National Bank Ahead of third-quarter earnings season in Canada’s Real Estate sector, National Bank Financial analyst Matt Kornack raised his target prices for equities in his coverage universe by an average of 9 per cent, pointing to “lower bond yield expectations across the curve with a particular focus on longer-term rates, which declined by 30 to 50 basis points vs. prior forecasts in Canada and the U.S., respectively.”
“We passed this through on NAV [net asset value], albeit to a lesser extent (cap rates down on average 20 bps),” he added. “Our view is we are at a crossroads where the rate environment is improving but pandemic induced inflationary pressures are subsiding (and we expect this will funnel down to rents).”
In a research report released Wednesday, Mr. Kornack said the impact of pandemic continues to impact economic performance, emphasizing “sequencing is important.”
“The playbook seems to be transitioning from an equity investment standpoint, but we are still sticking to a focus on quality of assets and defensive growth profiles,” he said. “We expected moves at the short end of the curve to push equity investors into yield product and for REITs to be a beneficiary. That appears to have happened. Given a focus on fundamentals, we don’t entirely agree with some of the undiscerning chasing of higher yields in spite of prevailing fundamentals. As such, we are maintaining a defensive bias, and this is reflected in our asset class pecking orders.”
“Asset class pecking orders largely unchanged with Seniors being re-added and with a strong showing. By total return, we favour seniors (23 per cent), apartments (22 per cent), industrial (20 per cent), retail (17 per cebt), office (8 per cent) and diversified (7 per cent). The aggregate total return across our coverage universe is currently at 18 per cent. Admittedly, in the course of writing this note and setting target prices, there has been some trading volatility around continued gyrations in bond yields, which are likely to continue as economic data emerges.”
Mr. Kornack’s “Focus Ideas” are currently:
Healthcare
* Chartwell Retirement Residences with an “outperform” rating and $18.50 target. The average on the Street is $16.50.
Analyst: “Within the healthcare group, CSH is now the top focus idea. As we’ve seen in industrial, self-storage and multi-family, when a real estate asset class gets moving, surprises tend to persist beyond initial expectations. We are taking the view that a similar setup is happening in seniors housing, and specifically for CSH. Our bullish posture is anchored around a Street high 2025 FFO/u estimate that is driven by rental/service increases of 5 per cent (which may be conservative as suite availability declines/a tight rental market persists) and modest opex/occupied suite growth of 1.5 per cent (from labour market slack / softening inflation data). Ultimately, we won’t have a full understanding of this trend until Q4 annual results which disclose data points on labour spend/occupied suite. Secondly, assuming the WELL transaction closes before year-end, Q1 results will be crucial for observing how the remaining suites performed on a top / bottom-line basis year-over-year after accounting for the new same-property pool. Both potential catalysts may turn into notable drivers of stock performance over the next 12 months.”
Canada Multi-Family
* InterRent REIT with an “outperform” rating and $15 target. Average: $14.95.
Analyst: “For the first time in a long time, InterRent tops our total return expectations for the apartment segment (was KMP going into Q2/24) — this is largely on the back of lacklustre trading performance relative to what we expect to be pretty solid fundamentals and a more favourable interest rate exposure. IIP’s strategy of targeting locations with structurally higher transience positions the REIT to better capture its imbedded MTM opportunity than peers. Capital recycling has seen the REIT dispose of lower growth assets, funding accretive unit buyback activity. Financial flexibility has improved while in-place interest rates are now relatively close to prevailing 5-year CMHC mortgage costs, meaning rent growth will better translate into earnings performance.”
* Flagship Communities REIT with an “outperform” rating and $20 target. Average: $19.50.
Analyst: “MHC is our top U.S. housing pick and highest total return in our coverage, given its steep valuation discount, despite offering some of the highest organic growth and defensibility in the REIT sector. Trading liquidity is sparse but for those that can, we would recommend buying this name.”
Industrial
* Dream Industrial REIT with an “outperform” rating and $17 target. Average: $16.05.
Analyst: “Our highest total return to target for the industrial segment goes to Dream Industrial, again, as the REIT remains relatively inexpensive vs. its medium-term growth outlook. DIR’s ability to grow its NOI is driven by its exposures to Canadian urban mid-Bay properties. As was highlighted at its investor day, demand for this segment has remained more resilient supporting elevated market rents, with still a significant MTM opportunity. We see nearer-term industrial fundamentals as stabilizing with peak vacancy in Canada forecasted for Q2/25 with an inflection in market rent growth likely thereafter.”
Retail
* RioCan REIT with an “outperform” rating and $23 target. Average: $21.15.
Analyst: “RioCan supplants First Capital as our top total return potential in the retail segment (in part because of relative trading strength of the latter). We like REI for its strong structural organic growth potential (3-plus per cent SPNOI growth guidance), comparably cheaper valuation and limited value attributed to an established development vehicle with sizeable near-term and leverage positive completions. On the latter, REI is slated to receive $700-million in condo sales and $500-plus-million in rental development completions through 2026, providing greater certainty over earnings and helping management achieve its 8 times D/EBITDA target. REI trades at 12 times 2025 estimate FFO/u, which is a half turn discount to peers, despite offering above average growth and a largely derisked development pipeline.”
Office
* Allied Properties REIT with a “sector perform” rating and $20 target. Average: $19.67.
Analyst: “Our highest total return to target in the office sector remains Allied, given the REIT’s relative asset quality (including an exceptional urban land footprint) vs. its Canadian office peers. There is an ongoing flight to quality where tenants are prioritizing built-out space with access to amenities, and as such, we believe Allied is better positioned on a relative basis given broader office turbulence. Additionally, their above-noted ultra-core urban portfolio provides for a value floor and could appeal to investors with a long-term view on the Canadian market and particularly its top cities. We continue to like the quality and footprint of the portfolio offering relative to valuation and expect management to continue proving this value through monetization of select assets while also improving balance sheet metrics. Nonetheless, office fundamentals are likely to remain challenging.”
Diversified
* H&R REIT with a “sector perform” rating and $11.50 target. Average: $11.33.
Analyst: “Within the diversified group, H&R remains our top focus idea, driven by exposure to multi-family assets in U.S. markets and industrial development lease-up around the GTA combined with a better balance sheet and limited office maturities. Recent transaction activity was a plus as management continues to showcase their progress in achieving reasonable pricing on a blended basis for the REIT’s assets in a market where transactions are still at somewhat of a standstill. These sales are incrementally positive given that the stock trades at an implied cap rate of 8.5 per cent and continues to move the pro forma entity more towards apartment ownership (we are still waiting on a broader inflection within the Sunbelt markets). We think there is torque to the upside on lower rates as the portfolio remains defensive but don’t see urgency to this trade.”