RESIDENTIAL REITS Q3 REVIEW: FUNDAMENTALS MODERATING TO MORE SUSTAINABLE LEVELS
THE TD COWEN INSIGHT
Canadian Residential REITs' Q3 results were in-line, but consensus estimates were cut modestly on the back of slowing (but still favourable) fundamentals. We view the 20% selloff since mid-September as overdone, but concede more downside vs. upside risks to our estimates at the margin. Valuation screens attractively at 5.5% implied cap rate and 75% P/NAV. Our top picks: BEI.un, MI.un, and KMP.un.
Fundamentals remain healthy, but show signs of slowing from an unsustainable pace.
SPNOI for the CAD-focused REITs was +8.5% (range: +6.1% to +13.5%), moderating from +9.4% in Q2/24 and +9.9% in Q1/24 (Figure 3). New leasing spreads fell to +14% vs. +15% q/ q, while increases on renewals held steady at +5%. Although recent market data has shown slowing (and in some markets, declining) y/y rent growth, we believe it is largely driven by newer condos/apartments coming at the market's top end. We see less of an impact on Canadian apartment REITs, given: 1) they focus largely on the mid-market segment and
2) there is a healthy mark-to-market spread, which should allow REITs to benefit from turnover. Our updated forecasts call for SPNOI growth slowing to what we view as more sustainable ~6% in 2025/2026, only slightly above the 5% average from 2019-2023.
Estimates have decreased marginally for 2025/2026, and we believe there is more downside revision risk than upside, but nowhere near enough to justify the recent selloff. We have lowered our 2025/2026 estimates by 3%/4% (consensus -2%/-3%), with our forecast 2025 growth slowing to +5% from +8% (+8% from +10% excluding CAPREIT). Although still early days after the immigration announcement (link), management commentary was generally constructive, with minimal concern on demand falling off a cliff. While we believe there is more risk to estimates declining further vs. increasing in the next several quarters, we view the ~20% sell-off in Canadian apartment REITs since mid- September as unwarranted. At current levels, we expect most apartment REITs to be active on NCIBs.
Valuation (Fig. 8-10) is attractive on an absolute basis, as well as vs. U.S. Apartment REITs.
On forward P/Consensus AFFO, Canadian residential REITs (BEI.un, CAR.un, IIP.un, KMP.un, and MI.un) are trading at a 12% discount to U.S. peers (vs. historically in-line), despite ~60% higher growth expected in 2025 (Figure 7). On P/Consensus NAV, Canadian residential REITs are trading at a 21% discount vs. U.S. REITs at a 1% discount. Canadian Apartment REITs have traded at these levels vs. NAV only for 5% of the time over the past 10 years.