More capital is expected to flow into real estate investment trusts in the coming months, but it’s likely to be a gradual increase and not a flood.
Either way, the situation is now “less bad” than it was over the past few years when unit prices were severely depressed, according to one portfolio manager during an investments roundtable at the Sept. 10 RealREIT conference at the Metro Toronto Convention Centre.
“We’re definitely getting an increase in the number of inbounds from multiple channels — investors, advisors, wholesalers and so on,” Chris Couprie, CI Global Asset Management‘s vice-president, portfolio manager and research lead for equities, said during one of the discussions. “People have got to be asking questions and showing engagement in the space before they start committing dollars to it.”
As interest rates start to come down for guaranteed investment certificates, some money invested in risk-free, fixed-term investments will likely be redeployed into other interest-bearing issues, including REITs.
REITs have outperformed Toronto Stock Exchange
Investment returns for REITs have significantly outperformed the overall Toronto Stock Exchange since the Bank of Canada started cutting interest rates, which should benefit trusts as more people become aware of the trend and their confidence in REITs returns.
“For REITs, people need them to go up 20 per cent before they’ll buy them,” said Lincluden Investment Management vice-president and portfolio manager Derek Warren. “What we’ve seen now is this first little leg that’s woken people up, the next leg will get them analyzing it, and the third leg gets them investing.”
Publicly traded securities offer more liquidity but the trade-off is more volatility and less efficient returns.
Multifamily
Panel moderator and RBC Capital Markets global head of real estate research Pammi Bir said REITs “have put up decent returns thus far,” but Canada continues to struggle with a housing shortage. He asked about the prospects for the multifamily sector.
Warren said multi-family fundamentals are good, as apartments have low vacancy rates and market rents can be charged when tenants roll over. Lincluden is invested heavily in quality apartments and will continue to support the asset class, he added.
“The only way to bring down the cost of housing in the ownership market or the rental market is to produce more of it,” Starlight Capital chief executive officer and chief investment officer Dennis Mitchell said. “If you want landlords to take care of their properties, give tenants choice.”
Seniors housing
The seniors housing sector went through some dark times during the COVID-19 pandemic but has made a robust recovery. Couprie expects to see continued improvements in occupancy rates and expects them to be in the 95 per cent range within 18 to 24 months.
“What we’re really looking for, though, is for margin expansion to continue,” Couprie said. “Margins for the industry are operating below where they were pre-pandemic by several hundred basis points.
“They will go higher as occupancy increases. Typically, with each new resident that comes into a senior or retirement home, about 70 or 80 per cent of that flows through to the bottom line.
“So we’re currently assuming that there’s going to be margin expansion, but we’re not underwriting that type of improvement, so that could be a positive surprise for us.”
Industrial
Bir said industrial REITs continue to experience healthy organic growth and asked where things may trend over the next few years.
Industrial fundamentals have been normalizing globally and while Couprie noted availability has increased by 270 basis points from the trough in Canada, it’s still well below the six per cent rate south of the border.
Demand was soft in the last quarter and 1.7 per cent of Canada’s industrial supply is under construction. Seventy per cent of that should be delivered this year, so Couprie expects vacancy rates to increase to the five- to six-per cent range.
“Market rents should be pressured somewhat for the next six to nine months,” Couprie predicted, “but beyond that, we think we can return to inflation-plus market rent growth.”
Couprie added that market rents are about 90 per cent higher on average than they were five years ago, so there’s still a lot of embedded rent growth for landlords.
Retail
While many Canadians are financially stretched, unemployment has been rising, and the large number of immigrants arriving in the country over the past few years is being curtailed, RBC Global Asset Management managing director, senior portfolio manager and co-head of North American equities Stu Kedwell remains positive about retail REITs. He said they have improving balance sheets and are moving from being acquirers to optimizers.
“You have to deal with some recession risk, which might show up on occupancy and might show up in some rent growth,” Kedwell observed, adding that he believes six to 12 months of challenging times due to higher unemployment should recede and lead to better things long-term.
While many retail-focused REITs have large mixed-use development opportunities within their portfolios, investors by and large have been unwilling to pay for that intensification potential.
“Unenclosed shopping centres tend to be the least efficient real estate,” Mitchell said. “Thirty to 40 per cent of it is covered in revenue-generating real estate, and it’s a huge plot of land that attracts a ton of property taxes and development levies and so on and so forth.
“So the more you can cover that space with revenue-generating real estate, the better.”
Office
The office sector has been severely challenged since the onset of the pandemic with the more widespread adaptation of remote work, the arrival of new supply and higher interest rates.
“There’s still power in being grouped together and that’s going to happen in offices, but they have to be great offices,” Warren said. “Our pension funds and REITs own those kinds of properties and real estate.
“I always said it’s going to take 10 years, and we’re about five years in on that, so we’ve got to get through these next two years, which are going to be critical.”