RBC Quarterly Review April 11, 2022
Real Estate Investment Trusts
Quarterly Review and Sector Outlook – Q2 2022
Recommendations
From the universe of 37 TSX-listed REITs, we have 14 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, Morguard North American Residential REIT, RioCan REIT, and SmartCentres REIT. Also rated Outperform is Chartwell Retirement Residences. Thematically, we remain overweight multi-family and industrial, subsectors we view as better equipped to deliver NOI, FFO, NAV, and distribution growth in a rising rate environment.
Highlights
A soft start to the year. After an impressive recovery in 2021, the TSX REIT Index took a breather in Q1/22, registering a flat (-0.4%) total return. The sector’s performance trailed the TSX Composite (+4%), but ranked ahead of the S&P 500 (-5%) and 10Y GoC bonds (-6%). Following a year of positive returns for listed real estate around the world, performance through 2022 to date is more mixed. TSX REITs outperformed REITs in Europe (-5%), the US (-4%) and the Global Index (-4%), but trailed Asia (+4%).
Reasons for optimism remain...In the face of a sluggish, but volatile start, our sector view remains constructive, with several pillars of support. Specifically, we flag 1) stronger economic traction amid full re-opening, 2) the recovery in fundamentals is firmly underway (~3% 2022E SP NOI growth), 3) healthy 2022E earnings (5%) and NAV growth (6%), 4) low interest rates, albeit rising, 5) reasonable valuations, 6) corporate liquidity near record highs; and 7) a still strong private market appetite for real assets.
...but can’t turn a blind eye to stiffer headwinds forming. Geopolitical instability, a sharp rise in interest rates, heated inflation, supply chain issues, labour shortages, and not to mention the ongoing pandemic – investors have plenty to digest in allocating capital. We believe rising interest rates have provided REIT investors a reason for pause, particularly as spreads to private market and REIT implied cap rates have materially narrowed. Tax policy and regulatory risks are also weighing on sentiment. Complicating matters further are the nearly inverted Canadian and US yield curves, raising questions around prospects of a possible recession down the road. As noted here-in, REITs have performed relatively well in periods of yield curve flattening and inversion, but the few recessions we’ve had have not been kind to the sector.
Valuation still screens reasonable on our preferred NAV gauge, but less favourable on others. The sector’s trading at 5% below NAV, unchanged from the start of the year, and below its 1% LTA premium. On P/AFFO, the current 20x forward AFFO multiple (4.9% AFFO yield) exceeds the 10-year average (17x), while the 249 bps AFFO yield spread to the 10Y GoC has slipped into expensive range. The AFFO yield spread to Moody’s Baa Index has also narrowed to 56 bps, below long-term levels, but remains within fair value goal posts. Relative to Utilities, REITs screen cheap, but appear reasonably valued relative to Communication Services and expensive vs. Banks and Consumer Staples.