Although the Canadian economy is expected to slow moderately in 2019, real estate specialist Lee Goldman believes that thanks to the positive underlying fundamentals, real estate investment trusts (REITs) will continue to perform well. He maintains that even with growth slowing elsewhere the sector could outshine others.
“The fundamentals are still relatively strong, although it does depend on the asset class and the geography,” says Goldman, senior vice-president at Toronto-based Signature Global Asset Management, a unit of CI Investments Inc. Goldman is senior portfolio manager of the 5-star $405.6 million First Asset Canadian REIT ETF (RIT). Launched in 2004 as an equal-weighted closed-end fund, it was converted 2007 to an actively-managed closed-end fund and converted again in 2015 to an actively-managed ETF. But Goldman concedes that the broader economy is slowing, partly due to the downward pricing of oil that is expected to hit Western Canada especially hard.
Nevertheless, despite a slowing global economy and concerns about U.S.-China tensions, Goldman argues that our economy can expect about 1.8% growth this year. “That is still decent. Our base case is not a recession scenario, although some people talk about it. We think the economy will be strong enough that most sub-sectors of the REIT sector will be just fine.”
A Toronto native who earned an MBA from York University in 1991, Goldman joined Signature Global in 2018, following the acquisition of First Asset Management. Goldman joined the latter in 2006 after more than a decade at Mackenzie Investments, where he worked on the treasury side and managed a mortgage fund. Goldman shares duties with Kate MacDonald and Josh Varghese, both portfolio managers. The three-person team manages in total about $3 billion in assets, including the $744.8 million Sentry Global REIT Fund.
In Canada, the REIT sector is composed of five main sub-sectors: multi-family, or rental apartments, offices, industrial, retail and seniors residences. Goldman notes that the multi-family area has been the strongest as it has grown disproportionately more than other sectors. “The vacancy rate is 2.4% across the country, an all-time low. Historically, it’s been 3%,” says Goldman. “In specific markets, such as the Greater Toronto Area [GTA], you have seen demand far outstrip supply. We have seen historically large increases in rent, especially the last 18 months. We believe that trend will continue.”
One factor that augurs well for the sector is that the Conservative government in Ontario has removed rent controls on new apartment buildings. “Builders don’t have to be so concerned about making sure that they maximize rents right from the start. They know they will always be able to get market rents [those that are determined by the market]. This will certainly help bring more development on line.” Combined with 300,000 immigrants to Canada each year, which is equivalent to about 100,000 units, demand is exceeding supply. “It will continue to be a very tight rental market for at least a couple of years.”
The industrial sub-sector has also been strong, notes Goldman, and it is mostly led by the rapid growth of e-commerce, in the form of expanding logistics and distribution centers and warehouses. “Most of the industrial space in Canada is in warehousing, not manufacturing. The vacancy rate is 3.3% nationally, compared to about 5% historically,” says Goldman, noting that the vacancy rate in the GTA is below 2%. “There’s been little supply response because land costs have gone up and the approvals process has slowed. Rents have gone up significantly. In the GTA rents were stuck around $5-6 a square foot. Now you’re starting to see $7-8. That will probably go up to $9-10 over the next few years.”
On the office side, there is a mixed picture. Toronto represents the strongest market, with a 3% vacancy rate. Even with 10 million square feet of new office towers coming on stream in the next four years, Goldman believes that it should be absorbed for the most part. Yet the oil industry dependent province of Alberta is struggling and centres such as Calgary have a 27% vacancy rate. It’s hard to see a recovery any time soon, says Goldman, noting that unemployment could only worsen as the impact of the low oil price sinks in. “Traditionally, they have had a lot more square feet per employee. It used to be around 300 square feet, but the trend is drifting downwards to one-third of that. Even if there are no more lay-offs or companies going out of business, they could certainly consolidate a lot of real estate and have a smaller foot-print, if they wanted to. It only makes sense.”
A bottom-up security picker, Goldman has allocated about 26% of the ETF to the multi-family sub-sector, 19% retail, 16% diversified (a mix of office, industrial and retail), 13% industrial, 7% seniors residences, 5% offices and the balance in miscellaneous REITs. Measured on where the assets are located about 70% is in Canadian properties, 25% U.S. and 5% Europe.
Running a portfolio with 37 holdings, Goldman and his co-managers look for five attributes, in no particular order: companies with strong management, high quality assets, balance sheet strength, strong growth prospects and attractive valuations. Goldman focuses on total return, which includes yield and capital appreciation. RIT has a running yield of 5%, before fees.
One top holding in the retail space is First Capital Realty Inc. (FCR), which operates shopping centres in major urban centres such as Toronto, Calgary and Vancouver. “It is best-in-class,” says Goldman, noting the firm is actually not a REIT but a real estate operating company that has 25 million square feet of space. “It has excellent management and growth potential. It plans to add 22 million square feet over the next 10-15 years.” Based on a 4% dividend yield, Goldman believes the stock has total return potential of about 20% in the next 12-18 months.
Within the office sub-sector, Goldman likes Allied Properties REIT (AP.UN) which specializes in converting heritage-type properties into corporate offices. “Their buildings have the advantage of lower operating costs, so even though rents have been going up, it’s generally more affordable for tenants to be in Allied Properties’ buildings than in the downtown office towers.”
The REIT is trading at a premium to its net asset value, yet the valuation is warranted because of the “excellent management and an industry-leading balance sheet,” says Goldman, noting that its debt to assets ratio is below 40%. Based on a 3.5% distribution and 10% upside, Goldman anticipates a total return of about 15% over the next 12-18 months.
Within the multi-family holdings, Goldman favors Canadian Apartment Properties REIT (CAR.UN) the largest apartment owner in Canada with over 50,000 units concentrated in Ontario, Quebec and British Columbia. “They are in the right geographies and really benefit from that. In 2018, it had its strongest growth ever,” says Goldman, adding that REIT had 10% growth in a measure of profitability known as same property net operating income. Goldman sees 12-15% total return potential.
Looking ahead, Goldman argues that market sentiment has grown more cautious compared to a year ago, and that will make REITs look more attractive. “We have a lot of head-winds today and are headed into a slower-growth world,” says Goldman. “If overall growth is slowing down then it makes REITs look relatively better when compared to other sectors.”
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