Ahead of first-quarter earnings season, National Bank Financial analyst Matt Kornack says interest rate expectations continue to dictate the performance of real estate investment trusts.
“In late 2023 and bleeding into the beginning of 2024, market participants were comfortable with the likelihood of interest rates cuts by the BOC and the Fed,” he said. “There were clear signs that Canada’s growth was beginning to stall but also cracks apparent globally. A series of hot inflation reports south of the border derailed this expectation – while Canada still looks relatively weak, a material deviation from the U.S. is unlikely given FX implications and their inflationary consequences. That said, Canada is still likely to act first on rates and this will have positive funds flow implications for REITs.
“While the valuation impacts are more punitive, staggered debt maturity profiles provide protection in terms of near-term earnings implications. Assuming interest rates remain the same over our forecast period, the average hit to FFO/unit in 2025 is a modest 2 per cent. In the case of REITs with heavy disposition expectations, like FCR, there is a benefit. For BEI and GRT, the higher interest rates were a net positive given interest earned on their large cash balances (FCR as well given its short-term investments). Office names are the relative losers as higher exposure to variable rate debt (namely credit facilities) has become a symptom of more limited access to capital.”
In a research report released Wednesday titled Stuck Between the Curve and the Economists, Mr. Kornack reduced his target prices for stocks in the sector by an average of 4 per cent to reflect bond yield adjustments. He also cut his 2025 financial projections by 2 per cent based on higher interest rate forecasts, though he notes “the shift hasn’t been universal across the curve with rates largely landing in the same spot by the end of 2025 according to NBF’s Economics & Strategy team.”
“This dynamic creates an upside scenario if bonds move lower quicker but downside if the current environment prevails longer term,” he said. “Our forecasted cap rates increased an average of 10 basis points (we tweaked these fairly universally across asset classes to account for the move in the current 10-year – as noted 2024 rate assumptions were up 70-80 bps) and NAV estimates were down 4 per cent (this was the primary driver of target price adjustments).
“Asset class pecking order remains the same – apartments followed by industrial with retail still relevant. Mean returns for Canadian multi-family are (up 24 per cent) followed by industrial (up 22 per cent) and retail (up 17 per cent). Apartment fundamentals remain strong with sustained expected market rent growth across a largely affordable offering. While demand is being targeted on the housing front in the form of student and temporary foreign worker adjustments, the result remains to be seen. The slowdown in industrial leasing dynamics is becoming more evident, but we like the current implied valuations relative to embedded MTM growth, providing downside protection.”
Here are Mr. Kornack’s “focus ideas” by asset class:
Industrial
Dream Industrial REIT ( “outperform”) with a $16 target, down from $16.50. Average: $16.07.
Analyst: “Our highest total return to target for the industrial segment goes to Dream Industrial as the REIT remains relatively inexpensive vs. its medium-term growth profile while presenting a lower risk profile than the others. We view DIR as the best way to gain exposure to the robust GTA/GMA markets. It is the closest proxy for an urban smaller-bay Canadian play, which has higher barrier to entry than other markets and less competing product to entice tenants away. DIR still has a strong MTM opportunity providing the best organic growth profile across the Canadian peer set with a favourable lease maturity profile over the next few years. Lastly, overlapping costs still employed since the DIR / SMU JV was established also present a potential source of synergies that may be realized over time.”
Mr. Kornack’s other target adjustments are:
- Boardwalk REIT ( “outperform”) to $86.50 from $87. Average: $85.22.
- BTB REIT ( “sector perform”) to $3.05 from $3.15. Average: $3.35.
- Crombie REIT ( “outperform”) to $14.25 from $15. Average: $15.56.
- Dream Office REIT ( “outperform”) to $18.75 from $19. Average: $18.
- First Capital REIT ( “outperform”) to $17.25 from $17.50. Average: $18.08.
- Granite REIT ( “outperform”) to $85 from $87. Average: $88.72.
- BSR REIT ( “outperform”) to US$12.50 from US$13.25. Average: US$14.98.
- InterRent REIT ( “outperform”) to $14 from $15.50. Average: $15.18.
- Killam Apartment REIT ( “outperform”) to $21.50 from $22.75. Average: $22.40.
- Minto Apartment REIT ( “outperform”) to $18.75 from $20. Average: $20.50.
- Nexus Industrial REIT ( “sector perform”) to $7.50 from $8.50. Average: $8.94.
- Primaris REIT ( “outperform”) to $15.50 from $16. Average: $16.98.
- PRO REIT ( “sector perform”) to $5.50 from $6. Average: $6.25.
- SmartCentres REIT (“sector perform”) to $23.50 from $26. Average: $26.16.
- Storagevault Canada Inc. ( “sector perform”) to $5.75 from $6. Average: $6.22.
- True North Commercial REIT ( “sector perform”) to $8.50 from $8.75. Average: $9.19.