Investing in listed real estate will now become even more difficult as one of Canada’s largest mall operators is going private.
In a $9.4 billion deal, including debt, Toronto-based First Capital Real Estate Investment Trust, a retail landlord with about 136 shopping centers in urban areas, will be sold to privately held KingSett Capital and Choice Properties REIT. The couple plans to split the portfolio.
It’s the latest REIT acquisition in a sector where stock prices have taken a hit since the pandemic and private companies often purchase assets at a discount. In this case, Canada’s largest REIT,
Selection properties
which is controlled by the Weston family, is involved in the deal.
The offer of $24.40 per share is a 17 percent premium to First Capital’s 20-day volume-weighted average price and an eight percent premium to the REIT’s net asset value of $22.57 per share. But for context, consider that the REIT was trading at nearly $22 before the pandemic.
One of the ongoing themes in real estate post-pandemic is that private assets have been trading at higher prices than their public counterparts, and many are arguing about this gap and who is right.
If you were an investor, you would have wondered how much you should hold in tepid real estate holdings, given a five-year total return of just over 2 percent based on something like the iShares S&P/TSX Capped REIT Index ETF.
That’s just ugly when the entire TSX Composite is up more than 75 percent in the same period.
But you can make money with REITs. Just ask Jeffrey Olin, president and CEO of Vision Capital Corp., which owns a large stake in First Capital.
“The bigger picture is that the difference between real estate and any other asset class is that the size of the private real estate market is much larger than the $2 trillion publicly traded REIT sector in North America, and there is an arbitrage between the two.” Olin said. “We don’t want to compete with a Blackstone or a Brookfield, we’d rather sell to them.”
In the 18 years his fund has been buying REITs, 25 of its holdings have now been acquired, and the average premium has been nearly 30 percent.
The list of REITs going private is long, and while retail hasn’t dominated the conversation, residential REITs struggling with low valuations have been the main targets. InterRent has already disappeared from the public market and Ottawa-based Minto Apartment REIT soon will, with private investors backing both moves.
Bank of Nova Scotia analyst Mario Saric issued a note lamenting that “another quality REIT is saying goodbye” but said the First Capital deal was a reason to be overweight the retail trust sector. There are other retail REITs like RioCan and Primaris, but that eliminates one important REIT.
Olin said none of the valuations fit, pointing to a point in the fourth quarter of 2022 when there was a 42 percent delta between public and private REITs in the U.S.
“Did that make any sense?” he said. “It was ridiculous. The question was who was right, and we said both. In some sectors the stock market was right, like the office. In other sectors the market was wrong.”
Olin likes retail space in grocery stores because the anchor tenant across the continent is typically a large chain like Loblaws, and points out that not all REITs are cut from the same mold. “It’s defense space that’s seeing growth,” he said of neighborhood malls that have more need-oriented tenants like grocers.
So what’s next?
“There’s no question the names are dwindling in Canada. But you know it can be cyclical,” Olin said, pointing to Go Residential REIT, which is listed on the Toronto Stock Exchange but holds residential real estate in New York City and began trading last year, as a sign of growth.
Adam Jacobs, head of research in Canada at real estate firm Colliers, said he remembers attending a REIT conference less than two years ago when everyone was complaining that no big deals were happening.
“Now one of the deals is happening every week. I guess the dam has broken,” he said. “There’s an argument that the public REITs are undervalued and inherently worth more when you look at rental growth and asset value, and people are willing to respond to that.”
But like Olin, he says the asset class is important. And grocery retail is something that everyone wants right now.
“This is just a portfolio that is difficult to unwind individually,” said Jacobs, who likened the deal to Blackstone Group’s decision to buy Pure Industrial REIT, a 2018 deal that was based on the premise of rental growth.
“Grocery retail could be at the same point in the cycle,” he said. “Really in demand, there’s not much in development and it’s really hard to buy.”
The research director said that in the private market looking to buy real estate and access to debt, which is crucial to any transaction, a lot of what people call “dry powder” has calmed down and interest rates have stabilized.
“People are now in a position to pull the trigger. The debt component is significant,” Jacobs said.
Carl Gomez, chief economist at Centurion Asset Management, which operates a private investment REIT, said publicly traded REITs will remain a target because of depressed prices.
“They’re trading below their intrinsic value, and this is an opportunity to buy them up, especially the REITs with high-quality, scalable portfolios,” Gomez said. “It’s just a great acquisition target.”
Gomez said REITs are really just real estate packaged as stocks.
“But the problem with the stock market is that it simply doesn’t trade based on stock fundamentals, but rather on noise, rumors and a lot of other things that increase volatility,” he said. “That’s the problem with some REITs right now. I would say the public REIT market has (less desirable) products there too.”
Another problem with the Canadian REIT sector is that it has always been very small compared to the United States
“You just can’t take the same type of sector bets,” Gomez said.
Once First Capital disappears, there will be even less to bet or invest in this sector. But is it the end of the world?
Certified financial planner Jason Heath noted that income trusts were very popular in Canada, with about 260 trading on the stock exchange in 2006. There are only 19 trusts left in the S&P/TSX Income Trust Index, most of which are REITs.
“For most investors, REITs are unlikely to play a significant role in portfolio construction. A good benchmark is that the S&P 500 in the US only has a real estate weighting of 2 percent. The S&P/TSX has even less,” he said.
An even better point is that most of Canadians’ net worth is in real estate, a factor driven by high home ownership rates.
“Adding more properties, particularly Canadian properties, is poor diversification,” Heath said.
So, goodbye to another REIT. For patient investors, getting out at a premium might not be such a bad idea.
• Email: gmarr@postmedia.com