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The recent interest rate cut delivered by the Bank of Canada appears to have done little to lift the outlook for Canadian REITs. Sam Damiani, Director for Equity Research at TD Cowen, speaks with MoneyTalk’s Greg Bonnell about the health of the REITs market and potential opportunities for investors.
Transcript
Greg Bonnell – The Bank of Canada delivered the first rate cut, several more potentially on the horizon. That said, it doesn’t seem to be doing much to help the real estate investment trust. Joining us now with more is Sam Damiani, Director for Equity Research at TD Cowen. And, of course, for full disclosure on the companies covered by TD Cowen, please see the link to the website at the end of this program. Sam, great to have you back on the program.
Sam Damiani – Pleasure to be back. Thank you.
Greg Bonnell – It felt like for some of these rate-sensitive sectors, including the REITs, that one thing that we’re waiting for was a rate cut from our central bank. Well, they got the rate cut. It doesn’t seem to be having much of a reaction. What’s going on with that?
Sam Damiani – Yeah, we were waiting a long time for this day. It finally came, and it really came with a thud. Since I was last on your program, back in February, I think the REIT index was down 7%, 8%. So I wish you hadn’t called me back so soon. Hopefully next time I’m back REITs are up.
But yeah, it’s clear the REIT market is really reliant not just on that first cut, but on visibility of multiple cuts. So the REITs rallied I think, 2% the day of the cut. But they’ve given back double that since then. And it’s all about the visibility and trajectory and the pace of those rate cuts.
But I think also, we look at the BOC. They cut. ECB, they cut. But we’re still waiting for the Fed. And there’s only so wide of a divergence that Canada and the US can go. And so I think the market really needs to see that first Fed cut– will be a catalyst as well.
And then, of course, just visibility on multiple cuts. Because we need that yield curve to come down but, more importantly, get out of inversion and get those money market GIC rates, which were 5% plus, get those down to 3%. And then individual investors would need to go back into higher yielding equities, like REITs, in search of something that offers 5% plus, maybe even 6% plus. But we’re still waiting.
Greg Bonnell – So I find it interesting that you brought in the Fed, too, because I did notice other asset classes that you would expect to have benefited from that First Bank of Canada rate cut did benefit on that day and then the following days. Now I feel like as I look at them, they’re moving with US bond yields and not so much Canadian bond yields, even though they’re Canadian assets.
Sam Damiani – Yeah, they’re Canadian assets. And the vast majority of what our coverage universe owns is north of the border here. The transaction market is actually pretty quiet still. So we need visibility on transactions. We need assets to trade, portfolios to trade. And they are– the pricing of those assets and portfolios is benchmarked off the longer end of the yield curve. But again the longer end of the Canadian yield curve is, to a degree, tethered to the US yield curve as well.
Greg Bonnell – All right. So some interesting things there. And then we’re going to have to wait to see how this year plays out. Apart from the yield sensitivity and what the central banks may or may not get up to for the rest of the year, obviously, when we break down the REITs we can go through the major categories. And each of them has their own, I guess, potential but also their own headwinds. So let’s start with the big one that always dominates in this new reality that we’re living right now in terms of people not coming to work five days a week – the office.
Sam Damiani – Sure. Office is challenging. It’s been challenging now for many years. Honestly, sentiment could be bottoming. I feel like sentiment almost could be turning a little bit more positive, at least temporarily. Talking to management at both Allied Properties (OTC:APYRF) and Dream Office (OTC:DRETF) recently, it just feels like there’s an acceleration of leasing interest, whereas over the last year or two, tenants, users making very– taking a very long time to make decisions. But it just feels like, right now, the momentum has picked up at a level we haven’t seen in perhaps a couple years.
So I don’t know if that’s a permanent turn upward or just a head fake, but it feels like, between that and the valuations of the publicly traded office REITs, of which there’s just a small number, it’s a very small percentage of the overall Canadian REIT sector. But those REITs are, by far, the cheapest on multiples and discounts to NAV. So for someone who’s got a little higher risk tolerance, certainly looks like an opportunity could play out there.
Greg Bonnell – Is one of the problems here too in terms of– we talked about visibility, overall, when it comes to interest rate policy– visibility on just where we’re headed as a workforce. I feel, anecdotally, that the train is busier than it’s been in a long time. Sometimes, I don’t get a seat – makes me grumpy. But at the same time, you’re seeing life return to the cores. But are we unsure about what that actually means longer term?
