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

FOCUS: Real estate stocks  

MARKET OUTLOOK:

As the fourth quarter progresses, the Canadian economy has continued to show unexpected resilience. Yet, as the focus starts to turn to 2024, there are a number of key economic data points that will need to be observed to determine the future direction of the economy and the severity of a potential recession next year. Historically, publicly traded real estate has fared well during and after contractionary periods. Over the six recessions observed since 1978, real estate investment trusts (REITs) have recorded significant outperformance compared to private property funds, and the stock market.

In the first half of 2022, there was a highly correlated market correction across all REIT sectors in conjunction with the rapid increase in interest rates. This generated a large dislocation in publicly traded real estate securities, resulting in a discounted valuation that still persists. Since then, the prevailing conditions influencing the economy have impacted real estate subsectors differently, creating a bifurcation across property-level fundamentals and dispersion in stock price performance.

Sectors such as single-family rentals, manufactured housing communities, industrial, data centres and necessity-based shopping centres have exhibited resiliency thus far in the current climate. This is compared to sectors such as office, malls, and U.S. healthcare that could display further signs of distress in the coming quarters. This structural inefficiency has created an attractive entry point into public REITs as many sectors trade at wide discounts to net asset value (NAV), underscoring the value proposition, flexibility and liquidity enhancement complement of publicly-traded real estate securities in an alternative investment portfolio.

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TOP PICKS:

Boardwalk REIT: (BEI.UN TSX)

Boardwalk Real Estate Investment Trust, the second-largest publicly-traded apartment REIT in Canada, owns over 33,800 suites with its largest markets of Edmonton, Calgary and Montreal.

With a large concentration of its exposure in Alberta, Boardwalk has been a beneficiary of strong population growth in this province driven by a significant increase in both international and interprovincial migration. In the second quarter of 2023, Alberta’s population grew by more than 50,000 people, the second largest quarterly increase since the data were tracked beginning in 1971. Interprovincial net migration contributed to approximately 14,000 of that increase, the greatest level of any province or territory in Canada over that timeframe.

In addition, rents remain affordable in Alberta. Boardwalk’s rent-to-income ratios in its largest markets of Edmonton and Calgary at 24 per cent and 28 per cent, respectively, which is significantly below its other regions, which are mostly in the mid- to high-30 per cent range. This has been a contributing factor towards record levels of migration to Alberta. In addition to these positive factors, the REIT benefits from having significant exposure to provinces that have not placed a statutory ceiling on rent increases, with Alberta and Saskatchewan comprising 74 per cent of its same property NOI. This allows the REIT to, on renewals, increase in-place rents closer to market rents, as compared to other regions. Combined, this has translated into strong operational performance for the REIT, with Boardwalk expecting to produce same-property NOI growth of 12.5 per cent to 14 per cent this year. Despite the strong fundamentals and operational results, units of the REIT continue to trade at a compelling 18 per cent discount to its underlying and quickly growing NAV. 

First Industrial Realty Trust, Inc.: (FR NYSE)

First Industrial Realty Trust, Inc. is a fully integrated owner, operator, and developer of U.S. industrial real estate. The REIT’s 64.8 million square feet portfolio is highly concentrated in 15 of the strongest industrial warehouse markets in the United States.

First Industrial’s portfolio is located in the top fifteen U.S. industrial hubs with a concentration in Southern California (25 per cent of revenue). Its exposure to these markets has caused the REIT to produce one the strongest NOI and FFO growth profiles amongst its peers, and once again is projected to be one of the leaders in earnings growth in 2023. With availability rates below national averages in the REIT’s core markets, market-rent growth has been robust over the last several years which has created a mark to market on the REIT’s portfolio between +40-to-50 per cent. Looking ahead, this spread between in-place rents and the market should remain elevated as supply in its markets is projected to remain muted. As a result, the REIT should have sustained top-quartile NOI and FFO growth for the next several years.

In addition to its strong internal growth, the REIT’s development pipeline offers accretive external growth prospects as, upon completion, it would expand its portfolio by 28 per cent. Notably, the REIT strategically acquired its land before the pandemic at an attractive cost basis therefore allowing for strong development profit potential. Complementing its positive internal and external earnings growth profile, First Industrial operates a well-managed balance sheet with no maturities until 2027 and at a low 5.1x net debt to EBITDA. Notwithstanding this, shares of the REIT trade a 21 per cent discount to NAV, the widest amongst the peers, which if sustained, makes the REIT a potential takeover candidate. 

Chartwell Retirement Residences: (CSH.UN TSX)

Chartwell Retirement Residences is the largest owner of seniors housing in Canada with more than 25,000 suites located across Ontario, Quebec, Alberta, and British Columbia.

At the beginning of the year, Chartwell’s occupancy was depressed due to the hangover effects of the COVID-19 pandemic. Investors had grown concerned that Chartwell’s occupancy might remain permanently depressed and this drove underperformance in Chartwell’s unit price. However, over the course of 2023, Chartwell invested heavily in sales and marketing efforts and made tremendous progress in improving portfolio occupancy. With leasing strength anticipated to continue through November 2023, the Trust’s forecast for November-end occupancy is 83.6 per cent, over four per cent higher than where it was to start the year. Supporting Chartwell’s stabilizing outlook is the ongoing reduction in new supply. The mix of higher interest rates, higher construction costs, and a very competitive leasing market have all worked to reduce the profitability of new development leading to diminished construction starts. In 2023, new construction starts are anticipated to represent only 1.5 per cent of inventory, well below the three to five per cent annual range seen over the last decade. Diminished new construction starts this year will lead to lower competition from new supply over the next few years, enhancing Chartwell’s potential success in leasing. Strong leasing success and declining new supply are combing to create a turning point for supply and demand fundamentals for the Trust and the opportunity for significant unit price appreciation as this backdrop translates into higher occupancy rates and higher earnings. 

PAST PICKS: November 29, 2022

First Capital REIT (FCR.UN TSX)

• Then: $17.17
• Now: $13.80
• Return: -20%
• Total Return: -15%

Sun Communities Inc. (SUI NYSE)

• Then: US$144.81
• Now: US$127.87
• Return: -12%
• Total Return: -9%

Dream Industrial REIT (DIR.UN TSX)

• Then: $12.09
• Now: $12.31
• Return: 2%
• Total Return: 7%

Total Return Average: -6%