Andrew Moffs, senior vice president and portfolio manager at Vision Capital

FOCUS: Real estate stocks

MARKET OUTLOOK:

Caution has returned to the market, catalyzed by Republican resistance to President Biden’s stimulus bill and vaccination delays due to problems related to rapidly expanding production capacity.

Globally, there is a coordinated effort to backstop the economy. At the conclusion of Wednesday’s two-day meeting, the U.S. Federal Reserve signaled its US$120 billion monthly asset purchase program would continue to operate in tandem with historically low interest rates for the foreseeable future. Similarly, the Bank of Canada announced on January 20th that its policy rate will remain anchored towards the lower bound of 0.25 per cent, with data implying growth in the first quarter of 2021 is now expected to be negative, compounded by projections that core inflation will not hit its two per cent target until 2023.

Publicly-traded real estate securities finished 2020 as the second-worst performing asset class in the S&P 500, only outperforming energy. However, a thorough analysis reveals a bifurcated landscape, as shifting economic activity and secular themes accelerated by the pandemic has altered the supply-demand fundamentals by property type, creating longer-term winners and losers. Beneficiaries of this development include homebuilders, industrial, single-family rental, life science and self-storage property types, with each maintaining constructive fundamentals into 2021.

A historically low interest rate environment has created an attractive spread between real estate and bond yields, allowing cash-flow resilient property types to realize cap rate compression on the strength of cheaper borrowing costs and favourable underlying fundamentals.

Capital raising earmarked for real estate from leading private asset managers, large pension funds and institutions has continued unabated. According to Citi, private equity funds across the globe currently hold a record US$345 billion in dry powder earmarked for real estate investments, which should support property valuations, specifically in sectors with favourable fundamentals. Cornell University indicates investors are in the early stages of increasing their allocation to real estate, reaching 10.6 per cent in 2020, up 170 bps since 2013.

TOP PICKS:

BSR Real Estate Investment Trust (HOM-U TSX)

$0.7B market cap, 4.5 per cent yield, US$11.15 close

BSR owns 7,900 suites in 27 properties, concentrated within the suburbs of Dallas (30 per cent of suites), Austin (20 per cent), Houston (20 per cent) and Oklahoma City (13 per cent).

BSR Real Estate Investment Trust  is a Canadian-listed REIT that primarily owns and operates Class B garden-style assets that cater to residents seeking “work-force” or affordable housing and select Class A assets in the U.S. Sun Belt.

The REIT possesses strong ownership alignment and experience from its management team, combined with a deep “bench” of onsite and regional managers, executing a laser-focused value add program.

Fundamentals in the REIT’s core markets continue to be sound. BSR reported 4.9 per cent same store NOI growth during its third quarter, one of the highest amongst its peer group. Reflecting stable fundamentals and record low interest rates, recent transactions in BSR’s core markets suggest that valuations for comparable assets have actually risen since the pandemic began. BSR is currently trading at an implied cap rate of 6.1 per cent, compared to recent comparable transactions in the mid 4.0 per cent cap rate range.

Even if the REIT were to trade at a 5.0 per cent cap rate, its unit price would be US$16.17, 45 per cent higher than its current price. The historically narrow cap rate spread between primary and secondary markets has benefited BSR’s capital recycling program in which the REIT is selling its non-core properties in tertiary markets with below average growth profiles and rotating into higher growth markets such as Austin, Dallas, and Houston, Texas. During the quarter, the REIT completed US$260 million of asset sales at approximately a 10 per cent premium to the REIT’s IFRS values and subsequently used the sales proceeds to transact on US$129 million of acquisitions in Dallas and Houston.

BSR is set up for a strong year in 2021, with consensus funds from operations (“FFO”) per unit growth expected to increase by 11.0 per cent. Despite one of the strongest earnings growth profiles in the apartment sector, units of BSR are trading at a 12 per cent discount to their (understated) IFRS NAV and a 15 per cent discount to Vision’s current NAV estimate of US$13.11 per unit.

