Upgrade In response to a recent pullback in unit prices for real estate investment trusts as well as treasury yields, analysts at National Bank Financial upgraded Dream Office REIT and First Capital REIT to “outperform” recommendations on Tuesday while making a series of target adjustments across their coverage universe ahead of first-quarter earnings season.
“[Funds from operations] revisions (down 0.3 per cent in 2023, down 0.1 per cent in 2024) are relatively modest across the universe, mostly accounting for smaller acquisitions/dispositions, debenture issuance and NCIB activity,” they said. “We have revised targets upward on select names within our Multifamily and Industrial coverage and largely downward revisions on our Office and Diversified coverage. We have made few target price revisions across our Retail, Healthcare & Special Situations coverage.
“We have the highest return estimates for multi-family (29 per cent) and seniors housing/healthcare coverage (22 per cent), as tight markets have persisted for quite some time given limited supply growth. Usually, the dispersion of expected returns within asset classes is relatively tight, but this has shifted in recent quarters, allowing us to upgrade names like Dream and First Capital, with relatively urban-focused portfolios, trading at healthy discounts to NAV.”
For Dream Office, analyst Matt Kornack thinks its portfolio optionality is “hard to ignore at today’s valuation,” raising his rating to “outperform” from “sector perform” previously.
“We are upgrading Dream to Outperform given current attractive pricing with potential catalysts, a stable outlook combined with financial flexibility,” he said. “FY23 is anticipated to be an inflection point on in place occupancy with management guiding to a mid-to-high 80-per-cent figure by year-end (vs. 81 per cent at Q4/22) resulting from lease up at the Bay Street Collection’s street front retail and renovation completions. That said, the earnings benefit will be back end weighted and largely felt in FY24 due to fixturing periods.”
“Dream is in a unique position whereby capital structure (via limited maturities and relatively low leverage) allows for continued share buybacks and sustained distribution levels although both are a function of capital allocation decisions. Dream’s liquidity position is also solid with $164-million in credit facility availability (excl. $100-million accordion) that should improve in Q1 with proceeds from the sale of 720 Bay in part used to repay debt. The REIT also benefits from lending relationships cultivated by Dream, improving access to capital/funding availability.”
His target for Dream Office units declined to $16 from $18.50. The average target on the Street is $18.31
“Significant trading weakness seems overly punitive for D (at a 35-per-cent-plus discount to NAV and an 8-per-cent-plus implied cap rate), particularly in light of the REIT’s $400-million DIR stake and $100-million-plus of density value that could be sold in the near-term and spur momentum in the underlying stock,” Mr. Kornack said. “The result is a high cap rate being applied to the residual office, the bulk of which is downtown Toronto and itself offers future density potential, which we view as undervalued.”
Analyst Tal Woolley expects further upward revisions to funds from operations per unit expectations for First Capital REIT as it executes on its $1-billion disposition plan of lower-yield assets, leading him to raise his recommendation to “outperform” from “sector perform.”
“Considering this with the recent slide in the unit price, we see the current price as an opportunistic entry point,” he said. “As FCR generates disposition proceeds, and with the share price low, we see unit price support as FCR is active on its NCIB. We have raised our FFO/u estimates approximately 3 per cent to account for the recent sales and modestly increased our NAV. Our $18.50 target translates to 14.9 times our 2024E FFO/u estimate (was 15.8 times), equal to a 10-per-cent discount (was 8 per cent) to our revised NAV/u estimate one year out, reflective of FCR’s relative leverage, growth prospects and business/ development risks.”
“While weak REIT trading assisted in FCR’s unit price decline, the magnitude of the pullback following the proxy challenge was surprising. With 1) total return potential over 20 per cent and plan that should generate close to 9-10-per-cent returns (5-per-cent yield + 4-per-cent FFO/u growth) without any valuation changes; 2) the declines in FCR’s debt ratios (now 10.2 times versus 11.2 times last year, with it poised to fall further); and 3) the potential for further upward FFO/u revisions as the disposition program progresses and the leasing environment remaining healthy, we think the current price offers reasonable risk/reward.”
His target remains $18.50, which falls below the $19.28 average.
In the report, National Bank analysts also laid out their top “focus ideas” by asset class. They are:
Multi-Family: Minto Apartment REIT with an “outperform” rating and $19 target (unchanged). The average on the Street is $19.23.
Seniors Housing/Healthcare: Chartwell Retirement Residences with an “outperform” rating and $11 target (unchanged). Average: $11.13.
Industrial: Dream Industrial REIT (DIR.UN-T) with an “outperform” rating and $18 target, up from $17. Average: $16.89.
Office: Allied Properties REIT with an “outperform” rating and $27.25 target, down from $32.25. Average: $35.15.
Retail: First Capital REIT with an “outperform” rating and $18.50 target (unchanged). Average: $19.28.
Diversified: H&R REIT with an “outperform” rating and $15.25 target (unchanged). Average: $15.75.
Special Situations: Tricon Residential Inc. with an “outperform” rating and $13 target (unchanged). Average: $12.59.