RBC Notes Our view: Our Outperform ratings include Allied, Boardwalk, BSR, CAPREIT, Chartwell, Colliers, Dream Industrial, FirstService, First Capital, Granite, InterRent, Killam Apartment, Minto Apartment, Morguard Residential, RioCan, SmartCentres, and StorageVault. Q2 results were largely as expected, with a pick-up in earnings growth supported by strength in fundamentals across most property types. Indeed, organic NOI growth is tracking near record highs, with several subsectors in the high-single to low-double-digit percentage range. Still, investor sentiment remains restrained amid rising interest rates and a clouded view on economic traction, with capital flowing to names where fundamentals are strongest. Set against this context, our recommendations remain largely skewed to more operationally resilient subsectors including multi-family, industrial, self-storage, and defensive retail.
A largely “in line” quarter, as earnings growth picks up. Q2/23 FFOPU increased 2% YoY for our coverage group, up from ~0.5% in Q1/23, but still tracking below last year’s 3% pace. By subsector, industrial and multi-family posted the strongest growth (+7% YoY, each), followed by retail (+3%) and seniors housing (+2%). In contrast, diversified (-6%) and office (-24%) materially lagged. Among reporting entities, 73% (27 of 37) delivered earnings that met our forecasts, while 11% were ahead. However, 16% fell short of our expectations across a mix of property types where results were impacted by lower NOI, higher G&A, and/or higher interest costs. Among subsectors, seniors housing and other (REOCs) had the highest proportion of entities that came in ahead of our forecasts (Exhibit 2).
Organic growth near record levels, with multi-family firmly in the lead; seniors housing accelerating.
Same-property NOI increased an average 6% YoY in Q2/23, consistent with last quarter and well above the 2% long-term annual average. Notably, multi-family has remained at the front of the pack for three straight quarters, with Q2 SP NOI up a strong 10% YoY, aided by solid rent growth. Seniors housing followed (+9% YoY), supported by gains in occupancy and fading expense pressures, particularly in agency staffing costs. Industrial continues to deliver strong advances (+8% YoY), mainly from higher rents, as the mark-to-market opportunity remains compelling. Diversified REITs were next (+5%), followed by retail (+3%), self-storage (+2%), and office (+1%).
Estimates down modestly; expect growth leadership where fundamentals are strongest. Coming out of Q2, our 2023E-24E FFOPU are down ~1% in each year. As Exhibit 4 illustrates, office REITs suffered the deepest cuts, with minor revisions elsewhere. Our 2023E reflect FFOPU growth of 1% (vs. prior 2%), rising to 5% in 2024E, with all subsectors in positive territory next year. Supported by fundamentals, we expect seniors housing, industrial, and multi-family to maintain leadership in 2023, with mid-to-high- single digit % growth in 2024 as well. IFRS NAVs were relatively flat sequentially with limited changes in IFRS cap rates (+6 bps QoQ, +34 bps YoY). Relative to Q1/22 (start of rate tightening cycle), IFRS NAVs have increased an average 2% (most subsectors are up, with the exception of office). In comparison, our NAVPU estimates declined 2% QoQ and are down 8% from Q1/22, mainly on higher cap rates.
On the whole, sector valuation screens reasonable; focus on fundamentals. The TSX REIT Index has delivered an uninspiring -1% YTD total return (Exhibit 8) as rising interest rates, an uncertain economic trajectory, and concerns over access to credit in more challenged property types have weighed on sentiment. On valuation, the sector continues to screen well on an NAV basis, with the current 26% discount well below historical parity. Yet, with reduced visibility on asset values, we believe investors are placing greater weight on cash flow multiples and spreads, where frankly valuation looks more reasonable (281 bps AFFO yield spread and 343 bps implied cap rate spread to 10Y GoC are within fair value range, but below long-term levels; Exhibits 9-12). In short, we believe fund flows will continue to gravitate toward strength in fundamentals, with our preferred subsectors well positioned to benefit.