NB Top Pick National Bank Financial analysts Matt Kornack and Tal Woolley expect returns in the Canadian real estate sector to continue to “oscillate with rates.”
In a research report released Monday previewing 2023, they emphasized interest rate discussion will “dominate again” this year.
“Our sense is that both private and public markets are in price discovery mode as investment volumes remain low,” the analyst said. “Debt capital is available, but certainly not at the quantum or cost seen in recent years. Real Estate equities underperformed in 2022 as a result. We are optimistic central bank tightening activity could slow, possibly even ease and provide a valuation tailwind (hopefully, in the absence of a difficult recession). That said, there is no certainty and given tight spreads between implied cap rates and bond yields, it is difficult to put new money to work at today’s valuations.”
“We are making no recommendations changes and select target prices adjustments. FFO revisions are modest, and we mostly reflect higher rates in our forecast premiums. We believe the market is still pricing in some degree of inflation protection offered by hard assets and/or a lower rate environment, based on the relatively low spreads offered by current implied cap rates over borrowing costs.”
Maintaining a “maintaining a cautious outlook on returns this year in light of the interplay between declining bond yields and rising recession risks,” the duo has the highest average return estimates for multi-family real estate investment trusts at 18 per cent followed by industrials at 15 per cent, leading them to increase their targets for each by an average of 5 per cent and 8 per cent, respectively.
By group, their top picks for the year are:
Multi-Family: Boardwalk REIT with an “outperform” rating and $65 target, up from $63. The average on the Street is $60.55.
Mr. Kornack: “Note that Dream Residential (DRR.UN-T, “outperform” and $10.50 target) has the highest total return to target, and we think it is a compelling opportunity; however, liquidity is limited, so we are highlighting our best total return option with broader applicability to institutional and retail investors.”
“Boardwalk tops our list in terms of apartment potential total returns in 2023 as it offers investors a reasonable valuation and one of the strongest organic growth/earnings performance profiles this year and into next. The REIT saw an inflection in operating performance in 2022 and is now at fractional vacancy levels across its W. Canada markets allowing for a recapture of past incentives offerings. Given a lack of rent controls, we expect this will result in some of the better aggregate organic growth across our coverage universe. BEI has also been a leader in controlling costs and has balance sheet metrics in line with the broader apartment REIT universe.”
Industrial: Dream Industrial REIT with an “outperform” rating and $15.50 target, up from $14. Average: $15.23.
Mr. Kornack: “DIR remains relatively cheap vs. its asset exposure and expected earnings growth profile in 2023 and 2024. We continue to view it as the best proxy for SMU’s exposure with 65 per cent of the asset base having similar locations and experiencing consistent growth prospects. We also like the European portfolio and FX has been friendlier of late (although interest rate exposure will be an earnings impediment in 2025 and beyond). In light of its relative valuation and operational attributes, we see DIR as a prime candidate for the allocation of SMU proceeds post deal-closing and expect that it has already benefited from some of this capital deployment.”