National BankNot sure what's going on at the National Bank but they are becoming very pessimistic on everything. Yesterday, they downgraded every energy company within their coverage. Today it's REITs. So I might take this with a grain of salt. GLTA
In reaction to a rapid rise in bond yields, National Bank Financial analysts Matt Kornack and Tal Woolley reset their return expectations across the real estate investment landscape, leading to “sizable” downward revisions to target prices for equities in their coverage universe.
“We have generally seen decreases in our near-term FFO [funds from operations] estimates to reflect higher interest costs when refinancing and increased NAV [net asset value] cap rates to reflect higher return requirements, in light of the step change in bond yields,” they said. “We believe the market is still pricing in some degree of inflation protection offered by hard assets with contracted cash flows like real estate, based on the narrower spread between implied cap rates and borrowing cost.”
In a research report released Wednesday, the analysts said average projected total returns across the sector’s asset classes are now “tight,” led by 19-per-cent gains for senior housing and healthcare and 18 per cent for multi-family and industrial.
“We have continued to lean into asset classes where we see the supply-demand balance as favourable for landlords, even if valuation is challenged in the short run,” they said. “We see average total returns of 15 per cent for Retail, which should see continued modest improvement in operating performance and might benefit from having relatively low expectations from investors, in a market that has been punishing to more highly valued asset classes. We project 8 per cent for Office, which still has to contend with an unclear demand picture.”
Seeing lowered return expectations relative to their peers, the analysts downgraded a trio of equities to “sector perform” recommendations from “outperform” previously. They are:
* European Residential Real Estate Investment Trust with a $3.75 target, down from $5.80. The average on the Street is $5.41.
Mr. Kornack: “The Netherlands’ complex rent control system is set to see an increase in the breadth of units captured by the regulated system (90 per cent of the market) targeted to begin in 2024, though a definitive policy is lacking. Navigating the regulatory framework has been a strength of ERES’s management team but incremental moves on this front add to an already complex story.”
“The euro has seen a sharp pullback in value as the region contends with food and energy uncertainty, rising inflation and the ongoing war in Ukraine. The winter could present broader challenges as governments struggle to meet heating needs. North American equity investors are wary of this heightened risk.”
* Nexus Industrial REIT with a $10 target, down from $15. Average: $14.38.
Mr. Kornack: “We are moving Nexus to Sector Perform in light of broader changes to our real estate valuation outlook and challenges for smaller-cap names with growth/repositioning ambitions as access to capital (through equity issuances and asset sales) becomes more challenging. We have a growing preference for liquidity but are also more cautious about non-core exposure.”
* Automotive Properties Real Estate Investment Trust with a $13 target, down from $15.50. Average: $14.25.
Mr. Woolley: “We reduced both our one-year out NAV estimate (on higher cap rates) and our FFO/sh estimates modestly. We also reduced the premium to NAV we used to set the target, reflective of the current environment .... The rationale for reducing the rating is a function of our new total return expectations for APR (9 per cent), relative to the rest of our Retail coverage universe (average is 15 per cent). Importantly, our view does not signal a change in the expected near-term financial performance for APR, and investors who hold units can feel confident in the current yield on offer, and management’s sensible approach to capital deployment. We like the steady, consistent performance of APR and would consider revising our rating higher when the relative return opportunity improves.”
The analyst made target price adjustments to all 36 equities in their coverage universe, including changes to their top picks in each asset class. They are:
Senior Housing/Healthcare: Chartwell Retirement Residences ( “outperform”) to $13 from $15. Average: $14.08.
Multi-Family: Boardwalk REIT ( “outperform”) to $52 from $68.50. Average: $59.68.
Industrial: Summit Industrial Income REIT (“outperform”) to $20 from $26.50. Average: $22.95.
Retail: RioCan REIT ( “outperform”) to $23 from $27. Average: $25.67.
Diversified: H&R REIT ( “outperform”) to $15.25 from $18.50. Average: $16.64.
Office: Allied Properties REIT ( “outperform”) to $36.50 from $51. Average: $48.75.
Special Situations: Flagship Communities REIT ( “outperform”) to US$21 from US$24. Average: US$23.43.