The real estate and REIT sector has been extremely popular among Canadian investors since the financial crisis, not least because they’ve offered competitive cash flow for income-oriented portfolios.
In 2022, however, the S&P/TSX Composite Real Estate Industry Group Index has dropped 20.8 per cent so far. Jenny Ma, an analyst at BMO Capital Markets, recently cut price targets for 13 real estate investment trusts in her 2023 outlook report while warning investors to temper their expectations for the year. Real estate investments may not be so popular by the beginning of 2024.
Ms. Ma entitled her year ahead report Something’s Gotta Give. This refers to a valuation divergence that the analyst believes will be resolved during 2023.
“Our coverage is trading at a weighted average net asset value discount of 11 per cent,” she wrote. “This suggests an attractive entry point when compared to the long-term average discount of 0.9 per cent.” On the other hand, she added, AFFO yield spreads are “well below” the long-term average, and the outlook for earnings growth through 2024 is “relatively muted.”
(AFFO stands for adjusted funds from operations; for yield spreads, Ms. Ma is comparing 10-year government of Canada bonds with BBB-rated corporate bonds.)
The situation is somewhat equivalent to a stock trading cheaply on price-to-book value but prohibitively expensive on price-to-earnings and price-to-cash-flow. By slashing her REITs’ price targets and emphasizing the muted outlook for earnings growth, the analyst is suggesting the valuation divergence will be settled in favour of AFFO yield. In other words, unit prices are unlikely to grow significantly.
The rise in bond yields are the problem for REIT investors. At the beginning of 2019, for instance, the dividend yield of the real estate index was 4.34 per cent, 2.9 percentage points higher than the 10-year bond yield. Now, however, the index’s 3.84 per cent yield is only one percentage point higher than the 10-year bond. The safety of government bond yields is now far more attractive relative to real estate investments.
Ms. Ma’s top investment ideas for 2023 include the relatively defensive residential REIT space with InterRent REIT and Boardwalk REIT. She also likes Crombie REIT and H&R REIT.
— Scott Barlow, Globe and Mail market strategist
This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.
The Rundown
Is the door slowly closing on 5% GICs?
It looks like we reached Peak GIC in early December. Rates on guaranteed investment certificates were at a point then where it was possible to find 5-per-cent returns for terms of one through five years from alternative banks and even some of the big banks. But this week, there was a noticeable retreat on GIC rates, reports Rob Carrick. A 5-per-cent return is still there for the taking, but it’s clear that GIC issuers are starting to pull back from that threshold.
Also see: Canadians are sitting on a growing pile of money in GICs
Nearly everyone thinks bonds will rally next year. Be prepared for a surprise
The current consensus among market players for the year ahead is that there will be a recession and a major bond rally. But more often than not, consensus views end up being wrong. And as veteran fixed income fund manager Tom Czitron tell us, there’s good reason to believe bond bulls may not have such an easy 2023.
No Santa rally for markets as central banks dampen peak rate hopes
Forget a year-end rally in financial markets. You can thank central banks for that, and their loud and clear message this past week that the battle to tame inflation is far from over.
Also see:
Don’t fight the Fed? Someone better remind markets
Bank of Canada’s inflation fight made harder as bond yields fall
For bear stock pickers, 2023 is full of rich pickings
Well-known activist short-selling hedge funds expect to find more companies squeezed by tough economic conditions in 2023, potentially increasing instances where balance-sheet sinkholes are hidden.
Others (for subscribers)
Top stock picks from ARC Independent Research (and those to avoid)
The highest-yielding stocks on the TSX, plus risk data
Number Cruncher: Strategy focuses on U.S. large caps with upward price momentum
Number Cruncher: Best-performing boring funds of 2022
Friday’s analyst upgrades and downgrades
Thursday’s analyst upgrades and downgrades
Friday’s Insider Report: Chair invests in this REIT with a unanimous buy recommendation
Birchcliff Energy CEO buys the pullback
Globe Advisor
Why Canada’s top wealth advisor is avoiding banks and consumer stocks in 2023
Why investors need to understand redemption freezes before getting into alternatives
Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation – a powerful tool to help you manage your clients’’ portfolios.
What’s up in the days ahead
What’s the implication of the Keystone pipeline rupture for TC Energy shareholders? David Berman will share his insight.
World market themes for the week ahead
Click here to see the Globe Investor earnings and economic news calendar.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
Compiled by Globe Investor Staff