RBC January 8, 2021
Real Estate Investment Trusts
Quarterly Review and Sector Outlook – Q1 2021
Recommendations
From the universe of 37 TSX-listed REITs, we have 14 Outperforms: Allied Properties REIT, Artis REIT, Boardwalk REIT, BSR REIT, CAPREIT, Dream Industrial REIT, European Residential REIT, First Capital REIT, Granite REIT, InterRent REIT, Killam Apartment REIT, Minto Apartment REIT, SmartCentres REIT, and WPT Industrial REIT. Also rated Outperform are Chartwell Retirement Residences, Colliers International Group, & Tricon Residential. On balance, we remain overweight multi-res and industrial.
Highlights
2020 returns: One for the record books (in so many ways). In 2020, the TSX REIT Index posted a -13% total return (-18% price, +5% yield), well-below the TSX Composite (6%) and S&P 500 (18%). Among the many records broken last year, it was also the weakest year of REIT underperformance relative to the TSX Composite in the past 23 years. Listed real estate returns were negative around the world, as the pandemic has raised many questions on the outlook for property fundamentals. TSX-listed REITs trailed the U.S. (-10%), European (-10%), and Global (-8%) REIT indices, but were in line with Asia (-14%).
Feeling optimistic about the year ahead, with tailwinds expected to build. While the pace may prove slow initially, we believe a favourable batch of ingredients is in place to drive stronger returns in the year ahead, including 1) a recovering economy (5% GDP growth) 2) a gradual mending of property fundamentals (2–3% SP-NOI growth), 3) a rebound in net asset values (5%) and earnings growth (5%), 4) a highly accommodative outlook for interest rates and limited yield curve steepening, 5) discounted absolute and relative valuations across several key gauges, and 6) solid corporate liquidity.
There’s still some money on the table as discounted valuations persist. Trading at 9% below NAV (-700 bps YoY), the sector has rallied from its record low 30% discount last March, but remains below the LTA 1% premium. While we acknowledge valuations likely reflect a larger margin for error, we see good support at current levels, particularly relative to benchmark equity indices. As well, AFFO yield spreads to the 10Y GoC yield and the Moody’s BAA Index yield have expanded to 508 bps (+194 bps YoY) and 259 bps (+166 bps), respectively, and are now firmly in “statistically cheap” range. Relative to Banks, Staples, and Communication Services, REITs appear fairly valued, but inexpensive relative to Utilities.
Setting the goal posts for 2021: our “base-case” outlook reflects a 13% total return. Elevated macro uncertainty may very well persist in the near-term, particularly for property fundamentals amid reintroduced and extended regional lockdowns. Against this backdrop, our preferred property types remain industrial and multi-residential. Yet, as summarized above, we see a supportive backdrop for broader Canadian listed real estate returns. Importantly, ~40% of our forecast return is driven by cash yield, with the balance from NAV/earnings growth, and limited multiple expansion.