Market Call: Andrew Moffs' outlook on Real Estate Stocks

Here's a comprehensive summary of the YouTube video transcript:

Key Concepts

• REITs (Real Estate Investment Trusts): Companies that own, operate, or finance income-generating real estate.
• Net Asset Value (NAV): The market value of a company's assets minus its liabilities. REITs trading at a discount to NAV are considered undervalued.
• Supply and Demand Fundamentals: The balance between the availability of properties and the demand for them, which influences rental rates and occupancy.
• Inflation Hedge: Real estate's ability to maintain its value or increase in value during periods of inflation.
• Replacement Cost: The cost to build a new property of similar type and quality. Rising replacement costs can support existing property values.
• Nearshoring/Onshoring: The trend of bringing manufacturing and supply chains closer to home, increasing demand for industrial and warehouse space.
• Rent Control: Government regulations that limit the amount landlords can increase rent, impacting profitability.
• Prologis: A global leader in logistics real estate, often used as a benchmark for industrial REITs.
• M&A (Mergers and Acquisitions): Opportunities for companies to buy or merge with other companies, often arising during market dislocations.
• Private Market Value vs. Publicly Traded Price: The discrepancy between the estimated value of real estate in the private market and the stock prices of publicly traded REITs.
• Defensive Asset Classes: Real estate sectors that tend to perform well regardless of economic conditions, such as grocery-anchored retail and healthcare.
• Internal Growth Rates: The increase in net operating income (NOI) from existing properties, excluding acquisitions or dispositions.
• Same Property Net Operating Income (NOI) Growth: A measure of the change in NOI from a consistent set of properties over a period.
• Payout Ratio: The proportion of a company's earnings paid out as dividends. A high payout ratio can indicate sustainability concerns.
• Leverage: The use of debt to finance assets. High leverage can amplify returns but also increase risk.
• EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization): A measure of a company's operating performance.
• 1031 Exchange: A U.S. tax provision allowing investors to defer capital gains taxes by reinvesting in like-kind property.
• CAGR (Compound Annual Growth Rate): The average annual growth rate of an investment over a specified period.

Real Estate Stocks: Opportunity Amidst Market Rotation

Andrew Moffs, Senior Vice President and Portfolio Manager at Vision Capital, discusses the current landscape for real estate investment trusts (REITs). He notes that while REITs underperformed the broader market in the US and Canada over the past five years, this is an unwarranted situation. Moffs believes there's a significant opportunity in public real estate markets due to REITs trading at discounts to their Net Asset Value (NAV) and strong underlying fundamentals.

Key Points:

• Underperformance: US REITs have delivered about half the performance of the broader market over the last five years, and Canadian REITs have performed even worse, at about a fifth.
• Opportunity: Moffs sees this as a prime time for investment, with REITs trading at discounts to NAV and solid fundamentals.
• Earnings Growth: REITs experienced 7% earnings growth in the third quarter.
• Supply Side: Falling construction due to three years of high inflation and crackdowns on immigration have led to reduced supply.
• Interest Rates: Stabilizing interest rates are expected to draw investor attention back to real assets, which offer a hedge against inflation and have seen increased replacement costs.
• Historical Parallel: Moffs draws a parallel to the post-tech wreck era 25 years ago, which saw significant M&A opportunities, suggesting similar potential for REITs with ample capital on the sidelines.
• Disconnect: A significant disconnect exists between private market values (NAV) and publicly traded prices of REITs.

Sector-Specific Opportunities and Challenges

Moffs highlights the dispersion within the REIT sector, with different property types and geographies exhibiting distinct supply and demand dynamics.

Industrial REITs:

• Positive Outlook: Moffs is particularly bullish on industrial REITs, citing positive GDP growth and the reorientation of global trade, leading to nearshoring and onshoring of manufacturing in North America. This activity drives demand for warehouses.
• Example: Granite REIT, operating in the industrial warehouse space with facilities in Canada, the US, and Europe, is mentioned. Its largest tenant is Magna. While facing some vacancy in US Midwestern markets due to new supply, Granite has managed this well, and the stock has responded positively as space has been leased. Moffs considers it fairly valued but sees larger discounts elsewhere.

