Our view: Supported by strong SP-NOI growth, continued cap rate compression, and tuck-in acquisitions, European Residential REIT (“ERES”) continues to deliver robust NAVPU and FFOPU growth. To this end, the REIT’s discount to NAV has continued to widen as unit price appreciation has not kept pace with underlying fundamentals. We raise our price target by $0.25 to $5.75 and continue to see attractive absolute, and risk- adjusted, return potential. Reiterate Outperform.
Key points:
An in-line quarter with sizeable fair value gains. Excluding a €0.2MM (€0.001/unit) landlord levy rebate, FFOPU of €0.039 (+15% YoY) was in line with our €0.037. More importantly, accelerating housing shortages, a growing number of apartment investors, and low bond yields supported 10 bps of sequential IFRS cap rate compression to 3.77%. This, together with healthy organic growth supported €77MM (€0.33/unit) of fair value gains and a 10% sequential increase in the IFRS BVPU to €3.77 (~C$5.43).
Significant MTM opportunity keeps top-line growth in 3–4% range. With releasing spreads of 16% in Q3, we believe the REIT's mark-to-market potential remains in the mid-teens. This supported residential SP-Revenue growth of 3.5%, including the impact of recent regulatory changes. While this is slightly down from 4.0% year-to-date, 3.9% in 2020, and 5.0% in 2019 (excl. pass-through items), top-line growth was in line with prior guidance. Looking ahead, we expect SP-Revenue and SP-NOI growth (ex-rebates) will remain in the 3–4% and 3–5% range—potentially near the high end.
A small post-quarter tuck-in builds on external growth story. On Oct-29, ERES announced the acquisition of a 63 suite, non-regulated building within Rotterdam, a core Randstad sub-market, for €19MM (€303,000/suite) at a 3.2% cap rate. Thematically, the fully leased building offers economies of scale given its proximity to existing ERES properties. With long-term debt still available at ~1.1%, we continue to see attractive financing spreads.
Raising our NAVPU 9% with minor tweaks to our FFOPU estimates. Post Q3, our 2021E–23E FFOPU increase by 1% to €0.15, €0.16, and €0.16 on the back of the REIT's post-quarter acquisition. Our estimates reflect growth of 10%, 5%, and 4% and a 2019A–23E CAGR of 5%, compared with our coverage at 2%. Our NAVPU increases by 9% to €3.75 (+€0.30), on the back of a 10 bps lower cap rate and slightly higher SP-NOI, with our 1Y forward NAVPU of €4.00 (+€0.40) implying growth of 6%.
Increasing price target $0.25 to $5.75; reiterate Outperform. In our view, ERES' units are trading at an unwarranted 18% discount to NAV, compared with: 1) European peers at -2%; 2) ERES' pre-pandemic premium of 4– 8%; and 3) our target at +/-0% (previously a 5% premium). Looking ahead, we continue to believe resilient fundamentals will ultimately prevail as investors gain comfort with 2021 regulatory changes, over time.