TD COWAN INSIGHT FROM THE TD COWEN INSIGHT
Canadian REITs were +4.3% last week as investors gain increased confidence in the prospects of near term BoC and U.S. Fed rate cuts. As this unfolds, and yield-seeking Canadian investors increasingly pull out of GICs/money market funds and re-deploy cash back into higher yielding equity securities, we expect Canadian REITs — including their trading valuations — to be a prime beneficiary.
The Capped REIT Index's +4.3% price gain last week was its second-best week since Nov 2023. REITs are now in positive YTD (price-only) territory for the first time since January, and +16%/+22% above their June 2024/Oct 2023 lows. However, REITs are still 20% below year-end 2021 levels, reflecting the spike and subsequent volatility in interest rates. The good news is that those headwinds have rapidly diminished and are starting to become tailwinds.
Today's GoC bond yields of 3.2% for the 2-year (a 24-month low), and 3.0% for the 10-year (a 15-month low) are down 180bps and 120bps, respectively, from their October 2023 peaks. Expectations for further BoC rate cuts and the commencement of U.S. Fed cuts next month suggest these tailwinds will continue, assuming no deep economic recession follows.
Last week, Canadian business media was flagging a theme we've been covering for some time: that continued central bank rate cuts should cause the $300bln of fund flows over
the past 30 months into term deposits/money market funds (Figs. 1 & 2) to reverse as yields on those investments continue to decline. As yield-seeking investors reallocate those funds, we see potential for Canadian REITs to materially outperform, as they have in past similar periods since 1998. Distribution yields average 6% for retail REITs and 5% for industrial REITs. Additionally, looking at 2025 AFFO growth, we see “growth + yield” sums exceeding 10% (Fig. 3) for much of our coverage universe. That represents a re-acceleration of growth, largely because the interest expense headwind has quickly diminished (i.e., no longer growing faster than EBITDA).
At just 2% of the S&P/TSX Composite Index, we expect the REIT sector to continue experiencing above-average price volatility in response to changes in the expected trajectory/pace of further central bank rate cuts. As this new rate-cutting cycle unfolds, we see potential for higher trading valuations and an improved property transaction market that should begin to push our NAV estimates higher.
Our top larger-cap picks remain CAR.un, GRT.un, REI.un, CSH.un, DIR.un, FCR.un, BEI.un, KMP.un, CHP.un, and PMZ.un
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