Residential/Apartment REITs:

• Supply Concerns: Moffs expresses caution regarding apartment REITs due to a supply overhang from excessive construction, which needs to be absorbed at a time when the job market is not as strong.
• Example: CAP REIT, a large Canadian landlord, is discussed. Despite its strong reputation, its performance has been impacted by reduced immigration levels and new supply. Moffs notes that two-bedroom rents in the Greater Toronto Area have declined, and incentives are higher than normal. He prefers markets without rent controls and with population growth, such as Alberta and Saskatchewan, over CAP REIT's focus on Ontario.

Self-Storage:

• Demand Drivers: Demand for self-storage is typically linked to housing activity (home sales, population migration).
• Current Challenges: A slowdown in home sales and population migration, particularly in Canada, has led to a decrease in self-storage activity. Rental rates are lower.
• Example: Storage Vault is mentioned. While the company is navigating well, it's in a holding pattern. Moffs believes a significant pickup in home sales volume is needed to fully support the self-storage industry. He clarifies that both renters and homeowners utilize storage, and high housing costs are also leading to less apartment turnover.

Healthcare Property REITs:

• Divergence between Canada and US: Moffs differentiates between Canadian and US healthcare REITs, particularly concerning government-funded nursing homes.
• Canadian Long-Term Care: Moffs favors Canadian long-term care REITs, which are backed by government credit (e.g., the Ontario government). The government effectively pays rent, and operators manage a margin. There's a significant waitlist for long-term care facilities in Ontario.
• US Nursing Homes: Moffs advises avoiding US nursing homes due to "stroke of the pen" risk related to Medicare and Medicaid funding, especially as many states face tax base pressures. Vision Capital actively shorts US healthcare stocks.
• Focus: Vision Capital is more focused on Canadian healthcare REITs for their better valuation and defensive cash flow characteristics.

Grocery-Anchored Shopping Centers:

• Defensive and Growth: Moffs identifies grocery-anchored shopping centers as a favorite, defensive asset class with growth potential.
• Example: Crombie REIT is highly regarded. Its primary tenant is Empire (Sobeys). Crombie owns grocery-anchored centers across Canada, which are necessity-based and recession-resistant. Despite potential concerns about owning centers in secondary markets (e.g., Maritimes), Crombie generates compelling internal growth. Moffs notes it trades at a discount to NAV with a compelling distribution yield and internal growth, complemented by development and redevelopment efforts.

Cold Storage:

• Infrastructure Backbone: Americold is a key player in refrigerated warehousing, forming a crucial part of the food supply chain.
• Current Challenges: The stock has suffered due to reduced grocery basket sizes (less waste, shift away from fresh food) and new supply. This has led to a loss of pricing power and low occupancy.
• Outlook: Moffs believes the stock is near a bottom and looks cheap on an NAV basis. However, it comes with risk, and calling the trough in fundamentals is difficult.

Automotive Properties REIT:

• Business Model: Owns automotive dealerships, operating in the net lease space with long-term leases to high-credit tenants.
• Governance Concerns: Moffs acknowledges concerns regarding governance, specifically the controlling shareholder (Dalawaii family) and the potential for independent directors to not be truly independent.
• Tenant Concentration: A significant concentration (48% of NOI) with one tenant is a risk.
• Diversification Efforts: The REIT is in its first year of diversifying away from its large tenant and pursuing third-party acquisitions of other dealerships.
• Yield: Offers an attractive distribution yield (over 7%).
• Market: The market for auto dealerships is vibrant in the US due to 1031 exchanges.

Retail REITs (Canadian Tire REIT & SmartCentres REIT):

• Stability: Both Canadian Tire REIT and SmartCentres REIT are considered stable due to their tenant bases (Canadian Tire and Walmart, respectively).
• Low Growth: They offer very low internal growth rates.
• Dividends: Both pay good dividends, with SmartCentres' payout ratio hovering around 100%, raising some questions about its stability. Canadian Tire REIT's distribution stability is not in question.
• Total Return: Investors should not expect significant total returns beyond the dividend yield.

