HRUFF - Boardwalk: U.S. Residential REITs Are More Compelling

2023-05-31 14:17:30 ET

Summary

• Boardwalk Real Estate Investment Trust had a solid Q1-2023, but has gone sideways since our last article.
• Valuation remains high at this point in the cycle.
• U.S.-side Residential REITs appear far better priced for a recession, and that is where the buy opportunities should surface first.

All values are in CAD unless noted otherwise.

Boardwalk Real Estate Investment Trust ( BEI.UN:CA ) ( BOWFF ) owns and operates multi-family rental communities in Canada. While based predominantly in the province of Alberta (north of Montana), Boardwalk has a decent footprint in the eastern part of the country.

We gave Boardwalk REIT a sell rating in February of this year, despite another dividend hike and consensus-beating Q4 results . We were beginning to see cracks in the foundation (no pun intended) due to inflation and labor shortages. The net operating income, or NOI, was losing the race to the rising interest expenses. Sure, it was trading at a discount to NAV, but that did not automatically make it cheap in our opinion. We expanded on that in the conclusion:

NAV is a small guide post and not the entire map. The cap rates are likely to expand here, especially with the risk-free rates now at 4%. The direction of NAV is very important and we go back to our decade-long flat FFO example. Even NAV is about flat over the last decade.

The REIT is trading at $59.32 as we type this and at 17.7X FFO. The dividend yield despite the recent hike remains extremely small and near 2%. We see more risks than rewards at this point and we are downgrading this to a Sell rating. Our fair value remains about $50-$52 and at the top end of that range is where we would consider upgrading it back to neutral, assuming fundamentals remain unchanged.

Source: Boardwalk: It Is Time To Sell .

Boardwalk REIT stock is more or less flat since then.

Let's review the Q1 results and see if the metrics, unlike the price, are moving in the direction we envisioned back in February.

Boardwalk REIT's Q1 2023

Year-over-year occupancy increased from 95.5% to 98.1%.

That combined with lower incentives on lease renewals (none on new leases), lower vacancy costs and property additions from 2022 resulted in an over 10% increase in net rental revenue for the quarter ended March 31.

Salaries, utilities, and property taxes cumulatively contributed to a 2.6% year-over-year increase in rental expenses. This increase was, however, more than offset by the higher revenue numbers. The REIT came out ahead in all categories when looking at the same quarter in 2022.

If we compare the above with Q4-2022, though, the operating margin was unchanged at 58.1%. The funds from operations ("FFO") and the adjusted funds from operations ("AFFO"), both came in lower than the last quarter of 2022.

The weighted average interest rate for mortgages increased slightly from 2.72% at the end of Q4-2022 to 2.76% at March 31, 2023, with the interest coverage showing a corresponding slight decrease.

At the time of the release of the Q1 report, Boardwalk had locked in the interest rate for $197.6 million of the mortgages maturing in 2023 at an average rate of 4.44%.

On the liquidity front, in addition to the $244 million noted below, Boardwalk can get an additional $96.5 million against its unencumbered assets, which comprise 866 rental suites.

The $340 million in liquidity seems a bit tight when compared to the $389 million in mortgage maturities. Not to worry, though, CMHC has Boardwalk's back.

Despite increasing its monthly distributions from $0.09 to $0.0975 effective March 2023, its payout will still be only around 35% even if it only manages the lower end of its upgraded FFO/unit guidance shown below.

Outlook & Verdict

The rental market in Alberta (Boardwalk's primary market) remains strong, and there are no signs of things easing any time soon. Canada's generous immigration policy, a hot-button topic in political circles, continues to add demand to a tight equation. That said, Boardwalk is not cheap here, running at over 19X FFO and 23X AFFO for 2023. The implied cap rate is close to 4.8%. That might be fine for a 0% interest rate world, but is not exactly appealing where risk-free rates are 4% and quality Canadian preferred shares offer 8% .

We think there is likely to be some repricing here once the recession gets underway. Everyone believes this time is different, but historically you tend to have a tough time holding 20X multiples when things go south. What is particularly interesting here is the relative valuations of the U.S. residential REITs. They are all trading at serious discounts to Boardwalk, thanks to the REIT having delivered a stupendous performance over the last 3 years.

The three we have shown, AvalonBay Communities Inc. ( AVB ), Mid-America Apartment Communities Inc. ( MAA ) and Equity Residential Inc. ( EQR ), all carry far less debt (almost half debt to EBITDA levels). They all trade 3-5X FFO multiples lower as well. So if we are interested in the Residential side of REITs, that is where we would look first. It also bears mentioning that H&R REIT ( HRUFF ) which is trying to realign its portfolio to be just residential and industrial, is trading under 8X FFO .

So, REIT choices are plentiful, and Boardwalk does not meet our criteria. We reiterate our Sell rating on Boardwalk REIT stock and think $50 seems to be where we could pivot.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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