Michelle Wearing's Top Picks: Oct. 31, 2019

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

MARKET OUTLOOK

Since we launched our Global Real Estate Fund in October 2018, we have seen dramatic selloffs, strong rebounds, Fed hikes, cuts, U.S.-China trade tensions, Brexit, etc. Despite this volatility, the fund has outperformed the S&P/TSX Composite Index by 6 per cent, the S&P by 6 per cent, and the MSCI World Index by 8 per cent. Year-to-date, the fund has experienced 23 distribution or dividend increases with an average increase of 6.7 per cent, and two companies initiated dividends. Our upside/downside capture shows the benefit of having real estate in your portfolio: We participate on the upside, but more importantly our negative downside capture means that when markets have gone down, our fund has gone up. This is precisely the diversification benefit investors get from owning real estate.

This week, we saw the Fed cut interest rates again. The U.S. 10-year yield is down over 90 basis points year-to-date while U.S. real estate is up 27 per cent, the second-best performing sector in the S&P, just slightly behind technology. We see REITs in North America as fairly valued. Looking out to 2020, we believe future returns are going to primarily be driven by earnings growth and yield rather than multiple expansion, which makes stock selection more important. Looking at global REIT valuations, yield and growth point to low double-digit total returns, holding multiples flat at current levels.

We’re bottom-up stock pickers and look for REITs that 1) generate recurring earnings growth; 2) have rising dividends/distributions; and, 3) are trading at a discount. In terms of sectors, we continue to favour apartments and industrial REITs and have a more negative outlook on retail REITs.

TOP PICKS

PROLOGIS (PLD:UN)

Prologis is the global leader in logistics real estate with a focus on high-barrier, high-growth markets. As of Sep. 30, Prologis’ portfolio totals 797 million square feet in 19 countries.

U.S. industrial fundamentals remain solid with rents up almost 6 per cent year-over-year to $7.57 per square foot, the highest level since CBRE began tracking the metric in 1989. Net absorption increased by 16.8 per cent quarter-over-quarter to 45 million square feet, marking the 38th consecutive quarter of positive net absorption.

Prologis has been active on the acquisition front this year, recently acquiring Liberty Property Trust for $12.6 billion and Industrial Properties Trust for $4 billion. With their Q3 results, Prologis raised their 2019 funds from operations (FFO) per share guidance again to nearly 10 per cent y/y earnings growth, following 9 per cent in 2018.

We believe Prologis should be a core real estate holding for investors and continue to see upside to its share price, driven by favourable supply/demand imbalance for logistics space.

KILLAM APARTMENT REIT (KMP-U:CT)

Killam is one of Canada’s largest residential landlords, owning, operating and developing a $3.1-billion portfolio of apartments and manufactured home communities.

Killam’s strategy to enhance value and profitability focuses on three priorities: 1) increasing earnings from existing operations, 2) expanding the portfolio and diversifying geographically through accretive acquisitions, with an emphasis on newer properties, and 3) developing high-quality properties in its core markets.

We like Killam’s younger portfolio in largely non-rent-controlled markets supplemented by its track record of net asset value (NAV) accretive development activity. We believe that Killam has developed a track record as a solid developer of high-quality assets, and we expect this program to continue to play a key role in its growth story.

Killam is well-positioned to deliver mid-single-digit AFFO/unit growth as acquisitions/developments come on stream, the REIT accelerates its renovation, recognizes further cost savings from its energy-efficiency initiatives and benefits from the implementation of its CRM system.

Killam has recently underperformed its apartment peers and we view the current unit price as an attractive entry point. The REIT offers a well-covered 3.4 per cent yield.

EUROPEAN RESIDENTIAL REIT (ERE-U:CT)

ERES is the only Canadian publicly traded REIT with European multi-residential assets. It owns a portfolio of 131 multi-residential properties (5,410 rental suites) in the Netherlands and three office properties, two in Germany and one in Belgium, with 400,000 square feet. 

Like most urban cities, there is an acute housing shortage in the Netherlands, particularly in the mid-market rental segment, as new housing supply has not kept pace with demand. Professional property management is in the early stages, with only about 2 per cent of the total housing stock institutionally owned.

Canadian Apartment Properties REIT, the external manager for ERES and its largest unitholder is well positioned to replicate its best-in-class management platform.

We believe ERES can generate significantly higher earnings growth versus the Canadian REIT sector, through higher organic growth by optimizing the rental regulatory framework and external growth by acquiring under-managed properties.

In our view, the superior growth profile of ERES is not fully understood by the market given its limited history and lack of a track record. The current valuation is attractive compared with a similar group of high-growth multi-family REITs listed in Canada. The REIT also provides a yield of almost 5 per cent.

PAST PICKS: AUG. 22, 2019

GRANITE REIT (GRT-U:CY)

• Then: $63.25
• Now: $65.22
• Return: 3%
• Total return: 4%

AMERICAN HOMES 4 RENT (AMH:UN)

• Then: $25.65
• Now: $26.47
• Return: 3%
• Total return: 3%

HUDSON PACIFIC PROPERTIES (HPP:UN)

• Then: $33.71
• Now: $35.92
• Return: 7%
• Total return: 7%

Total return average: 4%

WEBSITE: starlightcapital.com