TD Updating our 2024 Outlook for Year-End Prices
With this note, we are reiterating our 2024 REITs/Real Estate Industry Outlook
published last month (in which we raised target prices +6% on average), and
providing year-end updates to several exhibits.
The REIT Index continued its rebound in the back half of December and ended the
year +2.8% on a total return basis, narrowly avoiding a second consecutive down
year. Valuations also continued their recovery since mid-December with the sector
P/NAV up ~1% to 81%, while the FFO yield and FFO yield spread to the 10-year
GOC each declined 20bps to 8.9% and 5.8%, respectively. The FFO yield spread to
the 10-year GOC currently sits 90bps above its adjusted historical average. Looking
forward, we see potential for risks related to the macro environment, interest
rate volatility, and inflation expectations all to ease, which should help the
sector's FFO yield spread migrate closer to the long-term average.
The sector's 2023 total returns lagged our original forecast (Exhibit 1) largely due
to higher and more volatile interest rates. That said, our sub-sector relative call (e.g.
preference for Residential and Industrial) was mostly correct, other than the strong
outperformance by the Seniors sector.
We reiterate our call for 2024 sector total returns being most likely in the
15%-20% range, with 0%-35% defining the lesser probability extreme range.
The +17.5% midpoint reflects 60bps of yield compression plus cash distribution
yields and forecasted mid-single digit AFFO growth.
Our forecasted returns are based on the following considerations:
REIT trading valuations (FFO yields) and government bond yields will likely remain
highly correlated in the near-term — at least until interest rates settle in some new
and 'normal' range.
Should interest rates trend lower, we expect a reversal of individual investor funds
flow from term deposits/money market funds back into REITs. The historical trends
of these metrics are shown in Exhibit 6, however, we note that the term deposits
fund flows chart is dated as of the end of October. With the yield curve now lower,
we expect those fund flows to continue moderating, which should benefit REITs
and other higher-yielding equity sectors, in our view.
We anticipate a continuation of the favorable fundamentals enjoyed by most
sectors in 2023, driven in part by robust leasing demand in the Residential,
Industrial, and Retail property sectors. For Seniors Housing, we anticipate a
more pronounced occupancy recovery in 2024, while we expect Office sector
pessimism to moderate and valuations to rebound from current heavily discounted
levels.
Our sector pecking order is Industrial, Retail, Residential, Seniors, and Office,
while our three ACTION LIST BUY-rated names are CAPREIT, First Capital
REIT, and Granite REIT. Other larger-cap top picks include Chartwell Retirement
Residences, Dream Industrial REIT, and RioCan REIT.2