The recent move to make Real Estate its own standalone sector on the Toronto Stock Exchange main trading index is a potential game changer.
In its quarterly REIT review and outlook, RBC Dominion Securities noted that taking real estate out of the financial services sector and having it “promoted” to its own group is a recognition that listed real estate companies have characteristics which are distinct and unique from other companies within the Financials sector.
It is the biggest change to the Global Industry Classification Standard (GICS) system since its creation 17 years ago, RBC noted.
It could also prompt the exchange to add a REIT or real estate operating company to the benchmark S&P/TSX 60 index, an omission that currently means the real estate sector is underrepresented among investors who buy the index to get exposure to some of the country’s largest and most liquid companies.
Contenders for the inclusion? Perhaps one of the trio of largest real estate players by market capitalization: RioCan REIT with a float of $8.9 billion, Brookfield Property Partners with a float of $6.5 billion and H&R REIT with a float of $6.3 billion.
Though late to the party as the 11th GICS sector, real estate (comprised of 16 REITs and six real estate companies or limited partnerships) is no lightweight. The investment firm calculated that the new sector carries a 3.2% weight in the TSX. Real Estate is ranked 8th, ahead of Information Technology (2.9%), Utilities (2.7%) and Health Care (0.8%) but behind Consumer Staples (4.1%). With the real estate group currently yielding 4.9%, it is the highest dividend paying Sector within the TSX Index ahead of Utilities (4.8%) and Telecommunication Services (4.1%).
A good year
The RBC real estate team, led by analyst Neil Downey, gives real estate a good grade for 2016.
Even with a “modest” decline in the third quarter, year-to-date performance suggests the real estate group has a “high probability” of beating RBC’s prediction for a total return outlook of 11%, “possibly by a wide margin.”
Just how good? “Overall, we believe the group will likely deliver a 2016 total return between 15% and 20%, which, if achieved, will go down in the record books as a very strong showing.”
The nice list
Out of a field of 41 TSX-listed real estate trusts, RBC selected Brookfield Asset Management as its top pick it. The investment firm likes BAM as an international “owner and manager of long-duration cash-flowing, ‘real return’ assets, including property, power, and infrastructure investments. An increasingly profitable asset management business (fee income) is becoming more apparent and we believe investors should be increasingly willing to ‘pay’ for this.”
The firm also identifies a group of 10 “outperforms.” That cadre is made up of:
Allied REIT (AP.UN-T) — ”Pound-for-pound the best ‘play’ on the urban intensification theme” with expected accelerating organic earnings growth this year and “a focus on advancing a number of Toronto intensifications, and the maintenance of industry-leading low leverage.”
Canadian REIT (REF.UN-T) — “The REIT has a low AFFO payout ratio, low financial leverage and a good quality, diversified portfolio” and its “development pipeline has grown nicely and should contribute to earnings this year and next.”
Granite REIT (GRT.UN-T) — The Magna-linked trust has concluded a strategic review and will keep with its previous objectives which include growing and diversifying its asset base and reducing its exposure to auto parts maker Magna.
Killam Apartment REIT (KMP.UN-T) — “Improved economic growth this year and next in Greater Halifax, lower operating costs and the stabilization of new developments should allow for solid FFO/share growth.”
Milestone Apartments REIT (MST.UN-T) — “The only pure-play US multi-res REIT traded on the TSX with principal property/ geographic exposure being garden-style apartments throughout the Sun Belt. The REIT benefits from an integrated platform and an internalized, well-aligned management team with a strong track record.”
Morguard NA Residential REIT (MRG.UN-T) — “MRG units offer income diversification and stability, with long-term growth potential by virtue of: 1) regional/economic diversification; 2) currency diversification (~60% of NOI in US$); 3) properties of varied product types, price points, and tenant profiles; and 4) a steady occupancy track record (~95-97%) occupied for seven years.”
Plaza Retail REIT (PLZ.UN-T) — “Plaza has a value-add business model centered around secondary and tertiary markets, where it has strong local knowledge. With only one exception (the acquisition of KEYreit), Plaza Retail REIT makes acquisitions where there is an opportunity for management to use its competitive strengths to create value.”
RioCan REIT (REI.UN-T) — “One of Canada’s premier REITs based upon its size, scale and overall franchise value. REI focuses on Canada’s six largest cities and its active value-add development pipeline for growth. We view the units as a core holding.”
SmartREIT (SRU.UN-T) — “…. Focus on ‘value-oriented’ retail should prove defensive in a tentative consumer and/or economic recovery. SmartREIT benefits from a stable cash flow profile, and from this base management is intent on driving additional growth. Strategies aimed at achieving growth targets include: 1) focusing on improving SP-NOI via leasing; 2) development, intensification, and earnouts; 3) accelerating development with JV partner Simon Property Group; 4) acquisitions; and 5) long-term development at Vaughan Metropolitan Centre.”