July 7, 2021
Real Estate Investment Trusts
Quarterly Review and Sector Outlook – Q3 2021
Recommendations
From the universe of 38 TSX-listed REITs, we have 13 Outperforms: Allied Properties REIT, Boardwalk REIT, BSR REIT, CAPREIT, Dream Industrial REIT, European Residential REIT, First Capital REIT, Granite REIT, InterRent REIT, Killam Apartment REIT, Minto Apartment REIT, SmartCentres REIT, and WPT Industrial REIT. Also rated Outperform are Chartwell Retirement Residences, Colliers International Group, and Tricon Residential. Overall, we remain overweight rental residential and industrial.
Highlights
A record first half, as listed real estate comeback extends through Q2. The TSX REIT Index delivered an 11% total return in Q2/21, modestly outpacing the TSX Composite (9%) and the S&P500 (9%), and substantially ahead of 10Y GoC bonds (2%). The rally has pushed the REIT sector’s 1H/21 total return to a solid 22% (ahead of 17% from TSX), marking a new first half record. The REIT recovery is not unique to Canada, as listed property market returns are positive across the globe. Through 1H/21, TSX REITs outperformed the Global Index (16%), Asia (18%), and Europe (10%), and are in line with the US (22%).
We believe the sector sets up well for the balance of the year, with the right mix of ingredients to support a strong overall year of returns. Drivers include 1) an anticipated acceleration of economic activity, 2) recovering property fundamentals, 3) further upside in NAVs (+5% in N12M) and improving earnings growth (2021E/2022E of +3%/+6%), 4) higher, yet still favourable interest rates, 5) reasonable valuations, and 6) corporate liquidity near record highs. Notably, improving fundamentals have contributed to an 8% YTD increase in our NAVs, which currently sit just 1% below pre-COVID estimates. As well, we expect earnings for the majority of our universe to recover to pre-COVID levels in 2022.
Valuation is reading much more reasonable across most of our preferred gauges. The sector’s P/NAV discount has improved to 1%, up from -5% last quarter and -11% at the end of 2020. The reading leaves the sector a bit below our fair value range and the 1% LTA premium. AFFO multiples have also expanded, with the current 20x forward P/AFFO (5.0% AFFO yield) modestly below the Jan-2020 peak (22x). Yet, at 361 bps, the AFFO yield spread to the 10Y GoC is effectively in line with long-term levels. In contrast, the 163 bps AFFO yield spread to corporate yields (Moody’s BAA Index) remains well above average.
Sector returns could surpass our “high-case” call, though risks in the system are still elevated. The sector’s YTD return has surpassed our 13% base-case full-year forecast and seems to be on pace to exceed our 23% high-case scenario. Indeed, we believe the backdrop outlined above remains conducive for high single digit total returns from the sector over the next 12 months. While our outlook remains constructive, we remain cognizant of a potential pause in momentum from still heightened levels of uncertainty, particularly amid the ongoing pandemic, elevated broader equity market valuations, and inflationary pressures which could alter the course of monetary policy, as discussed further herein.