Andrew Moffs' Top Picks
FOCUS: Real estate stocks
The U.S. Federal Open Market Committee met Wednesday, continuing to employ a data dependent, fluid response to the global recovery. Fed Chair Jerome Powell asserted that even modest September employment figures would allow policymakers to establish a normalized timeline, beginning with plans to taper their US$120 billion monthly bond-buying program as early as December.
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 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.
U.S. House democrats have proposed an amendment to U.S. President Biden’s initial tax plan, targeting a corporate rate increase of 26.5 per cent, up significantly from the current 20 per cent rate levied on businesses. Due to their legal structure, REITs are obligated to pay out at least 90 per cent of their taxable income to shareholders, insulating its profits from prospective tax increases as a flow through entity. REITs are positioned as an attractive vehicle relative to the traditional legal corporate structure, and may benefit from increased capital flows
Spurred on by cheap, easy access to capital, REIT mergers & acquisition activity is accelerating in the second half 2021. These transactions are supportive of price discovery and lend confidence to NAV calculations as volumes improve. REITs have recorded US$12 billion net in property acquisitions year-to-date, competing with vast sums of private capital to secure assets that continue to realize meaningful cap rate compression. 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.
BSR, a Canadian-listed REIT, owns approximately 8,011 suburban U.S. multi-family apartments across 29 properties in the U.S. Sun Belt, concentrated within the suburbs of Dallas (38 per cent of suites), Houston (28 per cent), Austin (19 per cent) and Oklahoma City (12 per cent).
In the first quarter 2021, BSR completed its capital recycling initiative which saw the REIT sell US$613 million of non-core assets in low growth markets at a 6 per cent premium to its IFRS values over a three-year period. Proceeds were then reinvested into properties located in BSR’s core growth markets of Austin, Dallas, and Houston Texas that have recently or are currently in the lease up phase to immediately improve operations and significantly enhance cash flows. In addition, the REIT has US$100 million of acquisition capacity to further enhance its earnings growth and expects to deploy this capital by year end. As a result of these actions, BSR forecasts it can realize AFFO per unit of US$0.65 by year end 2021, implying 25 per cent year-over-year growth which is four times greater than its U.S. listed Sun Belt peers.
Recent sales of comparable portfolios in the Sun Belt have transacted at in-place and forward cap rates between 3.90 per cent to 4.25 per cent, versus BSR trading at an in-place cap rate of 5.10 per cent, and thus suggests significant near-term upside
Boardwalk is the second largest publicly-traded Canadian apartment REIT, owning 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 (38 per cent of suites), Calgary (17 per cent) and Montreal (14 per cent).
At the onset of the pandemic, Boardwalk’s unit price declined 62 per cent between February and March 2020 in tandem with a 35 per cent decline in the price of oil and a weak Alberta economy. Since then, operations have remained remarkably steady and occupied rents flat, mainly attributable to the affordable nature of its portfolio. Despite this, units of Boardwalk still remain 20 per cent below their peak price in February 2020.
With the price of oil rebounding and several new technology firms announcing expansions into the REIT’s core markets of Calgary and Edmonton, the outlook for a complete removal of tenant concessions is positive. If the REIT were to eliminate all concessions in its portfolio, it would imply a 14.0 per cent increase to its in-place NOI and FFO per unit would be 25 per cent higher than its current first quarter 2021 annualized run rate.
Boardwalk’s units currently trade at a forward FFO multiple of 15.9x, which is 7.1x lower than its Canadian peers, and an implied cap rate of 5.4 per cent, or 140 bps higher than its peers
Corporación Inmobiliaria Vesta SAB de CV (VESTA BMV)
Vesta is a developer, owner and operator of Mexican industrial real estate, with a portfolio of 33 million square feet of manufacturing and logistics facilities, in addition to 860 acres of land with the development potential of up to 16.9 million square feet, focused in the Bajio (48 per cent), North (31 per cent) and Central (21 per cent) regions of Mexico.
Vesta is well positioned to benefit from the accelerating theme of U.S. businesses nearshoring their manufacturing operations to reduce transport time to the end consumer by 75 per cent, and costs by 23 per cent, in a bid to minimize supply chain disruptions and maintain “just in case” inventory.
Vesta is not structured as a FIBRA (Mexican REIT), that is legally required to distribute 95 per cent of its net taxable income, and thus can retain cashflows to fund growth initiatives organically, while reducing the likelihood it will need to raise additional capital.
Additionally, unlike many FIBRAs, Vesta is internally managed, ensuring it is strategically aligned to benefit the company and its shareholders rather than the manager. The founding family and executive management team are aligned in the company’s success, with owning over 10 per cent of the float.
Vesta’s focus on development earns attractive margins, with the spread between development yields and cap rates at approximately 300 bps, which is well above the spreads in many markets in the U.S. and Canada that typically range from 100 to 200 bps. Its landbank could increase the existing portfolio by over 50 per cent in its gross leasable area, creating sizeable potential to drive future NAV growth.
Given many secular thematic tailwinds and compressing cap rates in its markets, Vesta is attractively valued, trading at a 28 per cent discount to its NAV and a 9.4 per cent implied cap rate, whereas its U.S.-listed peers trade at an average 16 per cent premium and a 3.6 per cent implied cap rate.
PAST PICKS: September 29, 2020
Tricon Residential (TCN TSX)
- Then: $10.89
- Now: $16.63
- Return: 53%
- Total Return: 55%
BSR REIT (HOM-U TSX)
- Then: $13.14
- Now: $19.34
- Return: 47%
- Total Return: 52%
Irish Residential Properties REIT (IRES ISE)
- Then: €1.37
- Now: €1.53
- Return: 11%
- Total Return: 16%
Total Return Average: 41%