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

FOCUS: Real estate stocks

MARKET OUTLOOK:

Investor sentiment has been adversely impacted by the war in Ukraine, escalating geopolitical tensions and resulting in the weaponization of key commodities, surging inflation, hawkish central bank policy, recurring supply chain disruptions and continuing COVID-19 outbreaks, engendering a strong policy response that is stifling economic activity in China.

The resulting weakness in the stock market has (once again) catalyzed a divergence between the valuations of North American publicly-traded real estate securities and the underwriting of comparable properties in the private market.

Generally, property fundamentals remain strong across the investable universe, evidenced in U.S. REIT earnings revisions continuing to surprise to the upside in the first quarter of 2022, reporting an average increase of 2.9 per cent, as compared to eight out of eleven GICs sectors reporting a decrease in earnings revisions over the same period, and the broader S&P 500 averaging a 1.2 per cent decrease.

With the liftoff of interest rates from the zero-bound across much of the developed world, it is important to reiterate that REITs are dynamic operating platforms that statistically reveal no correlation to the directionality of borrowing costs. Since the Fed’s announcement to begin its current hike cycle on March 16th, U.S. REITs have posted a total return of 3.5 per cent versus the S&P 500’s total return of -4.2 per cent.

A $364 billion wall of capital earmarked for real estate continues to underpin property valuations as M&A transaction volumes remain at elevated levels. The necessity of investing these funds has a positive impact on REITs both directly and indirectly. Indirectly, it boosts demand for the properties in their portfolios, pushing down cap rates and raising NAVs. Directly, it leads to takeovers of public REITs/REOCs.

Over the second half of 2021, real estate led all GICs sectors by M&A deal value, and this frenetic pace has continued into 2022, with Blackstone’s most recent acquisition announcements of American Campus Communities (NYSE: ACC) and PS Business Parks (NYSE: PSB) in deals valued at US$13 billion and US$7.6 billion, respectively, its fourth and fifth buyout of a publicly-traded REIT since the beginning of the global pandemic.

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TOP PICKS:

Boardwalk REIT (BEI.UN TSX)

Boardwalk REIT, the second largest publicly-traded apartment REIT in Canada, owns over 33,000 suites across 200 properties. With a focus on Alberta and Saskatchewan, the REIT owns assets ranging from Class A high-rise to garden-style Class B apartments concentrated in Edmonton (37 per cent of suites), Calgary (17 per cent) and Montreal (14 per cent).

With the price of oil rebounding and several new technology firms announcing expansions into the REIT’s core markets of Calgary and Edmonton, a significant five per cent reduction in tenant concessions has been reported by management quarter-over-quarter. This is expected to further accelerate in the second and third quarters of 2022, in line with the typical seasonal increase in apartment demand and leasing activity.

Operationally, the REIT continues to recover from the pandemic as new leasing spreads turned positive in the majority of its core markets in the fourth quarter 2021, while renewal leasing spreads increased from 2.5 per cent in September 2021 to 3.4 per cent in January 2022.

Finally, recent private market transactions indicate a significant mispricing of the REIT’s units, which may lead to cap rate compression in future appraisals. In March 2022, a $138 million acquisition of three multi-family properties in Calgary transacted at an estimated cap rate slightly above 4.0 per cent on in-place NOI, comparing to Boardwalk’s higher quality portfolio that trades at an implied cap rate approximately 50 bps higher. Combining all three catalysts have the potential to increase the near-term NAV per unit of BEI to almost $68.

Sun Communities Inc. (SUI NYSE)

Sun Communities Inc. owns and operates 477 manufactured housing and recreational vehicle communities, totaling approximately 159,000 sites, located in 39 states throughout the United States and the province of Ontario, and 125 marinas comprised of about 45,000 wet slips and dry storage spaces. Its portfolio is concentrated in high-quality properties clustered in the popular coastal and vacation markets of Florida, Michigan, Texas and California.

Sun’s external growth pipeline is robust, with its scale providing access to a wide opportunity set of assets to underwrite for acquisition, while leveraging its existing manufactured housing communities for development and expansion projects. The latter is particularly accretive, with returns on these projects returning seven to nine per cent and 10-14 per cent, respectively, on an unlevered five-year basis, as compared to private market transactions occurring at cap rates below three per cent.

Sun’s management team conservatively projects this will add US$5.00 to US$6.00 per share of value creation annually. Sun’s expansion into the marina business is synergistic to its core asset classes, also benefiting from a significant supply-demand mismatch driven by strict regulatory requirements, limited waterways and high capital expenditures to construct new stock. This is expected to result in same-property NOI increasing 6.7 per cent, outpacing its core manufactured housing and RV business by ~30-bps.

Sun continues to represent an attractive investment with its shares trading at a 13 per cent discount to the consensus NAV.

Summit Industrial Income REIT (SMU.UN TSX)

Summit Industrial Income REIT (“Summit” or the “REIT”) is a pure-play Canadian industrial REIT concentrated, in terms of gross leasable area (“GLA”), in the Greater Toronto Area (“GTA”) (44 per cent), the greater Montreal area (“GMA”) (23 per cent) and Alberta (26 per cent).

The supply and demand imbalance within the GTA and GMA regions are amongst the widest in North America. CBRE notes that although net rent growth increased 30-40 per cent year-over year, it has continued to accelerate 11 per cent from the fourth quarter of 2021 to the first of 2022. Continued rent growth has led to increased property values which are now 60 per cent higher than pre-pandemic levels. With almost 70 per cent of its gross leasable area in the GTA/GMA markets, the REIT is well-positioned for future FFO and NAV per unit growth as leases turnover and mark-to-market.

To this point, Summit reported record fourth-quarter results, achieving releasing spreads in excess of 100 per cent in its GTA portfolio and occupancy at 99 per cent, and releasing spreads between 25 per cent-to-30 per cent and occupancy remaining at 100 per cent in the GMA.

Finally, the REIT is relatively insulated from rising rates due to its lowly-levered balance sheet (28.5 per cent to gross book value) and short-term lease profile which allows the REIT to offset higher interest rates with meaningful rent growth upon turnover.

Despite strengthening fundamentals and private market transactions pushing asset values higher, units of the REIT continue to trade at an attractive 17 per cent discount to private market values.

PAST PICKS: March 30, 2021

Canadian Apartment Properties REIT (CAR.UN TSX)

• Then: $53.94
• Now: $50.72
• Return: -6%
• Total Return: -3%

Chartwell Retirement Residences (CSH.UN TSX)

• Then: $11.73
• Now: $12.44
• Return: 6%
• Total Return: 12%

StorageVault Canada Inc. (SVI TSX)

• Then: $4.57
• Now: $6.65
• Return: 46%
• Total Return: 46%

Total Return Average: 18%