Canadian real estate investment trusts have experienced dramatic highs and lows in the capital markets over the past year, RBC Capital Markets Real Estate Group managing director Carolyn Blair said during a presentation at the virtual RealREIT conference.
“After 2019’s recovery from some weakness during the prior years, aggregate earnings growth significantly declined during the first two quarters of 2020,” Blair observed during her introductory session on Sept. 23.
“Q2 2020 brought the largest ever year-over-year decline for quarterly earnings at minus-13 per cent. Over the past 19 years, aggregate earnings growth has averaged 1.7 per cent for the REITs.”
REITs have underperformed with a negative-20 per cent return over the past 12 months, compared to six per cent for bonds, four per cent for the Toronto Stock Exchange (TSX) Composite Index and one per cent for properties.
The 20 per cent negative return for Canadian REITs was worse than the negative-13 per cent for American and Asian REITs, and negative-seven per cent for European REITs.
Over five years, the compound annual growth rate has been four per cent for REITs, five per cent for the TSX Composite Index, six per cent for properties and four per cent for bonds. Returns from individual years have varied quite widely for the four asset types.
Five years of gains “wiped out” in a month
“While all asset classes suffered at the beginning of COVID, the REIT index and the TSX wiped out nearly five years worth of gains in just over one month,” said Blair. “Mercifully, both have recovered meaningfully since then.”
It was almost the opposite of 2019, when just nine were in negative territory. The worst returns over the past 12 months for REITs and REOCs were registered by Invesque at -66 per cent, American Hotel Income Properties REIT (AHIP) at -60 per cent and Morguard REIT at -54 per cent.
Total returns by property type over the past 12 months are industrial at 11 per cent, residential at -10 per cent, retail and office at -17 per cent, seniors housing at -30 per cent, diversified at -36 per cent and hospitality (with only one REIT in the sector) at -60 per cent.
Based on total annualized returns since their initial public offerings (IPOs), dating back to 1993, Killam Apartment REIT, Mainstreet and CAPREIT have been the top performers with at least a 10-year history.
The three residential REITs all have returns of 15 per cent or more. Another eight REITs and real estate operating companies (REOCs) with 10-plus-year histories have total returns of 10 per cent or more.
Of the 40 that have been trading for at least five years, 15 have total returns of above 10 per cent and all but three are in positive territory.
The capital market and Canadian REITs
Blair examined the impact of COVID-19 on the capital market and Canadian REITs.
“In spite of the pandemic causing one of the largest shocks to the world economy in recent history, equity markets in Canada returned to levels that aren’t too far off, and U.S. markets have passed the all-time highs reached in February of this year,” she said.
“Many observers have commented that equity markets have become disconnected from their underlying fundamentals.”
Until mid-February, the Canadian REIT index was outperforming the TSX Composite Index in relative total returns — at 10 per cent versus six per cent. Both swiftly declined in March as it became evident COVID-19 was starting to spread in Canada.
There were five days in March during which REIT prices dropped by five per cent. The decline exceeded 10 per cent on three of those days.
The REIT index reached a trough on March 23 after its largest ever single-day decline of nearly 15 per cent, which was followed the next day by a 10 per cent rebound.
Since the March trough, the REIT index has rebounded by 34 per cent but it remains down 22 per cent for the year to date.
The TSX Composite Index return has made a stronger recovery and was down just one per cent for the year as of Aug. 31. It has performed so well because it’s a market-weighted index and some of the best-performing categories are weighted heavier than those performing poorly, said Blair.
Liquidity ratio is calculated by adding unencumbered cash on the balance sheet plus undrawn revolver capacity, divided by total debt. The REIT liquidity ratio was at an all-time high of 13.3 per cent at the end of 2019 and before the pandemic. The ratio fell to 12.5 per cent in the second quarter, which is still high.
The liquidity ratio was nine per cent heading into the 2008 financial crisis, and there was a 6.7 per cent trough during that crisis.
“No matter how well things are going, preparing for that rainy day needs to be part of every good real estate management team’s job,” said Blair. “Extra liquidity, low debt ratios and low payout ratios may appear to have a cost in good times, but that investment is one very well-made.”
Factors needed for continued recovery
“The size and pace of REIT unit price recoveries will likely be uneven between property types and perhaps by geography,” said Blair. “Recovery size and pace will likely have less to do with traditional REIT financial metrics and more to do with investor confidence.”
Blair said that confidence will depend on:
* rent collections, tenant retention and tenant replacement, which are well ahead of levels reflected by current REIT prices;
* the current tolerable level of tenant insolvency remaining at least stable;
* investors being sufficiently confident to invest ahead of certainty regarding the delivery date, efficacy and take-up rate of a COVID-19 vaccine;
* and when people will release $127 billion in accumulated funds built up in savings accounts during the pandemic and how much of that money goes to REITs.
REIT IPOs and equity raises
No REIT IPOs were filed since last September, while Dream Global REIT, Partners REIT and Pure Multi-Family REIT were privatized. The privatization of Northview Apartment REIT is pending, while First Capital converted from a REOC to a REIT.
Aggregate TSX REIT market capitalization decreased by $14 billion to $72 billion in the largest ever one-year decline, according to Blair.
There were $7.4 billion in gross REIT/REOC equity raises in 2019, representing the second-highest annual issuance since 2008. It was behind only 2013’s $10.1 billion, which was bolstered by eight IPOs, including Choice Properties REIT and CT REIT.
Year-to-date equity raises of $1.5 billion are the second-lowest after 2008’s $1.1 billion, and about half of those were done prior to COVID-19-related economic shutdowns which began in March.
If annualized, 2020’s $2.3 billion in issuances would be the third-lowest in the last dozen years – about half the long-term average of $4.8 billion.
Industrial REITs and REOCs raised $1.86 billion, residential raised $1.49 billion, office raised $826 million, retail raised $662 million and diversified raised $70 million. There were no gross equity raises by seniors housing or hospitality REITs for the second year in a row.
REIT debt raises, distributions and leverage
The $4.9 billion in unsecured debt raises so far this year matches the previous highs from the past 18 years in 2014 and 2019. Annualized 2020 unsecured debt is on pace for $7.4 billion.
“Bolstered by record low rates and modest spreads, unsecured debt has become an attractive source of capital for the 14 investment-grade REITs and REOCs, which explains the $6.2 billion raised in the last 12 months,” said Blair.
“Tapping the unsecured market to repay revolvers and increase liquidity was a prudent move in 2020.”
The weighted-average distribution yield for REITs and REOCs over the past 12 months was 6.3 per cent as of Aug. 31, which was up more than 100 basis points from a year earlier despite 11 distribution cuts. Distributions ranged from zero for AHIP, Mainstreet and Invesque to just over 11.5 per cent for Brookfield Property REIT.
Fifteen REITs and REOCs have leverage below 50 per cent, including nine below 45 per cent, which is about half of last year’s total. Five have leverage below 40 per cent, down from eight last year. Twenty have leverage above 60 per cent, nearly double the number from last year.