MARKET OUTLOOK:
Strong economic data is supporting a growing body of policymakers within the FOMC that are advocating for an accelerated timeline to withdraw stimulus measures, though the consensus approach reflects continuing patience on the path to normalization, as the US$120 billion asset purchase program began winding down this month. Including food and energy prices, the PCE price index increased over 5 per cent in October, while concurrently, consumption increased 1.3 per cent and initial jobless claims fell to 199,000, its lowest level since 1969. 

The REIT sector has generally served as an effective hedge against elevated and rising prices, posting positive real returns almost 70 per cent of the time over a rolling 12-month period from 1973 to 2020, when inflation was greater than 3 per cent and increasing. 

Though publicly-traded REITs have posted outsized returns relative to broad indices year-to-date, structural themes combined with an improving economic landscape underpin property fundamentals, resulting in improving rent growth, occupancy and leasing activity that is approaching and, dependent on sector, eclipsing pre-pandemic levels. Stock performance has been corroborated by earning revisions, as 79 per cent of U.S REITs that provide guidance raised estimates in recent quarters. 

Spurred on by cheap, easy access to capital, REIT mergers & acquisition activity has continued to accelerate in the second half 2021. S&P Global Market Intelligence reports that real estate led all GICS sectors in transaction volume for Q3, totaling US$193 billion, in the context of a record-setting pace by deal and dollar value in 2021 as economic activity recovers from pandemic lows. 

These transactions are supportive of price discovery and lend confidence to NAV calculations as volumes improve. Additionally, publicly-traded REITs are well positioned to benefit from this environment, either through the price appreciation of publicly-traded shares to reflect the increase of underlying property values, or privatizations of undervalued securities at premiums, thereby closing the gap to NAV.


TOP PICKS:

Boardwalk REIT (BEI-U TSX)
Boardwalk REIT, the second largest publicly-traded apartment REIT in Canada, owns over 33,000 suites across 200 properties. With a focus on Alberta and Saskatchewan, the REIT owns assets ranging from Class A high-rise to garden-style Class B apartments concentrated in Edmonton (37 per cent of suites), Calgary (17 per cent) and Montreal (14 per cent).

Alberta’s continuing economic recovery has led to an increased demand for Boardwalk’s apartments, pushing vacancy rates in its portfolio from approximately 4.4 per cent at the height of the pandemic to approaching 3 per cent currently. Boardwalk’s management believes that tenant concessions can be reduced at these levels, which will meaningfully impact the REIT’s FFO and, once entirely eliminated, increase its NAV to over $75.00 per unit and representing over 35 per cent upside to its current unit price.

Boardwalk screens cheaply to both the private market, where two recent sizeable apartment portfolios in Calgary and Edmonton transacted at cap rates that suggest Boardwalk is undervalued to its estimated current IFRS value, and publicly-traded peers trading at an average FFO multiple 6.1x higher than its units.

Phillips Edison & Company (PECO NASD)
Phillips Edison is one of the largest owners and operators of grocery-anchored shopping centres in the U.S., comprised of 267 wholly-owned centres totaling approximately 30 million square feet across 31 states, as well as 22 centres owned in two institutional joint ventures. Approximately half of the REIT’s annualized based rent is derived from shopping centres in the Sun Belt region.

Phillips Edison operates a niche strategy that positions it well versus its U.S.-listed shopping centre peers, as 96 per cent of its rent is derived from grocery-anchored assets, whose tenants are largely more resilient to e-commerce and recessionary environments and were mostly able to remain open during the pandemic. 

Within this sector, management has focused on centres with grocers that have market-leading sales in their trade region, with their strong foot traffic improving PECO’s ability to increase rents. In addition, the REIT’s smaller than average sized centers are benefiting from strong tenant demand with PECO’s leased occupancy rate of 95.6 per cent at the end of Q3 2021 now exceeding its pre-pandemic level from the end of 2019 by 20 bps, whereas the publicly-traded REITs are on average still 220 bps below, at 93.0 per cent. Management believes there is further upside in its occupancy rate, which will contribute to higher rents, due to the decline in available space at their in-demand centres, and, as a result, an increase in their NOI growth rate.

PECO’s shares are attractively valued with an implied cap rate of 6.5 per cent, which is approximately 60 bps higher than the sector’s weighted average and more than 100 bps higher than some grocery-anchored portfolio transactions in the private market. If PECO’s implied cap rate was 100 bps lower, it would imply 25 per cent upside in the REIT’s share price.

 
InterRent REIT (IIP-U TSX)
InterRent is a Canadian multi-family rental residential REIT with a proven and impressive track record of sourcing and acquiring under-managed, under-rented, and strategically located properties with possibilities for densification and/or redevelopment. InterRent’s portfolio is primarily concentrated in Ottawa, Montreal, and the GTA, which together account for 80 per cent of its NOI.

InterRent’s urban-centric portfolio has benefited from improving vaccination rates across Canada, the return of young professionals and domestic students to urban cores and in-person learning. InterRent’s management estimates occupancy should improve to about 96 per cent by early 2022, inferring a noticeable improvement of 110 bps from current occupancy levels, and should allow leasing spreads across its portfolio to accelerate back to pre-pandemic levels of 20-to-25 per cent. This should result in outsized FFO and NAV per unit growth over the next twelve months.

Several recent transactions across the REIT’s core markets provide ample evidence that cap rates have reached as low as 3.25-3.50 per cent, which is well below the REIT’s units, which are currently trading at an implied cap rate of 3.98 per cent. The Fund continues to hold units of the REIT as a core holding because, if units of InterRent were to trade in line with private market transactions, it would infer a 25 per cent upside in their unit price. 

PAST PICKS: November 10, 2020

BSR REIT (HOM-U TSX)

• Then: $14.00
• Now: $21.75
• Return: 55%
• Total Return: 60%

Tricon Residential (TCN TSX)

• Then: $11.18
• Now: $17.63
• Return: 58%
• Total Return: 60%

Canadian Apartment Properties (CAR-U TSX) 

• Then: $48.94
• Now: $58.11
• Return: 19%
• Total Return: 22%

Total Return Average: 47%