Andrew Moffs' Top Picks
Andrew Moffs, senior vice president and portfolio manager at Vision Capital
FOCUS: Real estate stocks
Sweeping inflationary pressures, previously measured across commodities and key economic inputs are now cascading downstream into the broader distribution network of goods and services. Even excluding more volatile food and energy costs, the CPE index rose 3.1 per cent last month, reflecting the largest year-over-year increase since the early 1990’s. The CFIB’s recent survey of Canadian small businesses further corroborates this dynamic, forecasting a 3.3 per cent increase in prices over the next 12-months which represents the highest reading since data collection began in 2009.
Investors have long-espoused the REIT asset class as an effective inflation hedge, benefiting from growing cash flows as operators mark rents to market, and valuations of its underlying properties re-price as replacement costs rise.
However, applying this assessment to the broad REIT market may prove reckless. Property types experiencing challenged fundamentals, such as select retail and office assets are not in a position to raise rents with record vacancy levels and longer-term lease arrangements that may neglect to contractually peg annual rent increases to inflation.
Conversely, property types with favourable supply and demand conditions, specifically single-family rental homes and industrial logistics assets are well positioned to ride the tailwind and realize outsized rent growth. The case for active management within publicly-traded REITs is cohesively illustrated by Citi, who reports that since 2000, top quartile US REITs have outperformed their bottom-quartile counterparts by 47 per cent on an average annual basis.
On Friday, President Biden unveiled a US$6 trillion budget proposal that relies heavily on increasing corporate tax rates to finance the spending program. Due to their legal structure, REITs are obligated to pay out at least 90 per cent of their taxable income to unitholders, insulating its profits from prospective tax increases and thus positioned as an attractive vehicle relative to the traditional legal corporate structure.
Tricon Residential Inc. is a residential real estate enterprise primarily focused on single-family rental (“SFR”) homes in the U.S. SunBelt, operating 21,900 houses largely across the Southern U.S. (83 per cent of value), 7,300 multi-family suites in the U.S. and 3,000 suites under development in Toronto (14 per cent of value), and 45,300 acres of for-sale housing across 18 communities in the U.S. (four per cent of value)
Tricon remains a core holding in the Vision Opportunity Funds as its share price does not appropriately reflect management’s achievements, its current values, and growth prospects. Management has continued to execute on its strategic initiatives and fundamentals in the Company’s SFR vertical are showing no signs of decelerating.
Tricon has prioritized reducing its leverage, first by 500 bps through its exchangeable preferred equity transaction with Blackstone, in which Vision participated in August 2020. During the latest quarter, Tricon further advanced on its deleveraging goals by closing on an 80 per cent syndication of its U.S. multi-family portfolio to two leading global institutional investors, at pricing that was in-line with IFRS values. This transaction further reduced leverage by another 500 bps, bringing Tricon’s debt to gross book value down to 50 per cent.
Tricon’s operational results continue to lead its peers with first quarter same-property rental revenue, occupancy and NOI growth of 3.1 per cent, 0.8 per cent, and 4.1 per cent, respectively. In addition, at Tricon’s virtual investor day in February, management outlined its expectation that strong demand will continue post pandemic as work-from-home and an acceleration of household formation drive more families into larger homes in the suburbs. As a result, management believes Tricon can sustain an annual mid-single digit rental rate increase, which should translate into a five per cent annual increase in its same-property NOI for the foreseeable future. This implies the possibility of robust NAV and FFO per share growth over the coming
Dream Industrial REIT is a pure-play industrial REIT focused on owning primarily distribution and logistics assets across Canada (51 per cent of investment property value), Europe (37 per cent) and the United States (12 per cent), pro forma it’s pending acquisition in Europe.
Dream’s focus on “last-mile” urban logistics space is well-suited to meet the growing needs of e-commerce distribution as consumers increasingly shift towards online shopping. The REIT also owns concentrated positions in many of Canada’s key industrial distribution parks, providing significant pricing power and market control. As a result of the pandemic, the structural landscape for industrial real estate has been positively impacted, with factors including greater e-commerce adoption, a need for investment in the supply chain for industries that previously had low e-commerce penetration and an increase in inventory levels to protect against potential shortages.
Dream Industrial’s two largest markets in Canada of the GTA (20 per cent of gross leasable area) and the Greater Montreal Area (“GMA,” 17 per cent) have benefited from limited supply and robust demand, with availability rates of 1.6 per cent and 1.9 per cent, respectively, which are at or near their historical lows, according to CBRE. As a result, market net rental rates in these regions have increased over 2020 rates by 19 per cent and 17 per cent, respectively. Furthermore, CBRE is currently projecting robust rental growth of 12 per cent for the GTA and 10 per cent for the GMA in 2021. Such increases in rents should contribute to a growing spread between market rents and in-place rents in the leases at the REIT’s properties, which, at the end of Q1 2021, stood at 26.3 per cent for Ontario and 11.5 per cent for Quebec. This will be a substantial benefit to growing the REIT’s NOI as these leases are renewed.
With these factors, Vision believes Dream Industrial’s units are attractively valued, particularly as they trade at an eight per cent discount to NAV and a 5.4 per cent implied cap rate whereas its U.S.-listed peers trade at an average 20 per cent premium and a 3.8 per cent implied cap rate.
First Capital REIT is an owner, developer and operator of Canadian retail real estate primarily located in major urban centres, owning 150 properties, totaling 20.0 million square feet, at the REIT’s share. By fair value, the GTA comprises 48 per cent of FCR’s portfolio, followed by Montreal, Calgary and Vancouver, at 12 per cent, 12 per cent and 11 per cent, respectively.
While the REIT has not been immune to the effects of the pandemic, a cash rent collection rate of 95 per cent in the first quarter of 2021 and a decline in occupancy in 2020 of 70 bps to 96.2 per cent is indicative that FCR is well positioned. This is due to its more defensive focus on “high urban growth neighbourhoods” and importantly, its large concentration in grocery and pharmacy-anchored retail. Vision estimates that 84 per cent, of the REIT’s total GLA contains a grocery component, as well as an additional 11 per cent of GLA from locations that, while not having a grocery store, include a pharmacy. Vision believes this bodes very well for the valuation of the REIT’s assets given investor interest in grocery-anchored properties is the third most attractive acquisition property type in Canada as highlighted by a Q4 2020 Altus survey. In fact, management noted similar findings in a meeting with Vision in March 2021 that pricing for grocery-anchored centres, in all regions, are being indicated at values that are at or above pre-pandemic levels.
As a result of the quality and types of properties that FCR owns, leasing demand at the REIT’s centres has been strong. Management noted during the meeting in March that the REIT has been actively leasing space to a wide array of tenant categories allowing them to upgrade the quality of their tenant base.
In addition, management believes it can maintain its sector-leading annual renewal leasing spreads of approximately nine per cent, particularly as they have improved the quality of the portfolio retained after dispositions of $1.1 billion over the past two years.
Vision believes the REIT’s units are undervalued on both an absolute as well as a relative basis to its U.S.-listed shopping centre peers, with the REIT’s units trading at a 12 per cent discount to NAV, whereas its U.S. peers trade, on average, at an 11 per cent premium.
PAST PICKS: June 25, 2020
Tricon Residential (TCN TSX)
- Then: $8.85
- Now: $12.95
- Return: 46%
- Total Return: 50%
European Residential REIT (ERE-U TSX)
- Then: $4.21
- Now: $4.19
- Return: -1%
- Total Return: +3%
Granite REIT (GRT-U TSX)
- Then: $67.83
- Now: $80.78
- Return: 19%
- Total Return: 24%
Total Return Average: 26%