RBC Notes November 25, 2022
Canadian REITs and REOCs: Q3 2022 recap
Results in line; looking through the clouds, still see good opportunities
Our view: Our Outperform ratings are intact and include Allied Properties, Boardwalk, BSR, CAPREIT, Dream Industrial, European Residential, First Capital, Granite, InterRent, Killam Apartment, Minto Apartment, Morguard Residential, RioCan, SmartCentres, Chartwell Retirement Residences, and StorageVault Canada Inc. Overall, Q3 results were largely as expected, as traction continues to improve across most property types. Indeed, our forecasts reflect a healthy earnings outlook for the year ahead. Set against a backdrop of higher rates and an economy shifting to lower gear, our recommendations remain anchored in names where we continue to see resilient earnings and NAV growth profiles.
Q3 results in line, with growth leadership from the same cast as last quarter. Q3/22 FFOPU increased 3% YoY for our universe, in line with our estimate and the 3% growth registered in Q2/22. By subsector, self-storage (SVI) delivered the strongest growth (+23% YoY), followed by solid advances from multi- family (13%) and industrial (+6%). Among reporting entities, 72% (26 of 36) delivered earnings that met our forecasts, a bit ahead of the long-term average (65%). In contrast, 14% (5 of 36) exceeded our expectations and 14% (5 of 36) fell short. Among subsectors, we note that “Other” had the highest proportion of entities that came in ahead of our calls (Exhibit 2).
Multi-family and industrial remain firmly in the lead on organic growth, with the former accelerating. Same-property NOI increased a solid 5% YoY, above the sector’s long-term average (2%). The pace moderated slightly from last quarter, with the sharpest slowdown from seniors housing. Growth was aided by higher rents, occupancy gains, and lower bad debts, partly offset by higher operating costs, including labour and utilities (for gross lease property types). Notably, multi-family was the only subsector where SP NOI growth accelerated. Indeed, apartments led with +9% YoY SP NOI, followed by industrial (+6%), diversified (+4%), and retail (+3%), while seniors housing (flat) and office (-1%) lagged.
Overall earnings outlook remains healthy. Post Q3 results, our 2022E-2024E reflect FFOPU growth of 4%, 5%, and 4%, respectively. By subsector (Exhibit 3), seniors housing had the largest negative revisions as the ongoing pandemic and elevated operating costs will likely prolong the recovery period. Our estimates for the office REITs are also down more notably, partly due to restrained leasing velocity. While higher rates and a slipping economy present some downside risks to estimates, our forecasts reflect stronger momentum next year, with leadership from seniors housing, multi-family, and industrial.
For the most part, asset write-downs were immaterial. Once again, portfolio fair value charges were not much of a story in Q3. Despite the material YTD jump in debt costs, IFRS cap rates were fairly flat, with most citing a lack of transaction data to support material revisions (in some cases, higher cap rates were offset by higher NOI). That said, we believe that could change in the coming quarters. Specifically, capital recycling seems set to rise with several REITs/REOCs looking to sell assets and redeploy proceeds into debt reduction, developments/acquisitions, and/or unit repurchases given discounted valuations (Allied being the latest example). The proposed acquisition of SMU by the GIC/DIR JV could also have a positive impact on industrial values. Post Q3, our NAVPU estimates are down ~1% (Exhibit 4), with our one-year forward NAVPU estimates reflecting 7% growth.
Looking through the clouds, we still see good opportunities. The TSX REIT index has posted a -16% YTD total return, trailing the TSX Composite (-2%). In our view, several factors continue to weigh on the space, including higher rates, uncertainty surrounding tax/regulatory policies, a decelerating economy, and an extended period of price discovery. While the sector’s 18% discount to NAV screens attractive, valuation on AFFO yield and implied cap rate spreads look reasonable (Exhibits 9-12). Net-net, we continue to see attractive entry points on our preferred names.