Investors in the Real Estate sector should focus on the quality of properties and the stability and growth prospects of cash flows, according to Echelon Wealth Partners analyst Frederic Blondeau.
"Despite the potential negative impact from higher interest rates on the sector's sentiment, as well as on
underlying valuations, we would emphasize two potential positives for Canadian REITs for the rest of 2017 and for 2018: 1) The lack of investment alternatives, especially to the real assets space, in what seems to remain a low inflation environment; 2) Real Estate's relatively solid prospects compared to other sectors. In fact, our REITs sector coverage reflects our long-term positive biases towards four Real Estate asset classes, namely Multi-Family, Senior Living, Industrial, and Healthcare. In addition, we currently favour REITs with an international exposure, as we feel the CAD remains expensive and that the Canadian macroeconomic environment still remains unattractive," he said.
In a research report released late Friday in which he initiated coverage of 20 Canadian-listed real estate investment trusts and real estate operating companies, Mr. Blondeau noted REITS have "slightly" underperformed thus far in 2017 with S&P/TSX Capped REIT Index (SPRTRE) generating a 5.4-per-cent total return, which is 0.6 per cent less than the TSX.
"We note that the REITs' underperformance since the beginning of September now totals 317 basis points, " he said. "During that time, the 10-year UST increased from 2.17 per cent to 2.46 per cent," said Mr. Blondeau. "Although overall Trump's extended tantrum, seen since the U.S. elections in November last year, somewhat supports our cautious stance on REITs, in 2017 it became increasingly clearer that the Trump trade began to falter, to a point where the 10-year UST yield was hovering around the 2.05-2.25-per-cent mark again, at the beginning of September. Since then, the 10-year UST moved above the 2.40-per-cent mark, further underlining the volatility/irrationality on the fixed-income side. In regards to the Bank of Canada (BoC), despite its latest intervention, we believe the BoC should remain biased toward less expansionary measures in the mid-term."
In our opinion, currently, one of the challenges for REITs investors, from a top-down perspective, among other factors, has been to balance between two conflicting aspects: First "¦ the faltering Trump trade, and thus the demand for higher-yield vehicles that remain solid, especially within sub-sectors we favour, namely Multi-Family, Industrial and Senior Living, as well as internationally exposed Canadian REITs; and Second, the potential residual risks for REITs stemming from interest rates volatility (expectations of central banksprogressive unwinding, combined with the effects of the Trump trade/political agenda) and from a rather strong correlation between Canadian REITs and broader Canadian equity indices, combined with what we would perceive as rising global macroeconomic and systemic risks."
The analyst initiated coverage of the following equities:
Multi-Residential
- Canadian Apartment Properties REIT (CAR.UN-T) with a "hold" rating and $34.25 target. Consensus is $36.16.
- Boardwalk REIT (BEI.UN-T) with a "hold" rating and $40 target. Consensus is $42.95.
- Northview Apartment REIT (NVU.UN-T) with a "hold" rating and $23 target. Consensus is $22.96.
- Killam Apartment REIT (KMP.UN-T) with a "buy" rating and $14.50 target. Consensus is $13.95.
- Morguard North American Residential REIT (MRG.UN-T) with a "buy" rating and $16.50 target. Consensus is $16.83
- InterRent REIT (IIP.UN-T) with a "buy" rating and $9 target. Consensus is $8.85.
- Pure Multi-Family Apartment REIT (RUF.U-X) with a "buy" rating and $6.75 (U.S.) target. Consensus is $7.30.
Mr. Blondeau said: "Multi-Family is currently our favourite real estate sub-sector. The Canadian Multi-Family subsector remains vibrant and healthy despite new regulations and increasing supply. What we have seen so far is a constant readjustment of the market following the newly implemented laws in Toronto and Vancouver. In other words, despite the government's best intentions to increase rent affordability, what we have seen is a communicating vessels scenario in which capital moves from one city to another. At present, eastern cities such as Montreal and Ottawa are investors' new targets, with their appetite causing home prices to substantially increase in those cities, paving the way for a strong rental market. Some investors are simply waiting for the Toronto and Vancouver markets to fully absorb the impact of the new laws, after which housing prices should likely go back to a solid uptrend. Put differently, the recent impact we have witnessed on prices and number of transactions trending lower could only be temporary. In this context, InterRent (IIP.un, Buy, Top Pick) is our favourite name, while we rate Killam Properties (KMP.un) as Buy."