Irish Residential Properties REIT (IRES ISE)

€0.7M market cap, 4.2 per cent dividend yield, €1.40 close

Irish Residential Properties REIT currently owns 3,800 suites across 42 properties, concentrated in Dublin, and other major Irish city centres.

Irish Residential Properties REIT is the only publicly-listed REIT solely focused on consolidating the Irish multi-family rental sector.

CAPREIT (TSX: CAR.UN) serves as IRES’ external manager, and maintains an 18 per cent ownership stake. With a strategy of focusing on mid-market tenants, the REIT’s portfolio is highly defensive, operating at occupancy levels of 98.9 per cent and in-place rents at approximately 15 per cent below current market rents. Since its IPO in 2014, the REIT has grown its portfolio by over 10 times to amass the largest multi-family portfolio in Ireland and continues to grow through a robust development pipeline.

The REIT’s shares represent a compelling investment opportunity due to the strong operating fundamentals in Dublin and their highly attractive valuation. Supply and demand fundamentals across the Dublin residential market have remained robust even throughout the COVID-19 pandemic. This is due to a severe housing shortage across the city, and increased demand for housing as Dublin continues to be a burgeoning tech-hub. This has allowed IRES to report strong operating results, including its record occupancy levels of 98.9 per cent, along with annual rental growth of 2 per cent. This is in stark contrast to U.S.-listed urban multi-family REITs, which are experiencing both declining occupancy levels and net effective rents.

Despite these strong operating results, the REIT’s shares trade at a significant -13 per cent discount to the NAV of its apartment portfolio. Recent acquisitions by IRES have closed at a going in cap rate of approximately 4.00 per cent, in-line with other recent transactions by German pension funds. If this 4.00% cap rate was applied to IRES’ NOI, it would result in a share price of €1.80, or 29 per cent higher than its current price. Further upside can be realized from their substantial holding of approved density to develop about 500 suites, which IRES is actively pursuing, and is quite material relative to the current size and asset value of IRES.

European Residential REIT (ERE-U TSX)

$1.1B market cap, 3.6 per cent dividend yield, $4.42 close

European Residential REIT currently owns and operates 5,949 residential suites in 138 properties.

European Residential REIT is the only REIT globally focused on multi-family rental apartments in the Netherlands, the most densely populated country in Europe.

It offers unitholders the unique opportunity of first mover advantage in consolidating the apartment sector in the Netherlands where fundamentals are robust, and no other institutional operator of size currently exists.

Despite COVID-19, fundamentals in the REIT’s core markets remain largely favourable and unchanged; ERES is collecting rents in line with pre-pandemic levels, has increased occupancy by 130 bps year-over-year to 99.0 per cent, and successfully increased its same-property NOI by 8.0 per cent (as of Sept 30th, 2020). This compares to its North American peers, which have, on average, experienced increased vacancies, below average rental rate collections, and negative NOI growth.

External growth remains compelling reflecting extremely attractive long-term financing rates of less than 1.0 per cent compared to capitalization rates of between 3.75 per cent to 4.00 per cent achievable on acquisitions. Within its third quarter, 2020 results, ERES announced €20.1 million of acquisitions, comprising of 120 suites, at a blended cap rate of 3.9. per cent to reporting its earnings, the REIT announced a further €60.3 million of acquisitions, bringing year-to-date acquisitions to €80.4 million. Furthermore, the REIT has liquidity of approximately €200 million, allowing ERES to continue to grow despite trading at a 12 per cent discount to its IFRS NAV.

PAST PICKS: March 5, 2020

BSR Real Estate Investment Trust (HOM-U TSX)

• Then: $17.19
• Now: $14.01
• Return: -18%
• Total Return: -15%

Tricon Capital Group (TCN TSX)

• Then: $11.30
• Now: $12.92
• Return: +14%
• Total Return: +17%

StorageVault Canada (SVI TSXV)

• Then: $3.78
• Now: $4.10
• Return: +8%
• Total Return: +9%

Total Return Average: +4%