First Capital Real Estate Investment Trust T.FCR.UN

TD Notes

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Real Estate Sector Valuations Hit Compelling Levels

Recent Sell-off Prompted by Another Spike in GOC Bond Yields

TD Investment Conclusion

The S&P/TSX Capped REIT Index (price only) has declined 9% YTD and 29% versus the recent high in March 2022, with the declines occurring while 10-year GOC bond yields rose ~70bps/~180bps during the same time periods. Nearly all this year's YTD decline has occurred since we published our sector bulletin focused on balance- sheet leverage in mid-September (link), which coincided with the latest upward spike in bond yields (increases of 14bps/30bps for 2-year/10-year GOC bond yields). Since then, we have seen a more pronounced shift in market expectations for a “higher- for-longer” interest-rate scenario.

Although it is difficult to call an inflection point with confidence in this market, we believe today's valuations should compel some investors to revisit listed Real Estate and the REIT sector.

• The sector is currently trading at a 71% P/NAV — well below the 95% historical average since 2010, and the lowest month-end valuation since the GFC. The sector's P/NAV was at a similar level a year ago, and REITs prices subsequently rallied by over 20% in the next five months.

• On an FFO yield basis, at 9.6%, the sector is trading at the highest month-end level since 2010, and the 5.6% FFO yield spread to the 10-year GOC appears elevated versus the historical adjusted average of 4.9%. As has been the case since the yield curve inverted last year, REITs appear expensive on an FFO yield spread to the GoC 2-year at 4.7% (adjusted historical average: 5.8%), although we note that this gap has improved by 70bps since September 15. Relative to both the 10-year and 2-year GOC bond yields, today's FFO Yield Spreads are at close to their widest levels seen since before interest rates began climbing in March 2022.

• Overall, the sector's well-covered cash yields currently average 6.1% (5.8% excluding office REITs), and one-third of our coverage universe offers particularly well-covered yields in the 5.5-7.7% range — exceeding those offered by GICs/money market funds (Residential REIT yields are lower, averaging 3.3%).

• As valuations have fallen, we see increasing prospects for a resurgence in M&A activity, which we would see as a catalyst for higher trading valuations. Blackstone's recent announcement of expanding its Toronto office presence and acquisitions capability likely signals its increased interest in Canadian property, in our view. With our coverage universe trading at heavily discounted valuations versus private market pricing, we expect some property investors to consider the listed Real Estate sector as part of their investing strategy. Our coverage universe is currently trading at these implied price/sf and implied cap rate valuations:$243/sf and 7.4% on average for Retail, $130/sf and 6.1% for Industrial, and $212,000/suite and 5.3% for Residential. Office REITs on average are trading at $271/sf and an 8.9% implied cap rate.