Andrew Moffs, senior vice president and portfolio manager, Vision Capital

FOCUS: Real estate stocks 

MARKET OUTLOOK:

The speed and scale of contractionary monetary policy employed by central banks has resulted in a -61.1 per cent year-over-year decline in public real estate mergers and acquisition transaction values from the torrid pace of deal-making in the third-quarter 2021. Generally, buyers and sellers adjust to expanding discount rates in search of pricing equilibrium.

In spite of a rapidly evolving macroeconomic landscape, secular themes impacting business activity are producing favourable supply-demand imbalances in select property types, underpinning valuations in the private market. Concurrently, the MSCI U.S. REIT index is down -21.4 per cent year to date. Within its constituency exist high-quality property portfolios trading at wide discounts in net asset value (“NAV”), representing yet another opportunity to buy real estate cheaper in the stock market than one can in the property market.

Although capital has become more selective, sophisticated institutional investors recognize this public-private disconnect. On Nov. 7, 2022, a joint venture between Singapore’s sovereign wealth fund GIC and Dream Industrial REIT (TSX: DIR.UN) announced an agreement to acquire Summit Industrial Income REIT (TSX: SMU.UN). The acquisition was a $5.9 billion all-cash transaction valuing the REIT at $23.50 per unit. This is a 33.4 per cent premium to its 20-day volume-weighted average price (“VWAP”), yet largely in line with recent transactions in the private market.

Summit benefits from outstanding operating fundamentals, reporting a 60 per cent gap between in-place and market rents and low leverage, culminating in the REIT announcing a fair value gain on its investment properties in its third quarter 2022 MD&A, even as capitalization rates expanded.

On Sept. 28, 2022, Andrew highlighted Summit as a “Top Pick” on BNN Market Call, stating, “If I had to pick a name for M&A in industrial, this (Summit) would be the one.” The subsequent announcement represents the 20th take-over of a portfolio holding in the Vision Opportunity Funds, subject to the deal closing as projected in the first-quarter of 2023. 

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TOP PICKS:

First Capital REIT (FCR.UN TSX)  

First Capital REIT is a pure-play grocery-anchored shopping center REIT focused on Canada’s strongest demographic markets. By fair value, the portfolio is 48 per cent Greater Toronto Area (“GTA”), 12 per cent Greater Montreal area (“GMA”), and 11 per cent in each of the Calgary and Vancouver markets.

On Sept. 22, 2022 the REIT announced an enhanced capital allocation plan to monetize $1 billion of low-yielding assets where value-enhancing goals have been achieved to drive increased earnings growth and improved debt metrics. The plan is expected to take two years and will improve First Capital’s annual earnings growth rate to four per cent. While the plan has been subject to investor debate the REIT remains committed to its enhanced capital allocation plan at this time.

The supply and demand backdrop for grocery-anchored shopping centers is also increasingly favourable in the current economic environment with minimal new supply and a high degree of recession resistance. Over 85 per cent of First Capital’s tenants are necessity-based retailers which offer essential goods and services. In a recessionary environment these tenants, and as a result, First Capital’s properties will outperform peers more exposed to discretionary retailers.

The REIT’s third-quarter results demonstrated this portfolio resilience with same-property net operating income growth of 5.3 per cent on a year-over-year basis driven by higher rents and a strong portfolio occupancy rate of 95.7 per cent. Furthermore, rent spreads on renewal leasing increased to 12 per cent, above First Capital’s longer-term and year-to-date pace of nine per cent.

With a new capital allocation plan designed to surface value and units of the REIT trading approximately 30 per cent below comparable private market values (the most discounted valuation in the Canadian shopping center REIT space), First Capital is well positioned for strong unit price outperformance.

Sun Communities (SUI NYSE)

Sun Communities owns and operates more than 180,000 manufactured housing and recreational vehicle sites and over 46,000 marina wet slips and dry storage spaces, all of which are located in 39 U.S. states, Puerto Rico, Ontario and the United Kingdom. The REIT focuses on high-quality properties that tend to be clustered in popular coastal and vacation destinations. Its largest markets are Florida, Michigan, the U.K., California and Texas. The manufactured housing communities (“MHC”) sector has several uniquely positive characteristics, namely that its resilient demand and high barriers to entry have resulted in the publicly-listed U.S. sector, on average, never having a negative year of same-property net operating income growth. The sector also benefits from lower capital expenditures relative to other asset classes as it is largely a land lease business. The marinas business similarly has compelling supply-demand dynamics, with 12 million registered boats in the U.S. versus an estimated supply of between 0.9 to one million wet slips. As a result, approximately 85 per cent of Sun’s marinas have a waitlist.

With uncertainty in the economic environment over the next year, Sun is well-positioned to capture continued rental growth. To this point, the REIT is currently in the process of distributing 2023 rental rate increases to its tenants that are expected, on average, to range from 6.3 per cent year-over-year for its MHC business to as high as 7.8 per cent year-over-year for its annual RV segment, at the midpoint of its guidance. Importantly, these levels for next year represent an acceleration in growth from the current year-to-date levels that Sun is achieving, unlike other sectors where growth may be moderating next year. Sun’s shares are an attractive investment opportunity as they trade at a 14 per cent discount to NAV in a sector with positive supply-demand fundamentals and defensive and growing cash flows.

Dream Industrial REIT (DIR.UN TSX)

Dream Industrial REIT is a pure-play industrial REIT focused on owning primarily distribution and logistics assets across Canada (62 per cent of investment property value, excluding assets held for sale) and Europe (38 per cent). It also owns a 25 per cent interest in a private open-ended U.S. industrial fund, in which the REIT earns fees for property and construction management as well as leasing services.

On Nov. 7, 2022, Dream Industrial and Singapore's sovereign wealth fund GIC announced a joint venture agreement to acquire Summit Industrial Income REIT (TSX: SMU.UN) in an all-cash transaction valued at $5.9 billion, including the assumption of certain debt. The joint venture between GIC and Dream is structured as a limited partnership, with an ownership interest of 90 per cent and 10 per cent, respectively. The transaction is immediately accretive to the REIT. It expands its footprint in Canada, particularly in the high-growth Toronto and Montreal markets, grows its property management platform, expands its development pipeline and, most importantly, provides a new capital source to grow its Canadian footprint. Furthermore, GIC’s investment is validation of the attractiveness of Canadian industrial real estate by a significant global real estate investor.

Dream Industrial is benefiting from tight fundamentals across all of its markets and a substantial mark-to-market opportunity on in-place rents. Combined with a good balance sheet, the REIT should deliver strong internal growth over the next few years despite a challenging macro environment. Despite its attractive growth profile, units of the REIT continue to trade at a compelling 30 per cent discount to its underlying NAV.

PAST PICKS: November 29, 2021

Boardwalk REIT (BEI.UN TSX)

• Then: $55.13
• Now: $49.77
• Return: -10%
• Total Return: -8%

Phillips Edison & Co (PECO NASD)

• Then: $32.23
• Now: $31.77
• Return: -1%
• Total Return: 2%

InterRent REIT (IIP.UN TSX)

• Then: $17.04
• Now: $12.21
• Return: -28%
• Total Return: -26%

Total Return Average: -11%