In a recent review of the most widely covered Canadian income trusts, Investor’s Digest of Canada highlighted three Real Estate Investment Trusts favoured by analysts.
■ Morguard North American Residential REIT: Step in before growth steps up
CIBC World Markets analyst Dean Wilkinson says Morguard North American Residential REIT (TSX—MRG.UN) is one to step into, before its growth steps up.
Mr. Wilkinson highlights: “With Morguard delivering solid operational results, the relative valuation spread between the REIT and its Canadian peers has once again widened out substantially.
“Every time the relative valuation gap has reached similar levels, it has subsequently narrowed by at least 10 per cent within the following 12 months. With real estate fundamentals generally favourable in both the REIT’s Canadian (specifically Ontario) and US markets, we see a clear path to above-average growth, and combined with material valuation optionality, we believe that current unit prices represent a compelling entry point.
“We are maintaining our $22 unit price target, which we derive by applying an approximately 10 per cent discount to net asset value (note that this is the lower end of the discount range that units have traded at over the past five years).
“Third-quarter 2019 funds from operation were $0.30 per unit (flat from $0.30 per unit year-over-year), essentially in line with our estimate of $0.31 per unit. Results benefitted from solid same-property net operating income (NOI) growth of 2.4 per cent, comprising 3.4 per cent growth in Canada, 0.5 per cent growth in the US, and a modest foreign exchange tailwind.”
Morguard will increase its annual cash distribution by $0.02 (approximately three per cent) to $0.70 per unit, effective for the November 2019 distribution.
“During the third quarter of 2019, the REIT completed an equity offering for approximately 5.2 million units at $19.75 per unit for aggregate gross proceeds of $103.2 million (net proceeds of $99.6 million). Morguard Corp. purchased 1.269 million units as part of the issuance (or $25.1 million), and now holds a 44.8 per cent effective interest in the REIT.
“Average occupancy was 96.7 per cent in the third quarter of 2019, down 10 basis points quarter-over-quarter but still up 70 basis points year-over-year. Occupancy levels in Canada remain resilient at 99.4 per cent despite a 10 basis point decline from the third quarter of 2018 (and note that occupancy actually increased 60 basis points). Given the strength of the Ontario residential market, occupancy is unlikely to trend lower, and we would expect the REIT to continue to focus on rent optimization.”
The analyst gives the REIT an “outperform” rating.
■ Cominar Real Estate Investment Trust: Significant low-hanging fruit ripe for picking
Cominar REIT (TSX—CUF.UN) recently provided IA Securities analyst Brad Sturges the REIT’s strategic initiatives planned in the next two to three years. The REIT is targeting over 15 per cent growth in net asset value (NAV) per unit, and funds from operations (FFO) per unit, by the end of 2021. Subsequent to the updates the analyst maintains the REIT’s “buy” rating and upgrades his target price to $15, from a previous $13.50. This implies a 14.2 per cent target return.
The analyst highlights that Cominar intends to achieve these NAV and FFO growth targets by “generating same-property rental income (SP-NOI) growth of two to three per cent (above its long-term target of two per cent year-over-year).” The REIT also intends to reduce overhead costs. Cominar will be decreasing its interest costs by optimizing the use of available low-cost debt capital.
“While the REIT intends to execute additional non-core asset sales (around $300 million per annum in 2019 and 2020), Cominar can mainly achieve these financial leverage targets by increasing its portfolio fair market value (FMV) by approximately $500 million or $2.75 per unit. The REIT also plans to repurchase $100 million of its outstanding units by the end of 2020.
“The REIT has identified 10 properties with excess density potential to add 9,550 residential suites over time. In addition, Cominar’s Montreal industrial facility portfolio contains excess land that could provide approximately one million square feet of additional leaseable density.
“As we expect investor focus to shift towards Cominar’s execution of its strategic plan, there could be plenty of ‘low hanging fruit’ available to Cominar to capture improving Montreal commercial property fundamentals, particularly in the REIT’s Montreal industrial portfolio.
“The bottom line: we have a positive first impression from Cominar’s increased communication and transparency provided.”
■ Killam Apartment Real Estate Investment Trust: Capital spending catching up to peers as repositioning returns prompt increased investment
According to National Bank Financial analyst Matt Kornack, a positive shift in operating fundamentals in the Maritime provinces is changing the math on multi-family assets. He finds capital deployment into suite repositioning now justified given the rent growth upside. As such, Killam Apartment REIT (TSX—KMP.UN) is starting to look a bit more like its Ontario-centric comps and has been more aggressively investing in properties in order to get at juicy rent lifts.
Mr. Kornack goes on to say: “Rent increases have justified the move with appreciation on turnover at 28.9 per cent versus 5.7 per cent for non-repositioned suites (the medium-term opportunity is to invest in 3,000 suites or approximately 18 per cent of the portfolio).
“While we see this as positive signaling generally on the strength of Killam’s markets it is also modifying the investment thesis, which previously held the distinction of being a lower capital expenditure story with stable growth prospects.”
For the third quarter of 2019, the REIT reported: “Funds from operations (FFO) per unit was $0.27 per unit versus $0.26 per unit in the third quarter of 2018, in line with us and consensus of $0.27 per unit. Net operating income was 1.8 per cent above our forecast while general and administrative costs were lower, offset by lower financing costs leading to a positive 2.2 per cent variance in FFO per unit.
“Strong rental growth on unit turns and lease renewals resulted in a 3.4 per cent increase in same property rent in the apartment portfolio, this combined with only a 2.1 per cent increase in expenses and a 40 basis points increase in same property occupancy drove same-property net operating income (NOI) higher. In the third quarter, Killam spent $20.5 million on apartment capital expenditure, up approximately 79 per cent versus $11.4 million in the third quarter of 2018.
“As of Sept. 30, 2019, Killam had liquidity of approximately $62.8 million, consisting of $57.7 million availability on its credit facility. Subsequent to quarter end the REIT raised $100 million of equity.”
The analyst maintains the REIT’s “outperform” rating and $22 target price, implying a total return of 16.7 per cent.
This is an edited version of an article that was originally published for subscribers in the December 6, 2019, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846