CT REIT: Owns Canadian Tire assets.

SmartCentres REIT: Owns and manages Walmart-anchored retail centers with a large development portfolio.

Past Picks Performance and Current Views

Moffs reviews his past picks from January 30th of the current year:

• First Capital REIT (FCR.UN):

  • Performance: Up 17.4% since January 30th, with a total return of 21%.
  • Current View: Moffs still likes it, calling it the highest quality urban portfolio with necessity-based tenants. He believes there's more upside, with a target price of $22.50 (implying a 13% discount to NAV).
  • Fundamentals: Operates at over 97% occupancy, sees double-digit rent renewals, and has internal growth rates over 5%. Offers a 4.6% distribution yield.
  • Mixed-Use: Defined as a combination of retail, office, or residential in a single development.

• Dream Industrial REIT (DIR.UN):

  • Performance: Up 3% since January 30th, with a total return of 8%.
  • Current View: Moffs still sees significant upside, with a target price of $16.50 (a 26% discount to NAV).
  • Portfolio: Properties in Canada (Toronto, Montreal, Western Canada) and Europe (Germany, Netherlands), with US partnerships and a privatized Summit Industrial REIT venture.
  • Strategy: Focuses on smaller bay industrial properties closer to urban centers, crucial for last-mile delivery.
  • Customers: Includes Amazon and third-party logistics companies.
  • Dividend Yield: 5.7%.

• Sienna Senior Living (SIA):

  • Performance: Up 32% since January 30th, with a total return of 37%.
  • Current View: Moffs remains positive, highlighting strong fundamentals.
  • Segments: Operates in both long-term care and retirement homes (about 50/50).
  • Catalysts: Recovery of retirement fundamentals, achieving 95% occupancy rates ahead of schedule, leading to margin expansion. Redevelopment of older long-term care homes and acquisitions are also positive.
  • Outlook: Expects continued property NOI growth and margin expansion through 2026.

New Picks and Recommendations

Moffs shares his current top picks:

• Digital Core REIT (DCR.U - trades on Singapore Stock Exchange):

  • Focus: Data centers in key global markets (Northern Virginia, Frankfurt, Silicon Valley, Osaka, Toronto, LA).
  • Opportunity: Trades at a 35% discount to NAV, offering a 7.4% distribution yield. Moffs sees this as a unique arbitrage opportunity due to a tenant expiry in Northern Virginia, which he believes will lead to substantial rent increases that Singaporean investors may not fully appreciate.
  • Market: High-quality, stabilized data centers in power-constrained markets.

• GO Residential REIT (GO.UN - trades on TSX):

  • Focus: Ultra-luxury apartments in Manhattan, US.
  • Opportunity: Recently IPO'd but has not traded well. Moffs believes Canadian investors may not fully appreciate the quality of assets. Trades at a wide discount to NAV.
  • Fundamentals: Manhattan has 1% vacancy rates and compelling rent growth, unlike other US multifamily markets facing new supply. The majority of units are non-rent controlled.
  • Growth Story: Compelling growth story due to mark-to-market opportunities in rents.

• Chartwell Retirement REIT (CSH.UN):

  • Focus: Senior living facilities.
  • Fundamentals: Strong demographic tailwinds (over 4% CAGR in the over-80 population for the next two decades), limited new supply (less than 1%), market-leading occupancy (over 95%), allowing for rent pushes over 4%. Expenses are growing at less than 4%, leading to margin improvement.
  • Outlook: Moffs sees significant upside and good capital allocation.

Specific REIT Discussions and Opinions

• Slate Grocery REIT (SGR.UN):

  • Focus: Mid-size US grocery-anchored shopping centers in secondary markets and the Sun Belt.
  • Concerns: While the distribution yield (7.98%) is attractive, Moffs states it's not covered by earnings and is unsustainable. High debt levels are rolling over to higher costs, creating earnings headwinds.
  • Recommendation: Moffs suggests InvenTrust Properties (IBT) on the NYSE as a better alternative for US dollar investment in grocery shopping centers, citing a better quality portfolio, balance sheet, and sustainable dividend.

