Joshua Varghese, portfolio manager at Signature Global Asset Management, CI Investments
Focus: REITs

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MARKET OUTLOOK

In the last two years, Canadian REITs have returned around 14 per cent, significantly outperforming U.S. REITs which were essentially flat. A confluence of factors affected U.S. REITs: REIT fund outflows, rising supply in select markets, slowing rental growth and higher capex requirements. This caused many investors to cycle out of U.S. REITs and now it seems to be somewhat of an abandoned sector.

In Canada on the other hand, investors have remained relatively sticky and we haven’t seen the same volatile swings that we have seen in the U.S. Supply and demand is relatively balanced in many markets and many REITs have been able to post stable or increasing cash flows. Meanwhile, many Canadian REITs have been doing a good job adapting to the changing environment, selling off non-core assets and focusing more on intensification of their properties.

The rising tide of global quantitative easing is behind us, so we can’t rely on that theme to propel all real estate companies. Instead we find ourselves in a very bottom-up world, where we believe the companies that have positioned themselves to be value creators, rather than rent collectors, will do very well. By sheer size of the U.S. market, we’re finding much opportunity there as well as globally. But we still see attractive opportunities in Canada and have been putting more money to work in real estate than we have in quite some time.

Interest rates aren’t our main concern. They’ve more than doubled in Canada in the last two years and REITs here have still seen strong returns. Supply, demand, strength and capital allocation abilities of management teams are what will drive returns.

TOP PICKS

Joshua Varghese's Top Picks

Joshua Varghese, portfolio manager at Signature Global Advisors, shares his top picks: Brookfield Asset Management, Alexandria Real Estate Equities, and Prologis.

BROOKFIEL ASSET MANAGEMENT (BAMa.TO)

It’s hard to find a moat wider than Brookfield’s in the hard asset management business. They’ve a proven ability to generate strong returns for their investors involving themselves in complex deals at attractive prices, working the assets hard and then monetizing them. This has caused them to eat a lot of other asset managers’ lunches and the name Brookfield alone is a strong sell to an institution. Meanwhile, institutions continue to increase their exposure to hard assets and Brookfield is often a first call for them. They’re trading at a slight discount to net asset value (NAV), but we believe that NAV is a misunderstood number as investors struggle to understand the value of their asset management business. The amount of unrealized carried interest fees that they’re generating but have yet to be paid is staggering and will be an ongoing good source of cash. They also announced a massive share buyback program, which we think will help to support the stock and demonstrates their strong capital allocation ability.

ALEXANDRIA REAL ESTATE EQUITIES (ARE.N)

Alexandria is the key real estate provider in the life sciences and bioechnology sectors. They’re dominant in the major campus clusters throughout the U.S. (examples include MIT and Stanford). They create ecosystems that are vital for collaborative work amongst its biotech and pharmaceutical tenants. Because of this 20-year-plus relationship they’ve built with their tenants, they’re integral in the creative space needs of its customers and are able to capture value in rent growth. There are major tailwinds in this space, with good expansion ability for life sciences companies. As a result, Alexandria is rolling their leases at 25 per cent increases above expiring leases. We think strength will continue.

PROLOGIS (PLD.N)

Another winner that we think will continue to advance is Prologis. They’re the largest industrial real estate company in the world. Their most valuable attribute is that they realize this. They’re leveraging their place in the supply chain. Prologis understands that 1 to 2 per cent of global GDP flows through their buildings and they’re focused on how to leverage that value. They’ve stated that they intend to leverage the data they collect in their centers and in turn use this to consult their tenants on their supply chain needs. This means that in the future, they will be price setters. As supply chains rework, there will be a new standard for calculating industrial rents and we think Prologis will lead that charge. We believe they will capture more value through rent and other fees as they do this. They’re seeing 20 per cent uplifts as they re-rent expiring leases. This growth is led by the U.S., but Europe looks very poised to catch up and Prologis will participate.

 

DISCLOSURE PERSONAL FAMILY PORTFOLIO/FUND
BAMa N N Y
ARE N N Y
PLD N N Y

 

WEBSITE: www.ci.com