Investors cooled on their lengthy love affair with REITs in mid-2013 and it doesn’t look like they are in any mood to rekindle the romance any time soon.
That is one of the main takeaways from a report this week from RBC Dominion Securities analyst Neil Downey.
His themes for 2014?Less, less and less. Or more accurately: a further deceleration in investment volume; less equity issuance ($3 billion-plus, down from nearly $5 billion last year); increased emphasis on capital recycling; little M&A activity in the foreseeable future; and more corporates (i.e. the Loblaw Cos., Canadian Tire Corp. real estate spinoffs).
The analyst expects less deal-making as REITs have seen their cost of equity capital rise given an average price decline of 11% for REITs.
He estimates that investment property deals totalled $25 billion to $27 billion in 2013, down from 2012’s tally of $29 billion. He predicts deal totals (or direct market turnover) could fall 15% to $22 billion this year.
The pullout of REITs from the buyers’ table was stark in the second half of 2013: REITs and REOCs accounted for 25% to 30% of property investment volume in the first half of last year but less than 10% in the second half.
Less deal-making also means less need to issue equity to bankroll those acquisitions. REIT equity issuance totalled $4.7 billion in 2013, down from 2012’s record $6.8 billion, and braking noticeably over last year down to 40% in the fourth quarter compared to the first three months of 2013.
After a slow start, Downey forecasts equity capital issuance of $3 billion to $4 billion for the year.
Reduce, reuse, recycle
RBC expects that with real estate companies trading at a discount to their assets, they will be prompted to sell properties this year. Downey also predicts a modest rise in interest rates.
A further slowdown for the real estate sector will not prompt a flurry of mergers and acquisitions, the RBC report stated. Last year, there were three Canadian REIT/REOC M&A transactions that either began or finished in the first half of the year. Non occurred in the duck-and-cover second half of the year.
The investment firm does not see a flurry of M&A activity in the first half of this year because of a lack of supporting conditions – “good business fits; significant discounts to NAV or value disparities; over-levered balance sheets; weak operating fundamentals or miss-managed assets; fatigued management teams.”
Retailers raided their piggy banks in 2013 by selling big chunks of their real estate holdings to investors. Given the success of Loblaw and Canadian Tire with Choice Properties REIT (CHP.UN-T ) and CT REIT, respectively, look for Hudson’s Bay Co. and perhaps others to follow suit this year.
Real estate by the numbers
TSX-listed REITs ended 2013 with a market cap of approximately $56 billion, up 10% from $51 billion at the start of the year. At year-end, 16 REITs had an equity market cap in excess of $1 billion (up from 15 at the beginning of the year) and 11 REITS had a market cap greater than $2 billion (unchanged from 11 at the outset of 2013).
During 2013, the number of TSX-listed REITs expanded by nine, to 40. There were eight new additions due to IPOs. Three new listings were REITs that graduated from the TSX Venture Exchange. There was one REOC-to-REIT conversion and one REIT-to-REOC conversion for a “wash” in this regard. Finally, two names were lost due to M&A.
RBC predicts total equity market capitalization could increase by 10% again this year, or $5 billion to $6 billion split equally between value appreciation for existing entities and new capital raises.
While slowing, the $4.7 billion of equity and equity-related capital raised from the public in 54 financings was ahead of the 10-year and 15-year annual averages of $3.5 billion and $2.8 billion. REITs accounted for $4.4 billion (93% of last years deal volume) while REOCs were $0.3B (7%).
Overall, 2013 activity included 37 trust unit or common share offerings (including subscription receipts) totalling $3.9 billion, 15 convertible debenture offerings for $667 million, and two preferred equity offerings totalling $180 million.
Darlings no longer
The S&P/TSX Capped REIT Index fell 10.6% in 2013 and generated a total return of -5.5%, the first year with a negative total return since 2008. Last year, Canadian REITs underperformed global property stocks, with the FTSE/EPRA NAREIT Global Index 2013 total return of 4.4%.
By region, Europe was the strongest 2013 performer (+16.2%), followed by Asia (+4.4%) and the US (+2.5%).
“Thematically, global listed property investors took the view that economic growth rate were better elsewhere (e.g., the US), or that things were simply getting “less bad” in other regions (e.g., Europe)” and moved away from Canada.
The 2013 performance broke a four-year streak of Canadian REITs outperforming the broader market, as S&P/TSX Composite Index generated a 13.0% total return.