TD Notes RETAIL-FOCUSED REITS Q2/24 REVIEW
THE TD COWEN INSIGHT
Q2/24 results for the Canadian Retail-focused sector were largely in line with expectations, with management commentary confirming our positive sector outlook. Canadian Retail- focused REITs are currently trading at extremely rare and wide valuation discounts vs.
U.S. peers, and we see the current levels as a compelling entry point. Our top three Retail- focused REIT picks are FCR, REI, and CHP.
Operating Trends Continue to Improve. In Q2/24, Retail-focused REITs continued to benefit from strong demand for well-located retail properties. Occupancy remained elevated, with the Retail-focused sector average inching 20bps higher q/q to a decade-high of 97.5%. Leasing uplifts were robust at +9.8% on average, slightly ahead of the already strong 9.4% in Q1/24 and well ahead of the previous five-year average of 5.6%. We continue to believe Canada's strong population growth, limited retail supply deliveries, and in turn the decline in Canada's retail space per-capita (-6% since 2017) should all result in a tight retail leasing market in the near-to-medium term.
CBRE's recent H1/24 Retail rent survey provided another positive data point for the sector, with the report describing the sector as "supply-deprived" and seeing "incredible demand" and a "race for space" across all retail property types (link).
Results vs. Expectations. Overall, the results were largely in line with expectations, with AFFO per-unit metrics coming in slightly ahead of our estimates (+1%) as most REITs beat or were in-line, except SRU (-3% vs. our estimate). Looking forward, we expect continued strength in operational metrics and a further easing of interest cost headwinds to result in the Retail-focused REIT sector contributing more to REIT sector AFFO/unit growth.
Estimate Revisions. Overall, we have made modest revisions to our 2024/2025 AFFO/ unit estimates (2024: flat, 2025 -1%), while introducing our 2026 forecasts. Our new estimates reflect average AFFO/unit CAGRs of 3% for the next three years and 4% for the two years after 2024. We have not raised our SPNOIG assumptions, although there was some evidence to do so based on the YTD results and managements' outlook.
Historically Wide Valuation Discount vs. U.S. Peers (Figure 4). On P/AFFO, Canadian Retail- focused REITs are trading at a 33% discount vs. the U.S. peers (i.e. 12.9x vs. 19.3x), well above the historical average of a 14% discount. With similar AFFO growth rates and higher cash yields in Canada, we see the current relative valuation as excessively discounted, and we believe they have overshot to an unsustainable extreme.