In a recent report, Downey lays out a case for each property type in this slow-growth scenario. At the risk of oversimplyfing, it can be summed up as grim for office (“the grind begins”) and improving from there in the other sectors with industrial facing the best prospects over the next year and lodging/hotels at the head of the pack over the next two or three years.
While a “gradually improving economic backdrop and a stronger labour market” will help office over the next few years, “an occupancy grind is about to begin” in the form of 22 million square feet of new buildings under construction or 4.5 per cent of existing inventory. Most of that is in the downtowns of Vancouver, Calgary, Toronto, and to a lesser degree in Montreal, and will appear between 2014 and early 2018.
That new space will exceed demand and should push national vacancy rates, and especially central vacancy rates, up and make market rents in those cities “soft.”
RBC is more optimistic about retail real estate with cap rates continuing to push record lows, propping up investor optimism. Even the slow start for Target in Canada has not taken the shine off the sector as most new foreign retailers are doing fine, according to the report.
A “West-versus-East story” since the end of the recession, industrial real estate will likely continue that theme this year: Western Canada will continue to outperform. The good news for the East: new supply has been slow to come on which should push up rents. As well, the fall in the loonie is a positive for manufacturers and GDP growth. RBC is predicting national average rent growth of five per cent and a slight (20 basis points) reduction in national vacancy, to 5.7%.
The plus for the multi-res sector is the continued tightening on first-time home buyers at a time when new household formation is a key driver of rental demand. On the downside are an accelerating number of new multi-res developments and modest growth in rental rates for 2014. In the end, the report predicts “modest, consistent profit growth in 2014, albeit at a slightly lower rate versus 2013” for the multi-res sector.
Coming off another weak year, RBC expects the lodging/hotel sector’s rate of improvement to be “accelerating slightly” compared to 2013. The report warns that higher operating expenses still mean a return to peak profitability is still a number of years away.
“At some point, surely a weaker C$ and gradually improving GDP growth has to kick in for this pro-cyclical sector . . . right?” the report asks.
The nice list
RBC tags 15 companies it covers with an “outperform” rating. They are:
* Brookfield Asset Management: (BAM.A-T) “Global owner and manager of long-duration cash-flowing, property, power, and infrastructure investments. Leverage to a growing asset management business (fee income) is becoming increasingly apparent and we believe investor should be willing to ‘pay’ for this.”
* Brookfield Office Properties: (BPO-T ) “Shares are trading at a modest discount to the indicative $20.34/share cash (33%) and unit-exchange (67%) offer from Brookfield Property Partners LP (“BPY”). We see upside in the future re-rating of BPY units post $4B of float and potential S&P/TSX Index inclusion.”
* Calloway REIT: (CWT.UN-T ) “Newer assets, long lease terms, provide efficient flow through of NOI to AFFO. Focus on ‘value-oriented’ retail should prove defensive in a tentative consumer and/or economic recovery. Operating results have been stable, while liquidity remains strong.”
“Increasingly sophisticated operator”
* Canadian Apartment Properties REIT: (CAR.UN-T ) “Has become an increasingly sophisticated operator over the last half-dozen years. We have a generally favourable 2014 multi-res outlook. Now operating at the lower end of historical leverage range. Shares are trading at a 10%-plus discount to NAV which appears attractive.”
* Chartwell Retirement Residences: (CSH.UN-T ) “We expect favourable industry conditions for the next 1-3 years and we note that CSH’s units should be receiving a modest ‘kicker’ from its US$ revenues (weaker $CAD). We expect CSH to continue to focus its U.S. portfolio to three or so core U.S. states (Colorado, Florida, Texas) and repatriate capital to Canada over the next 12-24 months.”
* Canadian REIT (CREIT): “Low AFFO payout ratio. Low financial leverage. One of the longer track records of any REIT. The development pipeline is growing nicely and should be an earnings contributor in 2014+. NCIB renewal should provide modest support for the REIT.”
* Dundee REIT: (D.UN-T) “The office sector is expected to have the weakest fundamentals of the major property classes on a 1 -3 year basis and this is a contrarian stock selection. We believe Dundee’s AFFO/unit will generally hold steady and that it will cover the distribution. Valuation and high cash yield are attractive.”
* First Capital Realty: (FCR-T) “An increasingly urban portfolio concentration in defensive retail and mixed-use properties. Offers an interesting income and value-add business model ($1bn pipeline), which should allow for slightly higher earnings and NAV growth (vs. that of the average REIT) over time.”
* H&R REIT: (HR.UN-T) “High-quality commercial property portfolio consisting ~$10B of primarily long-term, triple-net leases plus ~$3B of malls. A liquid, large-cap that appears reasonably valued based on P/NAV.”
* InnVest REIT: (INN.UN-T) “We see InnVest REIT on path towards owning a higher quality, more concentrated portfolio of properties that should generate improved financial returns. Strategic plan continues to show early progress. Business should offer multi-year cyclical recovery potential.”
* Killam Properties: (KMP-T) “In the face of higher expected market vacancy this year in Greater Halifax, lower operating cost (easy comps) and the stabilization of 2013 new developments should allow for solid FFO/share growth. Well positioned to benefit from Irving’s $25B shipbuilding contract over time. P/NAV is attractive.”
* Morguard REIT: (MRG.UN-T ) “An attractively valued REIT that has improved its asset quality over the past number of years. The units are normally lacking any sort of catalyst, yet score well on stability and reliability. Unit repurchases have recently accelerated, which we take as a positive signalling event.”
* RioCan REIT: (REI.UN-T) “One of Canada’s premier REITs based upon its size and scale, focus on Canada’s six largest cities, its value-add development pipeline, and its overall franchise value. We continue to view RioCan’s units as a core holding.”
This is the second and final part of an article about Canadian REIT performance in 2013 according to the real estate analysts at RBC Dominion Securities.