The coronavirus pandemicdelivered a severe blow to the Real Estate Investment Trust (REIT) sector, which has not recovered to the same extent as the broader Canadian equity market. Year-to-date (Oct. 22) the S&P/TSX Composite index has returned -4.6%, while the benchmark S&P/TSX Capped REIT Index has returned -25.5%, and the discount to net asset value (NAV) has widened to about 15%.
With millions of Canadians working from home, there is much talk about deserted downtown areas and empty office towers, and accompanying rising numbers of failed retailers and vacancies in many shopping malls. Yet Lee Goldman, who oversees the $539.7 million CI First Asset Canadian REIT ETF (RIT) is optimistic because some sub-sectors have the resilience to overcome the current challenges, while others have benefitted.
He argues that selectivity is critical to getting through the current rough patch. That approach has paid off since year-to-date (Oct. 22) RIT has had relatively lower losses and returned -14.4%. Over three and five years, RIT has averaged 3.9% and 6.8%, compared to the Real Estate Equity category which has averaged 2.2% and 3%. Currently, RIT has a running yield of 5.2%.
Office Space Could Come Up Trumps
“Overall we remain very hopeful on the real estate sector. But there are definitely some winners and losers. COVID-19 has accelerated a lot of the trends that we saw pre-COVID. For instance, the office sector was doing very well across all of Canada, except for Alberta, due to the downward spiral of oil prices and oversupply. But everywhere else was very strong. Toronto and Vancouver each had vacancies around 2%, and Montreal 7%,” says Goldman, a 30-year industry veteran and senior portfolio manager at Toronto-based Signature Global Asset Management, a unit of CI Investments Inc.
Since then Toronto’s office vacancy rate has risen to 4.7%, in the third quarter, according to CBRE. “That’s a big jump, and it’s due to new space coming on the market and rising sub-lets,” says Goldman. “There is a lot of debate about office space going forward. A lot of people are working from home, most people somewhat successfully. People are wondering whether this trend will continue. Will people go back to the office? And if they do, is there going to be a requirement for more space?”
COVID-19 may have a surprising but lasting impact in the office sector. Although the trend in the past few years has been to squeeze more people into smaller spaces Goldman believes this will be reversed, which should somewhat offset the numbers of those who may not go back to the office.
“Without a doubt, there will be more people working from home, or on a temporary or a flexible schedule. But more space will be required for employees. Overall, and longer-term, COVID-19 could be potentially positive for office space,” says Goldman. “But that’s not what has been priced into some stocks. It’s overdone, the way some stocks are trading.”
By way of example, Goldman points to Allied Properties REIT, one of the office supplier holdings in RIT. It used to trade at a 10% premium to its NAV. It now trades at a 25% discount. Similarly, a favourite DREAM Office REIT has seen its share price drop to $20, from $35. “The REIT has bounced back, but has certainly underperformed its Canadian counterparts,” says Goldman. “It has lagged this year, although there is a good chance to catch up to the rest of the industrial space. It has about 96% occupancy, and given the strong fundamentals it could increase that rate. And it has a really strong balance sheet.” The REIT is trading at about a 6% discount to NAV and has a yield of about 6%.
The Five Buckets
Goldman breaks down the REIT space into five so-called buckets: office, retail, residential, industrial and seniors housing. “Retail has been very weak with many stores closing. On the other hand, the industrial sector has been very resilient and is perhaps even stronger now. With the increase in e-commerce, there has been incremental demand for industrial space,” says Goldman. “In many cases, stocks have rebounded and now reached all-time highs since last February. One of our holdings, Granite REIT, has seen its price fall from $75 down to $45, and is now up to $78.”
From a strategic viewpoint, Goldman has long focused on sectors that would do well, regardless of economic conditions. The single largest portion, or 36%, is in residential, which includes 5% in single-family rentals and 3% in so-called manufactured homes. There is also 20% is held in industrials, 16% in retail (most of which are shopping centres anchored by a supermarket), plus about 7% in offices, 6.6% operating companies, 6.6% diversified firms, and 6.5% cash. On a geographic basis, 90% of the fund is in Canadian-listed holdings and 10% in the U.S.
Running a portfolio with 35 names, Goldman likes companies that have management with a strong track record, well-located assets with high barriers to entry by competitors, good growth prospects, balance sheet strength and attractive valuations. One favorite name is European Residential, which he believes is more discounted than it should be. The firm, which was spun out of Canadian Apartment REIT, is focused almost exclusively on apartments in the Netherlands.
The REIT, which has 5600 suites, is trading at a 10% discount to NAV and yields about 3.9%. “It’s a very attractive market with solid fundamentals. ERE can be a consolidator and put in more professional management to really improve the margins on apartment buildings.”
Future Trends
Going forward, Goldman argues that two catalysts will drive real estate stocks upward again. First, the emergence of a vaccine will boost investor confidence. The second catalyst will be merger and acquisition activity. “Lots of money has been raised in real estate funds in the past few years. Last year was particularly active. A lot of money is sitting on the side-lines waiting for deals,” says Goldman.
That development is already reflected in a $300 million investment in Tricon Residential, a multi-family housing firm, by Blackstone Real Estate Income Trust. “People may say, ‘If Blackstone is willing to put money in, maybe we should too.’ The stock had a strong rebound based on that news.”
