Here are two REITs rated ‘sector perform’ and one rated ‘sector outperform’ from a survey of the most widely covered income trusts by Canadian analysts.
Minto Apartment REIT (TSX—MI.UN)
How was the third quarter of 2020 at Minto Apartment REIT? According to National Bank Financial analyst Matt Kornack, Minto underperformed multi-family peers in terms of aggregate same-property net operating income growth. However, he notes that this was largely due to vacancy and rent pressures in the furnished suite portfolio.
Looking past the continued weakness in the furnished suite portfolio, Minto’s apartment properties put up solid year-over-year organic growth driven by strong rent increases moderated slightly by lower occupancy levels, Mr. Kornack says. This speaks to continued demand for affordable rental product in Canada’s largest urban areas (only its Alberta properties showed signs of stress), he argues.
The analyst maintains his “sector perform” stance on the REIT and his $21 target unit price for it as well, implying an 18.1 per cent return.
Remarking on the third-quarter 2020 results, the analyst notes: “Funds from operations (FFO) per unit were $0.22, in line with us and consensus at $0.22. Net operating income was 0.8 per cent above our estimate; revenues were 1.2 per cent lower, while costs were 4.8 per cent lower than our forecasts.
“Unfurnished suite occupancy declined slightly quarter-over-quarter to 97 per cent from 97.2 per cent, with furnished suites serving as a yield maximization tool—the number of furnished suites has declined to 233 quarter-over-quarter from 239 due to COVID-related weakness in the segment. Furnished suite occupancy for September was 75 per cent, up from June at 65 per cent (versus September 2019 at 92 per cent).
“Average rent for furnished suites declined to $3,460 in the third quarter of 2020 from $3,956 for the second quarter of 2020 and well below the $4,410 for the third quarter of last year.
“With regards to capital expenditure Minto spent $8.7 million during the quarter versus $5.5 million in the third quarter of 2019 equating to 43 per cent of net operating income versus 31 per cent in the same period last year.
“Rent collections continue to be strong and largely at pre-pandemic levels. However, approximately 2.4 per cent of residents were on a deferral plan as of Sept. 30, which is a bit higher than peers.”
European Residential REIT (TSX—ERE.UN)
COVID-19 may have a surprising but lasting impact in the office sector. According to Statistics Canada, almost 40 per cent of Canadian employees have begun working from home amid the pandemic, up from about 10 per cent. Will this trend continue or will employees go back to the office? Either way, since people rely on their homes even more now, REITs in the residential sector remain a safe bet. European Residential REIT operates in an attractive market with solid fundamentals.
Scotiabank analysts give a “sector outperform” recommendation and set a $5 target unit price. Analysts Himanshu Gupta and Cody Unger emphasize: “European is trading at a 17 per cent discount to our net asset value. German residential firms (the closest peer group) are up about 16 per cent year-to-date (versus Euro, down 11 per cent year-to-date) and are trading at approximately 25 times the fiscal 2021 forecast adjusted funds from operations multiple versus Euro at 19.4 times. We believe Canadian investors have not fully appreciated the embedded growth in the Dutch multi-family portfolio.”
Messrs. Gupta and Unger note that for growth investors, “ERE is buying multi-family properties at 3.8 per cent to 4.2 per cent going-in cap rates and financing it with 1.5 per cent to 1.75 per cent cost of debt. Along with wide investment spreads, ERE is able to achieve three per cent to four per cent same-property net operating income growth, making it an attractive investment.
“ERE multi-family portfolio in the Netherlands has performed well during the COVID-19 period. Rent collection has been approximately 100 per cent. Portfolio occupancy has remained high in 98 to 99 per cent range. Rent growth on the liberalized portfolio has remained strong and led to over five per cent year-over-year growth in same-property rents in 2020 so far.
“After a brief pause in acquisitions from February 2020 to August 2020, ERE has completed a couple of acquisitions totalling 46 million Euros at weighted average cap rate of 4.10 per cent. ERE plans to put permanent financing on these acquisitions at an expected interest rate of low-one per cent.”
Granite REIT (TSX—GRT.UN; NYSE—GRP.U)
Scotiabank analyst Himanshu Gupta says Granite is the only REIT to collect 100 per cent of second- and third-quarter 2020 rents, all while declaring a distribution increase, amid COVID.
Mr. Gupta says full collection speaks to the strength of Granite’s tenant base and a distribution increase speaks to the confidence in the underlying cash flows.
The company’s net debt and assets is at 23 per cent of cash flow and net debt and earnings before interest, taxes, depreciation and amortization (EBITDA) is at 4.6 times as of the third quarter. This is the lowest leverage within the Canadian-listed REIT sector, according to the analyst.
Granite has around $540 million of cash in hand and a roughly $500-million undrawn credit facility. The company has closed $125 million worth of acquisitions in 2020’s fourth quarter so far and lined up an incremental $925 million in 2021 and $750 million in 2022. “In our model, we have assumed leverage remains at 28 per cent levels in 2021 and 2022,” says Mr. Gupta.
Moreover, the analyst says Magna International Inc. (a major tenant) exposure could reduce to 31 per cent by 2021-end and 27 per cent by 2022-end, but stresses that holding an investment-grade, well-capitalized covenant from Magna in these volatile times has proven beneficial. “We note Granite’s same-property net operating income growth has been increased by 4.2 per cent in 2020 so far and we have assumed a three per cent increase in 2021 and 2022, while management has guided for a 2.5 per cent increase to a three per cent increase of growth in 2021,” comments Mr. Gupta.
The analyst notes that the company’s leverage metrics are at par with US industrial names, but trading at 19.3 times 2021 adjusted funds from operations multiple versus 32.2 times average for US names. “We recognize that 20 per cent of Granite’s portfolio are Specialized Properties which are likely to reduce to 17 per cent by end of 2021 and 15 per cent by end of 2022,” says Mr. Gupta. The analyst maintains his “sector perform” recommendation while increasing his target unit price to $87 from $82.
This is an edited version of an article that was originally published for subscribers in the December 4, 2020, 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.
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