Michelle Wearing, associate portfolio manager at Starlight Capital
Focus: Global real estate stocks

MARKET OUTLOOK

Year-to-date global REITs have generated a total return of 12 per cent in Canadian dollars. Canadian REITs have generated a total return of almost 14 per cent, generally in-line with the S&P/TSX.

This strong performance has been driven by a combination of factors:

• The decline in 10-year bond yields globally and central banks essentially being now on pause. The market is currently pricing in over an 80 per cent chance of a 25 basis point cut the U.S. in 2019.
• Strong earnings growth, which modestly beat expectations.
• Economic uncertainty with the trade war, elections in Europe and Brexit, all of this is driving investors to more defensive sectors like REITs.

Looking ahead, we see REITs as generally fairly valued in Canada and the U.S. with more opportunities in Europe. Running a global portfolio, we have the advantage of being able to look globally for the best opportunities to allocate capital.

In terms of sectors, we continue to prefer apartments and industrial REITs and are more negative on retail REITs. Our preference for apartments is driven by a significant undersupply of rental apartments in most urban cities. Our preference for the industrial sector is driven by the tailwinds from e-commerce and the evolving retail channel.

TOP PICKS

BROOKFIELD PROPERTY PARTNERS (BPY_u.TO)

This company is Brookfield’s flagship listed-property vehicle and owns what we believe are some of the best assets in the world. Brookfield Asset Management owns over 50 per cent of Brookfield Property Partners and continues to buy more units due to the discounted unit price (currently trading at a 33 per cent discount to its $28.50 net asset value per unit). Management is very focused on closing this discount, more so than I have ever seen. Earlier this year, Brookfield Property completed a substantial issuer bid where they bought back 18.7 million units at an average price of $20.83 per unit.

Brookfield Property announced it was only investing $1 billion in Brookfield Asset Management’s new $15-billion real estate fund versus the $3.75 billion expected (about 25 per cent). Brookfield Property sees better value in its own units today than Brookfield Asset Management’s fund and this leaves Brookfield Property with over $2.3 billion of excess capital to fund additional buybacks over time. If Brookfield Property continues to trade at a material discount, I think Brookfield Asset Management will explore opportunities to privatize the business.

Brookfield Property has also raised its distribution every year since going public and targets 5 to 8 per cent annual distribution growth. The stock currently has a very attractive yield of almost 7 per cent. 

DREAM GLOBAL REIT (DRG_u.TO)

Dream Global is an owner and operator of a diversified high-quality portfolio of office and industrial properties located in key markets in Western Europe with a focus on Germany and the Netherlands. Due to limited supply and solid demand, the “Big 7” German office market vacancy reached 3.7 per cent at the end of 2018 and Big 7 prime rent grew 11 per cent year over year. Approximately 84 per cent of Dream’s portfolio is core and core-plus properties that are well positioned to benefit from favourable and improving fundamentals in many German and Dutch office markets. We believe Dream Global’s unit price is very attractive, as it trades at a 17 per cent discount to its $16.36 EPRA net asset value per unit and yields 5.9 per cent. We see upside to Dream Global’s unit price driven by a very favourable supply-demand imbalance in Germany and the Netherlands and redevelopment and value-add opportunities within its portfolio.

DUKE REALTY CORPORATION (DRE.N)

Duke Realty is an Industrial REIT that owns and operates approximately 150 million square feet of industrial assets in 20 major U.S. logistics markets.

We continue to see significant demand for the U.S. industrial space, which has driven rents up 8.1 per cent year over year. The U.S. industrial availability rate has been declining for 35 quarters and ended Q1/19 at 7 per cent. While supply has been picking up, we expect Duke to be somewhat insulated due to its infill nature. In addition, Duke has a robust development pipeline of $765 million (52 per cent pre-leased), which will help drive future growth.  We believe Duke stands to benefit from the potential sale of GLP’s U.S. industrial portfolio, which is rumored to be pricing around $20 billion, implying a capitalization rate of  about $120  per square feet. Duke currently trades at an implied 5.2 per cent cap rate or $100 per square foot.

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