May 23, 2024
Canadian REITs and REOCs: Q1 2024 recap
Good start, strong traction; still looking for some macro co-operation
Our view: Our Outperform ratings are intact and include Allied, Boardwalk, BSR, CAPREIT, Chartwell, Colliers, Dream Industrial, FirstService, First Capital, Flagship, Granite, InterRent, Killam Apartment, Minto Apartment, Morguard Residential, RioCan, SmartCentres, and StorageVault. Big picture, a good start to the year. Underlying results delivered decent earnings growth, as organic NOI growth continues to track near-record highs. Indeed, fundamentals across the majority of property types remain in good shape, with our forecasts reflecting moderate, yet healthy earnings expansion through 2025. While higher rates continue to weigh on investor appetite, BoC rate cuts and compression at the long- end of the yield curve could light a spark under fund flows. In the meantime, our recommendations remain skewed to where we see the strongest operating traction, particularly multi-family, select seniors housing, industrial, self-storage, and defensive retail.
Outsized growth to start 2024 (with some caveats). Q1/24 FFOPU increased 7% YoY for our coverage universe, well ahead of our +3% forecast and the +3% delivered last quarter. However, results had some significant support from lumpy non-recurring and lower visibility income in a select few names. Excluding this income, growth was closer to ~3%. By subsector, seniors housing maintained leadership (+52% YoY, with help from one-time amounts), followed by multi-family (+9%) and retail (+7%, with some assistance from lower quality income). Office (-15% YoY) and diversifieds (-11%) continue to lag, while industrial growth was soft (-4%). Among reporting entities, 63% (24 of 38) delivered earnings that met our forecasts, while 16% were ahead, including all three of our seniors housing names (Exhibit 2). At the opposite end, 21% fell short of our expectations across a variety of subsectors.
Strong round of organic growth, as “living” once again leads the way. Sector average SP NOI increased 5% YoY, still tracking near record levels and well above the +2% long-term average. Seniors housing remains in double-digits (+18% YoY), supported by higher rents/service rates, easing cost pressures, and the on-going recovery in occupancy. Multi-family fundamentals remain solid (+9% YoY SP NOI), with a brisk pace anticipated to persist on still sizeable mark-to-market opportunities. Self-storage is also in strong form (+5% YoY), with industrial (+4%) not far behind, as tailwinds from higher rents are more than offsetting modest occupancy erosion. Retail accelerated (+3%) as tenant demand remains robust, with a decent print from the diversifieds too (+3%). Not surprisingly, office continues to lag (flat).
Estimates up the most in seniors housing – on pace to lead overall earnings growth this year. Post Q1 results, our 2024E FFOPU are relatively stable, with 2025E down ~1%. Our seniors housing estimates rose the most from improving operating traction and increased govt funding (Exhibit 4). In contrast, office saw the steepest negative revisions. Our forecasts reflect +2% 2024E FFOPU growth, rising to +4% in 2025E. Taking a closer look, we expect 2024 growth leadership from seniors housing and multi-family, with industrial and multi-family out front in 2025. On NAVs, our estimates slipped 1%. That extends the group average drop to -15% since the BoC tightening cycle started in Mar-2022 (10Y GoC +180 bps), in contrast with IFRS NAVs which are up 1% since then.
Higher rates still impeding stronger flows; valuations remain well within reason. The TSX REIT Index has posted a -4% YTD return (to May 21), lagging broader equity markets as headwinds from higher rates continue to weigh on sentiment. Importantly though, at 15x N12M AFFO/7.3% implied cap rate, sector valuation remains well within fair value parameters in our view (Exhibits 11-12). Specifically, the AFFO yield and implied cap rate spreads to the 10Y GoC have risen to 328 bps (vs. 362 bps LTA) and 377 bps (vs. 423 bps LTA), respectively. As well, the sector’s 25% discount to NAV (Exhibit 9) provides a good margin for error, particularly with double-digit discounts available on many of our preferred picks.