions (real estate has historically been considered an inflation hedge). As such, we do not believe that there has been any significant change in the underlying cap rates owing to the recent rise in interest rates — thus far — nor do we expect a negative impact on NAV estimates. That said, we will be looking for additional colour on this topic from management teams as they report.
With this report, we are also making minor forecast adjustments for AP.un, CHP.un, HR.un, and PMZ.un (Exhibit 1).
Based on current valuations and near-term fundamentals, we continue to prefer the apartment and industrial asset classes. Our ACTION LIST BUY-rated names are CAP REIT, First Capital REIT, and Granite REIT.