Anybody who’s been watching the impact of higher interest rates on home prices might be wary of real estate as a whole right now. But real estate investment trusts (REITs) actually pose an opportunity in the eyes of Nicola Wealth’s Public Assets team. As of March 7, 2023, REITs make up more than 7% of the Nicola U.S. Equity Income Fund, compared to a 2.6% weighting in the benchmark, the S&P 500.
“Coming out of a recession, REITs are historically the second-best performing sector (after materials),” explains equity analyst Caleb Ho. In the event of an economic recession this year, the Public Assets team views it as being mild due to a strong labor market and healthier consumer balance sheets. Moreover, they believe that interest rates will stay higher for longer this year but should moderate in 2024 due to lower economic growth and inflation deceleration. Nonetheless, given the correction in REIT valuations over the past year, Ho says “current entry points are pretty attractive.”
As usual, though, they are being meticulous with security selections. To them, four sub-sectors stand out for their potential to add value to clients’ portfolios: industrial, multi-family residential, manufactured housing and self-storage.
In the industrial space, they like Prologis Inc. (PLD), a REIT that saw a big pullback last year due to its association with Amazon and other formerly fast-growing ecommerce operations that announced they were reducing footprint of their distribution centres. “The company has a well diversified customer base globally,” Ho says. Amazon only represents approximately 5% of its rent, and rent growth has been significant, while occupancy stands at 98%.
In rental apartments, their favourite REIT is Camden Property Trust (CPT). Geographically, it’s skewed to the Sunbelt, which saw net in-migration as a result of the COVID-19 pandemic and has a more balanced, recession-resilient employment base than the West Coast (which is more dependent on technology). The region is also relatively free of regulation and rent controls. “We look for scale and more importantly local scale, and this is where Camden dominates,” Ho says. It has a meaningful presence in each of the markets it operates, meaning it has the strength to buy, sell and develop properties efficiently.
CubeSmart (CUBE) appealed to them in the self-storage niche due to its conservative management and focus on quality self-storage locations. CubeSmart locations exhibit favorable characteristics such as having the highest household density within a 5-mile drive and also having one of the highest household income demographics relative to its self-storage public peers. A significant contributor to the company’s net operating income is the New York City MSA which is very densely populated and largely services apartment dwellers, who move nearly four times as often as detached homeowners, and hence have a greater need for storage. “The threat of rising interest rates does not really impact the company’s financials as close to 98% of its debt is locked-in at a weighted average coupon of 3% with no major maturities until 2025,” notes portfolio manager Sean Oye.
Lastly, their manufactured housing pick is Sun Communities Inc. (SUI), an owner of manufactured home parks, recreational vehicle resorts and marinas. It currently trades at a 25% discount to its peer Equity Lifestyles Property Inc. (ELS), but still offers various recession-resilient characteristics.
The team is steering clear of other subsectors of the expansive REIT universe such as retail or office, where it sees either specific headwinds, valuation disconnects, or thematic overlaps with their other positions. They are confident these holdings will outperform in the foreseeable future.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. This investment is intended for tax residents of Canada who are accredited investors. Residency restrictions apply. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. All investments contain risk and may gain or lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth Management Ltd. (Nicola Wealth) is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions.
