RBC January 7, 2022
Real Estate Investment Trusts
Quarterly Review and Sector Outlook – Q1 2022
Recommendations
From the universe of 37 TSX-listed REITs, we have 12 Outperforms: Allied Properties 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, and SmartCentres REIT. Also rated Outperform is Chartwell Retirement Residences. Thematically, we remain overweight multi-family and industrial, which continue to rank at the top of our fundamental pecking order.
Highlights
2021 returns: An impressive comeback. The TSX REIT Index delivered a 35% total return in 2021 (30% price, plus 5% yield), well ahead of the TSX Composite (25%) and S&P 500 (29%). The sector’s return was its second best on record, while its outperformance vs. the TSX Composite marked a strong reversal of the underperformance in 2020. Notably, listed real estate returns were positive around the world, as visibility on fundamentals improved and investors capitalized on discounted valuations. TSX REITs outperformed REITs in Europe (18%), Asia (16%), and the Global Index (27%), but trailed the US (43%).
A good setup, but still sleeping with one eye open. We believe support remains in place for a healthy year of returns ahead, including 1) further gains in economic traction, 2) a continued recovery of property fundamentals (~3% SP NOI growth), 3) upside in NAVs (6%) and healthy earnings growth (8%), 4) low interest rates, 5) reasonable valuations, and 6) strong liquidity. Yet, we remain acutely aware of potential downside risks from pandemic related setbacks to economic activity, particularly with re- introduced restrictions, and rising interest rates, including a sharp steepening of the yield curve.
Valuations in better shape across the board, but value still exists. The sector’s trading at 4% below NAV, a marked improvement from the 11% discount at the outset of 2021. Still, the discount remains below the 1% LTA premium. On P/AFFO, the current 21x forward AFFO multiple (4.8% AFFO yield) exceeds the 10-year average (17x), although the 334 bps AFFO yield spread to the 10Y GoC and 137 bps spread to the Moody’s Baa Index yield are well within fair value parameters. Relative to Communication Services and Utilities, REITs appear fairly valued, but screen expensive vs. Banks and Consumer Staples.
Expecting a moderation in returns: our “base-case” call reflects an 11% total return, with the bulk driven by moderate NAV growth and yield. Coming off a strong year and acknowledging potential headwinds in the system, we think it’s only prudent to dial back return expectations for 2022. With this context, our bias still leans toward multi-family and industrial, subsectors we view as better equipped to deliver FFO and NAV growth in a rising rate environment. We also see attractive risk-adjusted returns in select seniors housing, retail, and office names that offer a mix of high quality assets, value, and growth.