McMurtry Investment Report – June 2024
Also available in PDF: McMurtry Investment Newsletter – June 2024
June 2024 Investment Newsletter
Outlook for REIT Stocks in this Current Economic Environment.
We all know that REITs are one of the most interest sensitive stocks in the economy. Now that interest rates are finally beginning to come down with 25 basis point declines in the Bank of Canada’s and the European Central bank’s rates respectively announced over the last week. The Federal Reserve has been more stubborn about lowering rates, but they do risk materially weakening the economy by waiting too long. We all recall how the Federal Reserve underestimated the growth rate in inflation during the pandemic. At that time, they waited much too long before increasing rates.
Key Factors to Consider for REIT Sector
Lower interest rates are expected both in Canada, Europe and eventually in the US.
Probability of a soft landing with no recession is increasing. While the economy is growing at a slower rate, it is still growing with no recession on the horizon.
Poor recent investment performance of the REIT sector in both Canada and the US relative to the benchmark domestic indices. Investors who have not participated in this sector are being provided a good opportunity for entry. The combination of an improving outlook as a result of lower rates and taking into account the very low REIT equity sector weight of 2.20% and 2.20% in Canada and the US, are encouraging money managers to increase their exposure. This will provide these money managers with an opportunity to outperform their peers.
Total Return %
As you can see from the above table, both Canadian and US Reits have underperformed their domestic indices. Canadian Reits performed much worse than their US counterparts.
This poor performance can be largely attributed to rising interest rates.
Valuation Measures
In regards to valuations, I am using both TTM FFO and FWD EBITDA numbers for my calculations. This is because Projected FFO numbers are not provided, while FWD EBITDA numbers are readily available.
SECTOR TECHNICAL PRICE FACTORS
The two Canadian and US Equal REIT Equal Weight ETFs have recovered somewhat as evidenced by their recent RSI level. However, this sector has been underperforming for a long time and is due for a lengthy period of better performance.
Types of REITS
There are many types of Reits. My two Investment Models have exposure to the following types of Reits.
Residential Reits through Boardwalk, Minto and Inter-Rent
Retirement Homes through Chartwell
Industrial / Logistic Reits through Granite and Prologis
Data Center Reits through Digital Realty and Equinix
Health Infrastructure Reits through Wellness
I have intentionally avoided the Office and Retail Reits as a result of their ongoing issues.
Dividend Payouts on TTM FFO and Leverage Ratio
While US Reits have much lower dividend payouts than their Canadian counterparts, the probability of further interest rates cuts is much higher domestically with our weaker economy.
Valuation Spreads Between Dividend Yields and 10 Year Canada’s and 10-year US Treasury Yields
In the above table, it is interesting to see that Canadian spreads have narrowed sharply, but remain positive. On the other hand, US spreads have narrowed considerably and are currently in negative territory. If one were only to take these spreads into account, this would imply that Canadian Reits are cheaper than their US counterparts when compared to their domestic federal government bond yields.
However, valuation is not the only factor to consider when purchasing Reits. Other equally important factors include low dividend payouts, and projected growth in this year’s EBITDA.
Recommendation
In regards to sector weights, the current Canadian and US weight is 2.2 and 2.2% respectively for the TSX and S&P 500 indices. I am increasing my overweight to 3.25%.
Overall, I continue to like investing in this sector with reasonable valuations and solid growth. In addition, the macro factors like declining interest rates are likely to have a more positive effect over the next year.
In regards to groups within this sector, I continue to like Residential, Industrial, Retirement Homes, Data centers and Health Infrastructure. Lastly, I like both US and Candain Reits and would maintain exposure in both countries.
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