Canaccord downgrades several REITs on rising rates impact

Canaccord Genuity analysts lowered their recommendations and price targets on several REITs as they assess the impact of rising interest rates on their expected future returns.

Canaccord Genuity Corp. analysts lowered their recommendations and price targets on several real estate investment trusts (REITs) as they assess the impact of rising interest rates on their expected future returns.

The TSX Capped REIT Index posted a return of 0.9 per cent in the first calendar quarter this year, underperforming the broader Canadian market return of 3.8 per cent. It also lagged returns of other yield-oriented sectors.

“We attribute the underperformance of REITs relative to the broad market to rising long-term interest rates, widening credit spreads and outsized returns for the Canadian energy and materials sectors,” Mark Rothschild, an analyst at Canaccord Genuity, wrote in a note to clients on Tuesday.

He pointed out with long-term rates rising, the risk of capitalization rates -- or the estimated return based on property income that is expected to be generated -- will rise as well.

“In general, REITs with a favourable long-term outlook for same-property [net operating income] and cash flow growth trade at higher multiples. However, with long-term interest rates rising, future cash flow growth is now being discounted at a higher rate compared to earlier this year, resulting in lower valuations for a number of ‘higher-growth’ REITs,” he said.

Rothschild reduced his 12-month price target for eight REITs in his coverage universe by an average of 5.5 per cent, including Brookfield Asset Management, Canadian Apartment Properties REIT, Dream Industrial REIT and Granite REIT. The new price targets reflect “our belief that investors will, and should, consider the potential for cap rates to rise and the impact on property values,” he said.