Pointing to the impact of rising interest rates, National Bank Financial analyst Matt Kornack and Tal Woolley lowered their target prices for Canadian real estate equities by an average of 15 per cent on Tuesday ahead of the start of third-quarter earnings season for the sector.
“This was not uniform across asset classes: we significantly reduced targets for Office (down 40 per cent on average),” the said.
“We revised our FFO [funds from operations] forecasts 5 per cent lower for 2024: issuers with elevated variable debt were disproportionately impacted. Our forecasted cap rates increased an average of 31 basis points (again, office is an outlier at up 62 basis points), driving NAV [net asset value] estimates down 12 per cent. Our price targets follow suit, down 15 per cent.”
The analysts noted seniors and healthcare REITS are currently showing the highest average return for investors.
“Mean returns for seniors housing/healthcare are (up 32 per cent) followed by multi-family (up 28 per cent), industrial (up 26 per cent) and retail (up 21 per cent),” they said. “While the expected mean return for seniors/healthcare is highest, this is due to some target prices being set on non-fundamental factors (e.g., a potential bid for NWH from its former CEO), inflating the average. Across all asset classes, limited new supply expectations and immigration-fuelled demand for space is positively impacting all asset classes (excluding office), resulting in high occupancy and improving rents. Unfortunately, the spread offered by implied cap rates over marginal borrowing costs is not high historically, making a challenging market for equities.”
The analysts made one rating change with Mr. Kornack downgrading True North Commercial REIT (TNT.UN-T) to “underperform” from “sector perform” previously, citing a “challenged operating/financial backdrop” and emphasizing a deterioration in office REIT valuations.
“Underlying this is a belief that there should be a risk premium to owning non-core and suburban properties that doesn’t currently exist relative to peers,” he said. “We believe TNT’s occupancy is elevated relative to the broader suburban office market and the REIT’s current leverage levels present an earnings and refinancing challenge as lenders are pulling back on office financing availability and LTVs.
“TNT reported Q2 occupancy of 89 per cent (which has continued to trend lower) with sales of vacant buildings propping up headline figures. Having said this, market reports show the national vacancy of suburban office in the low-80-per-cent range; thus, further deterioration is possible. Capital investment will be required to maintain occupancy, but we anticipate this to come at a significant cost to the REIT (by way of TI’s/free rent) which will further pressure forward earnings.”
Mr. Kornack reduced his target for True North units by $1 to $1.25. The average target on the Street is $2.55, according to Refinitiv data.
“A return to a more positive bias on the name would require a more constructive operating environment and a shift in investor/ lender sentiment around office,” he said.
For their “Focus List” ideas, the analysts made these target changes:
Seniors Housing/Healthcare