While he warns an economic slowdown in 2023 is “increasingly likely,” Canaccord Genuity analyst Mark Rothschild expects fundamentals in the real estate secor should “remain healthy” for most property types and believes REITs “appear more attractively valued on various valuation metrics.”
“We are forecasting total returns of, on average, 18.4 per cent, and we have the strongest conviction for the rental apartment REITs,” he said in a research report released Monday. “Our top picks are Killam Apartment REIT, BSR REIT, Minto Apartment REIT, Dream Industrial REIT, Granite REIT and Brookfield Corporation. Although we remain extremely cautious toward office fundamentals, there appears to be attractive long-term value for many of the office REITs.”
Mr. Rothschild expects “steady” operating performance from most REITs, “with cash flow growth remaining positive despite the negative impact of rising operating costs, higher interest rates on maturing debt, as well as the impact of slowing economic activity.
“In general, fundamentals are robust for most Canadian asset classes and markets,” he said. “In particular, rental apartment fundamentals are solid, industrial fundamentals across Canada continue to be very tight, and well-located retail space remains highly occupied. We believe these fundamentals will allow most REITs to achieve positive rental spreads on lease renewals and new leasing, leading to solid NOI and cash flow growth.
“For 2023, we expect positive FFO per unit growth across all sectors, with our forecast for a rise in FFO per unit of, on average, 4.7 per cent overall. The strongest cash flow growth is expected from industrial REITs/REOCs and seniors housing operators, while growth is expected to be weaker from office and diversified REITs. We note that excluding Tricon, weighted-average FFO per unit growth for the residential sector is 5.2 per cent and 6.0 per cent in 2023 and 2024, respectively.”
Mr. Rothschild also made these target adjustments:
- American Hotel Income Properties REIT LP (“buy”) to $4 from $3.75. Average: US$2.81.
- First Capital REIT ( “buy”) to $18.50 from $19. Average: $19.
- Flagship Communities REIT ( “buy”) to US$18 from US$19. Average: US$20.76.
- RioCan REIT ( “buy”) to $22 from $23.50. Average: $24.18.
- Tricon Residential Inc. ( “buy”) to US$12.50 from US$11. Average: US$10.97.
“Overall, REIT’s appear more attractively valued on various valuation metrics,” he concluded. “Investments in real estate are typically underwritten based on discounted cash flow or IRR models. We have therefore estimated what each REIT in our coverage universe is trading at on an implied IRR basis. Overall, our analysis suggests that, by asset class, REITs/REOCs offering the best value, through either trading at the highest implied IRRs or steep discounts to both NAVs and historical AFFO multiples are the industrial, seniors housing, and residential REITs/ REOCs.
“Implied IRRs are highest for industrial REITs at 11.2 per cent, and considering the strong internal growth expected from the sector over the next several years, current cash flow multiples are attractive, which should allow for healthy returns in 2023. Residential REITs currently trade at, on average, 19.8 times 2023E AFFO, well below the historical one-year forward AFFO multiple of 24.6 times over the past five years. Given the outlook for healthy cash flow growth as a result of the strength of fundamentals, we believe current valuations for residential REITs are attractive.”