Andrew Moffs' Top Picks
Andrew Moffs, senior vice president and portfolio manager at Vision Capital
FOCUS: Real estate stocks
The appearance of inflation, widely debated as transitory versus more structural, is gaining momentum as a combination of supply chain disruptions, increasing raw materials costs, higher labour expenses and pent-up consumer demand concerns business operators across the broader economy. The backlog of orders index registered 64 per cent in February, an increase of 4.3 percentage points from January, and the highest level recorded in the history of the PMI. Inflation is generally a tailwind for real estate as portfolios should re-price to reflect increasing replacement costs.
Despite the recent surge of bond yields, the spread between real estate AFFO yields and BBB corporates remain significantly wider than historical averages, allowing cash-flow resilient property types to realize cap rate compression on the strength of cheaper borrowing costs and favourable underlying fundamentals.
A fascinating dynamic is evolving as the US$250 billion (and growing) capital base earmarked for real estate by leading private asset managers, large pension funds, and institutions is struggling to deploy capital in a market that has demonstrated greater resilience than anticipated and thus constrained the supply of properties that are distressed or undervalued. This imbalance may widen in the near term, as approximately 30 per cent of institutional investors are targeting distressed and opportunistic commercial real estate deals this year, according to a recent survey by CBRE Group Inc. A necessity to transact is forcing investors to bid up prices to secure deals, which should be supportive of valuations.
Conversely, accessing real estate through publicly-traded securities significantly reduces the friction attributable to transacting in the private market. In the public markets, one can buy at a discount to where comparable assets are currently trading in the property market, maintain a superior liquidity profile and allows investors to be selective by property type and geographic region.
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. Homebuilders, industrial, single-family rental, life science and self storage property types continue to maintain constructive fundamentals through 2021. The U.S. Sunbelt remains a favoured submarket as the beneficiary of many high-profile corporate relocations, outsized population and employment growth. For example, this has resulted in an average five-year rent growth of 61.9 per cent in Austin, Texas versus the U.S. average of 17.8 per cent.
Canadian Apartment Properties REIT (CAPREIT), Canada’s largest publicly-traded rental residential enterprise, owns 59,000 residential rental suites and manufactured housing communities. It also owns controlling stakes in two publicly-traded European apartment REITs focused on Ireland and the Netherlands, respectively. The largest geographic component of their portfolio is the GTA where more than 16,000 suites generate approximately 36 per cent of the REIT’s NOI. Until very recently, the strength in the Canadian economy, together with high levels of immigration and limited new supply of multi-family residential buildings, has created favourable demand and supply conditions for the REIT. This has resulted in historically low vacancy rates and significant upward pressure on rents, especially in the GTA, Greater Vancouver, Ottawa and Montreal markets. Notwithstanding the uncertainties generated by the pandemic, CAPREIT’s units are a compelling investment for several reasons:
First, it possesses a strong balance sheet with $750 million of liquidity, a debt to gross book value of only 36 per cent, which management estimates equates to over $1.9 billion of acquisition capacity.
Second, CAPREIT’s portfolio proved to be pandemic proof during 2020 with the REIT still able to grow its stabilized property NOI by four per cent, largely aided by its highly affordable rents which management estimates to be over 20 per cent below market.
Third, recent transactions suggest that apartment valuations have increased during COVID-19. Notably, two centrally-located Toronto assets that are comparable to properties in CAPREIT’s portfolio came to market during the quarter at estimated cap rates in the low 2.0 per cent range, which compares to the REIT’s IFRS cap rate for its GTA assets of 3.6 per cent. If Vision were to apply a 2.0 per cent cap rate on just CAPREIT’s GTA portfolio, the resulting NAV per unit would be $63.89, 18 per cent higher than its current price. With units of the REIT currently trading at consensus NAV compared to its long-term average of a three per cent premium, and at an implied cap rate of 4.0 per cent compared to recent transactions in the low three per cent range, Vision views CAPREIT as an attractive long-term investment opportunity.
Chartwell Retirement Residences is the largest seniors housing owner and operator in Canada, owning interests in or managing over 200 communities encompassing 30,804 suites across the country. It operates across the full spectrum of the seniors housing industry, including retirement homes (91 per cent of NOI) and long-term care homes (nine per cent of NOI). The Trust also has a sizable retirement home development pipeline, a portion of which it owns and manages directly and a portion of which is owned with strategic development partners.
Chartwell is an attractive investment opportunity due to its strong growth prospects and compelling valuation. As the Canadian population increasingly becomes vaccinated, a recovery in the seniors housing sector has become more likely, and Chartwell should benefit by regaining occupancy lost during the pandemic. As of February 2021, occupancy in Chartwell’s retirement portfolio was down 10.1 per cent year-over-year to 78.7 per cent and 11.3 per cent below what management would consider to be a stabilized rate. As a result, units have fallen over 20 per cent since its pre-pandemic high of $14.47 per unit.
However, given the strong rollout of vaccines in its target market (nearly 60 per cent of adults aged 80 and older, and 91 per cent of seniors who live in congregate settings have received one dose of a COVID- 19 vaccine), Chartwell should be able to recover the occupancy lost during the pandemic over the next few years. If Chartwell is able to regain occupancy back to pre-pandemic levels, it represents an opportunity for them to increase its funds from operations by over 40 per cent from its pandemic lows. Despite this opportunity, units remain undervalued, trading at a 18 per cent discount to its stabilized NAV and priced at only 13.4x 2022 consensus FFO. This compares to U.S. peers that are trading between 18.2x and 23.7x 2022 FFO.
With a robust growth profile, compelling valuation, a well covered 5.2 per cent dividend, and the vaccine rollout beginning to gain traction across Canada, Chartwell remains a highly attractive investment.
StorageVault is the only Canadian-listed corporation that operates, manages and develops self-storage facilities across Canada, with a focus on Canada’s fastest growing regions of the Greater-Toronto Area,
Ottawa and Montreal. The Canadian self-storage industry is highly fragmented, with the top 10 owners only controlling an estimated 15 per cent market share. StorageVault has been the leading consolidator and has become the largest operator in Canada with over 200 facilities under management, which is nearly 3x more than the second largest operator.
Through its economies of scale and superior operating capabilities, StorageVault is able to acquire under-managed facilities and improve NOI by almost double in a relatively short period of time. This has allowed the company to achieve robust same-property NOI growth during the pandemic of over five per cent, which compares to its U.S. peers that saw their NOI decline by over one per cent during the same period of time. Despite significantly outperforming its U.S. peers, StorageVault currently trades at an implied cap rate of 4.50 per cent, which is 50 basis points higher than its peers. Should the valuation gap narrow, this would imply a 20 per cent increase in its share price.
PAST PICKS: April 30, 2020
BSR REIT (HOM-U TSX)
- Then: $13.58
- Now: $13.66
- Return: 1%
- Total Return: 5%
American Homes 4 Rent (AMH NYSE)
- Then: $24.14
- Now: $33.49
- Return: 39%
- Total Return: 40%
WPT Industrial REIT (WIR-U TSX)
- Then: $11.47
- Now: $14.94
- Return: 30%
- Total Return: 36%
Total Return Average: 27%