RBC Notes August 21, 2024
Canadian REITs and REOCs: Q2 2024 recap
Results ahead of forecast, with good momentum; back in black
Our view: Our Outperform-rated recommendations include Boardwalk, BSR, CAPREIT, Chartwell, Colliers, Dream Industrial, FirstService, First Capital, Flagship, Granite, InterRent, Killam Apartment, Minto Apartment, Morguard Residential, RioCan, SmartCentres, and StorageVault. After a strong Q1, momentum extended through Q2 with the sector delivering decent overall growth that exceeded our forecasts. Combined with strong fundamentals across most property types and more favourable debt costs, our earnings outlook has modestly improved. While YTD sector returns are back in the black, we’ll likely need some further macro support to light a bigger spark under fund flows. In the meantime, our preferred picks remain anchored in names where we continue to see superior operational resilience, including select seniors housing, multi-family, industrial, self-storage, and defensive retail.
Results ahead of forecast, with healthy overall growth. Q2/24 FFOPU increased 3.5% YoY, ahead of our +1% forecast. While the proportion of “beats” this quarter exceeded the long-term average, results were partly boosted by non-recurring/lower visibility income (e.g., prior period recoveries, insurance proceeds). Seniors housing held on to leadership (+32% YoY, excluding outliers), followed by multi- family (+7%), retail (+3%), and industrial (flat). Meanwhile, diversified (-5% YoY) and office (-10%) REITs continue to trail the group by a sizeable margin. Among reporting entities, 57% registered earnings that were in line with our forecasts (vs. 65% LTA), while 31% were ahead and 11% were short (Exhibit 2).
Same-property NOI up strong, with good momentum across multiple property types. Sector average SP NOI increased 5% YoY, in line with the elevated levels of the past two years and well above the +2% long-term average (Exhibit 3). Several subsectors continue to buoy results, including seniors housing (+20% YoY) where higher rents/service rates, occupancy gains, and fading cost pressures are fuelling momentum. Multi-family moderated (+7% YoY vs. +9% in Q1) with fundamentals in relatively more affordable markets (e.g., AB, SK, NS) holding strong while those in more expensive markets (e.g., Toronto) are seeing some pressures from condo deliveries. Notably, SP NOI growth accelerated in industrial to +5%, notwithstanding normalizing market fundamentals, while retail remains healthy (+3%) on strong demand and minimal new supply. Rounding out our coverage, self-storage growth decelerated (+2% YoY), followed by office (+2%), and diversifieds (+1%).
Seniors housing continues to see the most positive estimate revisions. Post Q2 results, our 2024E and 2025E FFOPU increased by an average 1% in both years. Similar to last quarter, our seniors housing estimates increased the most (Exhibit 4), with relatively minor changes across the remaining subsectors. Our forecasts reflect +3% 2024E FFOPU growth, with 2025E improving to +4%. On a 2023A-25E CAGR basis, we expect growth leadership from seniors housing, followed by multi-family, and industrial. As for NAVs, our estimates are up an average 1%. Notably, revisions were positive across most subsectors, with seniors housing leading the group, followed by industrial and multi-family (Exhibit 5).
Back in black, as more favourable macro picture forms. Since the end of June, the TSX REIT Index has delivered a solid +10% total return, driving the sector’s YTD return (+3%) back into positive territory. Recent bond yield compression, softer inflation, and further anticipated BoC rate cuts are likely providing some key support. Still, valuations screen quite reasonable, in our view, with the sector trading at 16x N12M AFFO/7.2% implied cap rate (Exhibits 11-12). In particular, current spreads to the 10Y GoC have risen closer to long-term levels, including the AFFO yield spread (342 bps vs. 362 bps LTA) and the implied cap rate spread (416 bps vs. 423 bps LTA). At 22% below NAV, we also continue to see a wide margin for error, particularly with the majority of our top picks at double-digit discounts.