• Northwest Healthcare Property REIT (NWH.UN):

  • Focus: Medical facilities in Canada, US, Brazil, UK, Australia, and New Zealand.
  • Turnaround Story: The company grew too fast with too much leverage. A new executive team is in place, and the focus is on selling international assets to refocus on Canadian and US medical facilities.
  • Outlook: It's a "show me" story. Moffs is unsure about the distribution or earnings trajectory but notes the enterprise has stabilized. It's for investors with higher risk tolerance.

• Dream Unlimited (DRM):

  • Focus: External asset manager of Dream Industrial REIT, also involved in land development (communities in Alberta/Saskatchewan, GTA, Ottawa) and purpose-built rentals.
  • Structure: A corporation, not a REIT, with two distinct businesses: asset management and land development.
  • Valuation: Perennially trades at a wide discount to NAV. The land business, particularly condos, is currently impaired.
  • Outlook: Considered a good store of value for the long term. Moffs prefers investing in entities controlled by Dream Unlimited, such as Dream Industrial REIT.

• Mainstreet Equity (MEQ):

  • Focus: Apartments in select Canadian markets (Edmonton, Calgary, Abbotsford, Surrey, Saskatoon, Regina).
  • Strengths: Benefits from non-rent-controlled markets, compelling demographics, and interprovincial migration.
  • Structure: Not a REIT, allowing for growth without dilutive equity or paying out all cash flow. Moffs trusts them to reinvest capital effectively.
  • Liquidity: Moffs acknowledges the stock's illiquidity but sees pullbacks as great entry points for this "long-term compounder."

• Nexus REIT (NXR.UN):

  • Focus: Industrial properties primarily in Ontario, Quebec, Saskatchewan, and Alberta.
  • Concerns: Lower growth rates compared to other industrial investments (same property NOI growth less than 3%). Guidance has been lowered due to lease-up timing. Higher leverage (debt to EBITDA) and a high payout ratio (100%) are also concerns.
  • Outlook: Moffs believes there are better opportunities in industrial with higher growth rates.

• Allied Properties REIT (AP.UN):

  • Focus: Office properties.
  • Challenges: Facing significant headwinds in the office sector due to work-from-home trends. The company has missed occupancy and leverage reduction goals and is unlikely to meet them until 2027.
  • Distribution Cut: Moffs anticipates a distribution cut in the coming weeks, advising against owning REITs facing such cuts. The 13% distribution yield is unsustainable.
  • Skepticism: The market is skeptical about Allied's ability to sell a Vancouver building and receive a large loan repayment from West Bank, as well as the completion of condos in Toronto, which would inject capital to pay down debt.
  • Outlook: While the office portfolio is high quality, Moffs believes it's too early to invest, and he will remain on the sidelines until after a distribution cut.

• BSR Real Estate Investment Trust (BSR):

  • Focus: Multifamily apartments in the US Sun Belt (Dallas, Austin, Houston, Oklahoma City).
  • Challenges: Navigating a difficult operating environment with significant new supply impacting pricing power.
  • Strengths: Moffs believes they have managed well through this period. A recent transaction involved selling 30% of the portfolio to AvalonBay.
  • Outlook: Trades at a discount to NAV with a safe distribution yield. Moffs expects a return of positive operating fundamentals for US apartments in the Sun Belt by 2027.

Conclusion

Andrew Moffs emphasizes that despite recent underperformance, the public real estate market, particularly REITs, presents significant opportunities. He advocates for a sector-specific approach, favoring industrial, grocery-anchored retail, and senior housing due to their strong fundamentals and defensive characteristics. He advises caution on sectors facing oversupply or regulatory risks, such as certain segments of the US healthcare market and Canadian multi-family properties with rent controls. Moffs highlights the importance of looking for companies trading at discounts to NAV with sustainable cash flows and growth potential.