Canadian Apartment Properties Real Estate Investment Trust T.CAR.UN

RBC Notes

[retiredcf]

January 30, 2022

Multi-Residential REITs Fundamentals inflecting

Our view: We are assuming coverage of the multi-residential rental sector. In an inflationary environment, we like the combination of short duration leases and pricing power. In the U.S., pricing power is here and raging. In most of Canada, it is inflecting. Valuation is attractive relative to private markets. We have a bullish view on the space.

Our general view on the space: Overweight

• The multi-residential rental sector is one of the four major food groups of commercial real estate that has stood the test of time – it is on the defensive end of real estate and mostly free from technology disruption. The necessity-based nature of the real estate makes it a core part of any dedicated or non-dedicated REIT investor’s portfolio.

• The value proposition today? The underlying business can typically generate mid to high single digit levered return with income that can grow by 2-4% annually over the long term. In a world where risk free long bonds yield less than 2%, the sector should remain appealing to public and private market participants.

• The Canadian-listed multi-residential REIT space is reasonably “mature” with sector depth. Each has carved out somewhat of a geographical niche, including the United States and Europe. This makes it conducive for portfolio managers to tilt their portfolio positions one way or another depending on the nearer term geographical outlook. For example, worried about rent control changes in Ontario? There is always Alberta and the U.S. Sun Belts to play. Importantly, most operators have been around for a while – there is a sleep-well-at-night factor given lower likelihood of capital allocation missteps.

• The sector, relative to other REIT sectors, has done well over the long term. Same property NOI growth trends for the Canadian residential REITs have generally outperformed the rest of the sector (3% vs 2% - see exhibit 1). Outside of macro conditions (like population growth or interest rates), one of the drivers of this outperformance is what we view to be the “secret sauce” of the multi-residential space: A value-add strategy applied to an old inventory of apartment units generates attractive returns (generally high single to mid double digit) while still providing affordable housing.

  How to position:

• While we are bullish on the entire multi-residential space, our slight preferred tilt is to the more cyclically levered names, i.e., names where recovery has not been as pronounced or lagging, especially when compared with pre-COVID years. We believe that mean-reversion trading strategies generally work well in the REIT sector and an underperformance in SP NOI growth last year usually results in outperformance in following years partly due to base effects. To this end, names that generally fall in that bucket include Boardwalk REIT, InterRent REIT, Minto Apartment REIT, Morguard North American Residential REIT and to a lesser extent CAP REIT. Several of these names have started to see fundamentals inflecting last quarter and we expect these trends to continue in Q4. The strong US multifamily fundamentals serve as a good guide as most US markets have inflected sooner due to less restrictive COVID conditions.

• Investors who do not share the view that a reversion to the pre-pandemic years (2019) is coming anytime soon or worried about potential rent control changes in Ontario should do well holding names where NOI growth has been fairly strong or remained resilient throughout the last two years. These include: BSR REIT and European Residential REIT.