Michelle Wearing, associate portfolio manager at Starlight Capital
Focus: Real estate stocks

MARKET OUTLOOK

Investors have been watching the sharp move lower in global bond yields, with now about one-third of tradeable bonds worldwide having negative yields. Investors are looking for safety over the long term, with the focus shifting to a return of their capital not earning a return on their capital.

The U.S. government 10-year bond yield has briefly dipped below the yield on the two-year, one of the most reliable recession indicators. However, investors have piled into U.S. Treasuries as a safe-haven, driving down the 10-year bond yield to lows not seen since 2016. 

All eyes will be on the Federal Reserve Chairman Jerome Powell speaking at the Jackson Hole symposium on Friday. The market is currently pricing in a 100-per-cent chance of a rate cut in September.

REITs have benefitted from the global uncertainty and declining interest rates. Year-to-date, real estate is the second-best performing sector in S&P 500 up 24.9 per cent (price-only), just slightly behind tech (up 28.7 per cent), well ahead of the S&P (up 16.7 per cent). Low interest rates are generally positive for REITs who have high-quality assets with long-term contractual cash flows, unless the low rates stem from a recession.

We see REITs as generally fairly valued in Canada and the U.S., with more opportunities in Europe. However, given Brexit and political uncertainty, we continue to favour North America. Running a global portfolio, we have the advantage of being able to look globally for the best opportunities to allocate capital.

We are bottom-up stock pickers and look for REITs who 1) generate recurring earnings growth; 2) have rising dividends/distributions; and, 3) are trading at a discount. In terms of sectors, we continue to favour apartments and industrial REITs, and have a more negative outlook on Retail REITs. Our preference for apartments is driven by a significant undersupply of rental apartments in most urban cities. Our preference for the industrial sector is driven by the tailwinds from e-commerce and the evolving retail channel.

TOP PICKS

GRANITE REIT (GRT-U:CT)

Granite REIT is a global industrial landlord, owning approximately 34 million square feet of industrial space in North America and Europe.

Last year, Kevan Gorrie joined Granite as CEO. Kevan is the former CEO of Pure Industrial REIT, which was acquired by Blackstone. We like what Kevan has done so far, and believe he is the right person to grow the portfolio.

Granite has announced a strategic plan to transition the REIT’s assets into a high-quality industrial portfolio. As part of this strategic plan, Granite has significantly reduced its Magna exposure from approximately 97 per cent five years ago, to only 48 per cent of revenues today. We expect this will fall further as Granite disposes more Magna assets.

Granite has the benefit of an under-levered balance sheet with only 20 per cent debt and approximately $1 billion of liquidity. Year-to-date Granite has acquired over $1 billion of acquisitions and developments.

We expect Granite to generate double digit earnings growth through solid organic growth as well as acquisitions as it levers up its balance sheet (target leverage is 35 per cent). Further, we like that Granite has access to the lower-cost debt markets in Europe, resulting in lower interest rates than its North American peers.

Year-to-date, Granite’s unit price has lagged many U.S. and Canadian industrial peers. We view Granite’s current share price as attractive, offering a 4.4 per cent yield.

AMERICAN HOMES 4 RENT (AMH:UN)

American Homes 4 Rent is the second-largest publicly traded single-family rental REIT in the U.S. with over 50,000 single-family properties across 22 states. We like its solid balance sheet and development platform.

Macro data continues to point toward U.S. single-family rental outperformance. Specifically, 1) existing single-family home supply is below historical levels, 2) single-family housing starts are below historical levels, and 3) significant pent-up demand for housing. We expect single-family rentals to outperform due to the lack of affordable housing alternatives. American Homes 4 Rent average monthly rent is only US$1,600.

We view American Homes 4 Rent’s current share price as attractive, trading in-line with its net asset value versus its other single-family rental peer at a 20-per-cent premium and U.S. apartment peers at a 10-per-cent premium.

HUDSON PACIFIC PROPERTIES (HPP:UN)

Hudson Pacific Properties owns high-quality office and state-of-the-art studio properties in Los Angeles, the San Francisco Bay Area, Seattle and Vancouver — 100-per-cent West Coast. Hudson Pacific is often referred to as the “Silicon Valley Landlord” as Silicon Valley makes up over 50 per cent of total base rent and its top tenants include Google, Netflix and Uber. Hudson Pacific recently entered the Canadian market with the purchase of the Bentall Centre in Vancouver with joint-venture partner Blackstone.

We’re bullish on the West Coast office market in the U.S., as we see significant demand and limited supply, which is driving strong rent growth. Hudson Pacific is generating over 20-per-cent rent growth on leasing activity. Contrast this with the New York office market, which has seen a significant influx of supply and continues to have a significant development pipeline, limiting rent growth.

We view Hudson Pacific’s current share price as attractive, trading at almost a 25-per-cent discount to net asset value and implied 6-per-cent cap rate, when comparable assets trade for low-5 per cent or sub-5 per cent cap rates.

PAST PICKS: MAY 30, 2019

BROOKFIELD PROPERTY PARTNERS (BPY-U:CT)

• Then: $24.81
• Now: $25.31
• Return: 2%
• Total return: 2%

DREAM GLOBAL REIT (DRG-U:CT)

• Then: $13.53
• Now: $14.32
• Return: 6%
• Total return: 7%

DUKE REALTY CORPORATION (DRE:UN)

• Then: $30.00
• Now: $33.44
• Return: 11%
• Total return: 12%

Total return average: 7%

WEBSITE: starlightcapital.com