Real Estate Q2/22 Earnings Recap
Sector Generally Not Seeing Signs of a Slowing Economy Majority of REITs Leave IFRS Values Largely Unchanged
Q2/22 results overall matched our expectations, with AFFO/unit (index names only) coming at +4.0% y/y and 0.4% ahead of our estimates (Exhibit 1). More importantly, despite broader macro uncertainty, management teams generally reiterated their favourable near-term outlooks for fundamentals. And, although 2023 is hard to predict, the strong consensus was that real-estate fundamentals are on a very strong footing heading into whatever slowdown may be around the corner. Fundamentals remain very robust in particular for the residential rental, industrial, and retail property sectors. Visibility on office remains uncertain due to the continuing trends related to hybrid work policies, although most office REITs are seeing positive leasing momentum, given the flight to quality. In the Seniors sector, the latest COVID-19 waves have affected operating margins.
Despite the overall real-estate sector's favourable outlooks, we proactively incorporated economic slowdown assumptions into our forecasts (similar to our recent recession scenario report), resulting in a 2.8% average negative revision to 2023 AFFO/unit estimates (still expecting 5% y/y growth, however). By sector, Residential had the smallest decline, and Industrial would have as well if not for the removal of future modelled acquisitions. The largest downward revisions were in Seniors (-10%) and Office (-6%). Our inaugural 2024 estimates (Exhibit 2) show a sector-wide, three-year AFFO/unit CAGR of ~5% (2022: 3%, 2023: 5%, 2024: 6%).
A key area of focus during the quarter was IFRS fair values, which in the end, on average, were reduced by just 0.9% vs. Q1/22 levels. Other than the 3% average reductions by CAR.un, CHP.un, and GRT.un (which we attribute to relative conservatism), changes for nearly all other REITs were immaterial, citing a lack of market transactions. Many management teams did acknowledge the potential for increased cap rates as transaction activity picks up.
In contrast, we have reduced our average property portfolio valuations by a total of 3.9% since Q1/22 (resulting in 6.5% lower NAV/unit estimates), including changes made in June and during the Q2/22 reporting season to reflect higher bond yields and the potential for an economic slowdown. Our NAV cap rates are higher by 22bps on average since Q1/22 (Exhibit 3).
Overall Q2/22 reporting season confirmed our outlook for the REITs. Although the sector is up ~7% since our upgrade to OVERWEIGHT, we continue to see good value and see upside to our estimates should a meaningful economic slowdown not materialize. On valuation, REITs are currently trading at a 15% discount to our lowered NAVs (Exhibit 4), vs. historically in line. REITs are currently trading at a 4.5% spread to the 10-year GoC vs. the historical adjusted average of 4.9% (Exhibit 5). Our sector pecking order in terms of fundamentals remains Industrial, Residential Rental, Retail, Office, and lastly Seniors.