Sam Damiani – I think so. Listen, I think we’re settling in some new normal. We’re not going to be out of the office five days. We’re not going to be in the office five days a week. But we’re going to be in the office some portion of the week. And it varies by function and company or whatever. But it feels like we’re heading– settling in towards some new normal, which we’re all a hell of a lot closer today than we were 6, 12 months ago.
And one thing we look at is this physical census data for downtown Toronto. And those numbers continue to tick higher every week and at a slower pace. So, again, it feels like we’re getting closer to the new normal, Mayor Chow reportedly asking the banks to bring more employees back to the office. So we’re seeing those kinds of– even the government. The government is trying to pull more people back to the office.
So there’s obviously a desire by decision-makers and leaders to make this happen. And I think it’s just a compromise. We’ve got to fix the commute in downtown Toronto. We’re getting off topic here. But there’s things, there’s issues. But I think we’re reaching an equilibrium. And then, hopefully, over time, some of those commuting issues get resolved, and you start to see more and more people happy and willing to come downtown.
Greg Bonnell – Make my morning commute happier. I’m all for it. All right that’s the office space. What about retail?
Sam Damiani – Retail is doing great. I said this on our last appearance here, but the occupancies, the leasing spreads– so the rents they’re getting on renewal and replacement leasing– those spreads are back to historic highs. And what’s that indicating is that the retailers have rediscovered the need for the physical store. Obviously, the pandemic, you had a surge in online shopping. And then people, with the vaccine and everything reopening, went back to shopping, back to dining, et cetera, et cetera, et cetera.
And then the other major factor over the last couple of years has been population growth. So we look at our population is up 8% since the beginning of the pandemic. And equally importantly, the number of employed people is up 6% since the beginning of the pandemic. So there’s a hell of a lot more people shopping than there were before the pandemic, and there hasn’t been much retail space built.
And so when you look at the retail space per capita, it’s actually been declining considerably. And so there’s a shortage of retail space. And what we’re seeing evidence of– it’s certainly the way I read it– is that some retailers are scrambling. And so they’re putting out announcements like I want to have 300 locations in Canada, like a fast food chain. There’s no way in hell they’re going to get 300 locations in Canada in whatever, three years.
But they want to put that out there and put landlords on notice that hey, if you’ve got a space, call me up. I want your available space.
Greg Bonnell – Right. So interesting on retail population driving a lot of that. So apartments then, naturally, we know we have a shortage of housing in this country.
Sam Damiani – Same thing, yeah. Again, there has been construction in housing, both for sale and for rent, but it hasn’t kept up, as we all know. Occupancies with our coverage universe are at historic highs. The leasing spreads, as well, historic highs. The issue is the turnover has really come down. So with the shortage of a scarce commodity, people are sitting in an apartment maybe for $1,300 a month, and the market rent might be double that. And so they’re just not willing to move.
And so the turnover rates, which might have been 25% annually five years ago, down to 10%, 11%. And so you’re capturing a much higher spread, but you’re on a far fewer percentage of your portfolio. But yeah, it’s a very very tight market. The issue there is affordability. So we’re at a bit of a ceiling in some markets not overall, but in some markets. But yeah that’s a very strong leasing market as well.
Greg Bonnell – I want to end off with industrials. Warehouses, obviously, they were shining stars during the pandemic in e-commerce. What’s going on with them now?
I mean, the momentum has slowed. The vacancy rates are still low. They have come up. The market rent growth has slowed. By some measures, it’s even come off a little bit. But from the landlord’s perspective, if you’ve got an available space and you’re leasing it directly as a landlord, that market rent really hasn’t come off. It’s really just the sublet spaces that have brought the averages down in terms of the market rent surveys.
Momentum has slowed. But we’re looking at a sector that, in our view, does have a long runway of rent growth and asset value growth. Because these buildings take so much land to build, so there really is a barrier to entry. And as interest rates settle down, as the economy finds a groove, finds a base here, we think users are going to pick up leasing activity, and these vacancy rates should come back down in 2025.
And that coincides with a reduction in supply, as well, because not a lot of people have started new construction over the last year with the volatility in interest rates. So next year, we think, is going to be a real resurgence of momentum in the industrial property sector, which– and that is our top sector right now.
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