Yahoo Finance CIBC sours on office REITs, cuts multiple price targets
The analysts say investor sentiment has yet to recover as the future of offices looks "murky"
CIBC analysts are reducing their price targets for Canadian office real estate investment trusts across the board, as investor sentiment on the sector remains low and the impact of remote work takes a toll.
“While it is clear that overall investor sentiment has soured towards the office sub-sector due to a plethora of macroeconomic variables, we would be remiss not to mention that much of the pessimism regarding the Canadian office REITs does indeed stem from declining fundamentals,” Dean Wilkinson, real estate analyst at CIBC Capital Markets and lead author of the note, said on Wednesday.
He lowered his 12-month price target on Allied Properties REIT (AP-UN.TO), Dream Office REIT (D-UN.TO), Slate Office REIT (SOT-UN.TO) and True North Commercial REIT (TNT-UN.TO).
Allied and Dream were also hit with rating downgrades to neutral, from outperformer, bringing them in line with the other two names.
“While it’s clear that the office of the future will not resemble that of the past, what remains to be seen is what the ultimate space requirements will look like,” Wilkinson said.
“Given the long-dated nature of office leases and the erosion of current fundamentals, we envision any form of long-term recovery (or alternate use) will ultimately fall outside of our intermediate forecast period.”
While some firms have settled on a post-pandemic work arrangement, others are still trying to find the right balance between in-office, hybrid and remote work. Last month, Royal Bank of Canada asked its employees to return to the office three or four days per week, while also acknowledging that hybrid work was “here to stay.”
CIBC said the most significant factor in waning office fundamentals is the pandemic-fuelled shift to remote work, with employers under pressure from employees for the ability to work from home at least some of the time. Combined with a possible looming recession, CIBC says the outlook for the office sector is “murky at best.”
A recent report by commercial real estate services firm Colliers Canada said the national office vacancy rate was 13.3 per cent in the first quarter, a slight increase from the prior quarter and significantly higher compared to pre-pandemic times.
With higher vacancy rates, CIBC also notes the increased risk that REIT distributions, a key attraction for yield-hungry investors, could be cut.
Over the past month, Slate Office and True North Commercial slashed their payouts to stabilize their balance sheets in the face of higher interest rates.
"The problem we then run into is heightened interest costs, the aforementioned waning fundamentals, and runaway inflation pushing payout ratios above comfortable levels. While debt maturities may not pose any major issues within our forecast period, it has led us to question the sustainability of certain distributions.” Wilkinson said.
“We are of the belief that the spectre of potential further distribution cuts specific to the Office REITs is palpable and while such cuts are not our base case scenario, we can’t summarily dismiss the possibility whilst having amongst the highest payout ratios in the sector.”
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.
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