In a sudden twist, real estate investment trusts are falling back into investors’ favour, resulting in a rare resurgence of initial public offerings -- all in the face of rising interest rates.
In the past month, two real estate companies decided to test the waters and go public. In early May, BSR REIT completed a US$135-million IPO, and on Wednesday, Minto Apartment REIT filed for its own IPO, hoping to raise around $200-million, according to people familiar with the transaction.
The mere fact that REITs are trying to go public again signals a major shift. These trusts were some of the hottest investment vehicles coming out of the global financial crisis, because they paid fat distributions as bond yields plummeted. But starting in 2013 fears about rising rates, followed by economic shocks from the energy crash in Canada, hurt the sector.
From its peak in May, 2013, to the worst of the oil and gas crisis in January, 2016, the S&P/TSX Capped REIT Index lost 25 per cent of its value. After a torrid run of financings in the first few years following the crisis, there’s been a dearth of real estate IPOs since.
Lately, though, certain classes of Canadian REITs have watched their valuations soar – particularly owners of industrial and multifamily, or apartment, properties. The rebound has convinced issuers to explore IPOs.
The swift reversal in sentiment is rather surprising considering that it is playing out amid expectations of higher interest rates. Should they jump, REIT yields will look less attractive relative to those offered by bonds, something that has hurt dividend-heavy utilities and telecom stocks. Rising bond yields also boost mortgage costs for real estate companies.
However, the fundamentals for the hottest real estate sectors appear to override any rate fears -- particularly for multifamily properties. The national average multifamily vacancy rate is expected to continue hovering around a remarkably low 3 per cent, according to Canada Mortgage and Housing Corp. In Toronto and Vancouver, it currently sits near 1 per cent, with no changes expected in the near term.
“Rising home ownership costs continue to drive demand for comparatively affordable multifamily units and, as supply of this product type continues to lag, cap rates for existing multifamily stock are expected to remain low,” CBRE noted in its latest quarterly report on the Canadian market. Low cap, or capitalization, rates mean property values are incredibly high.
Because so few units are available to rent, major retail REITs such as RioCan and Choice Properties are starting to shift their focus and build their own residential properties, despite the added risks that come with development.
As for fears about investors fleeing for bonds, lately there appears to be an acceptance that a hot economy and strong housing demand changes things. Many multifamily property owners have excess cash that can be used to upgrade their existing buildings, allowing them to charge much higher rents once the renovations are finished.
“We struggle with the notion that somehow a 3-per-cent bond yield with no growth can serve as a viable investment alternative to average REIT yields in excess of around 6 per cent with 3-per-cent-plus earnings growth – which, if multiples were to hold, would imply a return in the 9-per-cent range,” CIBC World Markets analysts wrote in a note to clients last month.
“We fully acknowledge that the current move in rates does tend to have a dampening effect on investor enthusiasm, and at the margin even small moves can impact sentiment and possibly shift invest preferences; however, we also believe that rates would need to increase significantly beyond current (or projected, for that matter) levels to represent a real alternative,” they added.
In the latest IPO, Minto Apartment REIT is looking to raise money to acquire 22 properties predominately located in Ottawa and Toronto from Minto Properties, which is a well-regarded private real estate owner. If the offering is successful, it is expected that Minto Properties will sell more income-producing apartment properties to the REIT over time. Toronto-Dominion Bank and Bank of Montreal are serving as lead underwriters for the IPO.
Tim Kiladze