NARRATOR: Welcome to Viewpoint, a TD Securities podcast. Listen in as we draw perspectives from a variety of thought leaders on key themes influencing markets, industries, and the global economy today. We hope you enjoy this episode.
AMY VAN ARNHEM: Hello, and welcome to episode 24 of Viewpoint, a TD Securities podcast. My name is Amy Van Arnhem, and I will be your host for today's episode. I'm joined by my colleague, Sam Damiani.
Sam is a top-ranked analyst in real estate who's been with TD Securities since 2000. Can you believe that? With real estate remaining a trending hot topic, we are joined by Sam to speak to some of the key themes and trends in the real estate sector. Sam, thank you so much for joining me today.
SAM DAMIANI: Pleasure, Amy. Thank you for having me.
AMY VAN ARNHEM: So Sam, maybe to start off with, could you tell the listeners sort of what your coverage universe is across the real estate sector? And what are some of the key factors that you would consider when looking at an investment in the real estate sector from a public markets perspective?
SAM DAMIANI: My team and I cover about three dozen REITs-- mostly REITs, some of them are corporations-- in the real estate space. And the unique thing about the REIT space is they do offer high cash dividend yields. So within the overall TSX, you are getting a relatively high cash yield today, which is attractive.
The other thing about REITs is it's a specific type of investment vehicle that offers a pass-through benefit from a tax perspective. So for individual investors that might be at a high tax rate personally, or even, obviously, some of our institutional clients, there are advantages of owning REITs. Similar to the way a private investor would own the real estate, you get certain tax deductions.
So those cash distributions, many of them offer enhanced tax advantages. So the less portion of the distribution is actually taxed. So that's a unique thing about the REIT space compared to many other sort of income-oriented sectors of the TSX.
When we look at our coverage today, it's a real kind of a crazy time because there's a dichotomy. There's three sectors, which are shopping centers, apartments, and industrial warehouse real estate. So those three sectors actually represent 80% of our coverage universe, 80% of the REIT index.
And those three sectors today are enjoying the strongest leasing fundamentals in 10, 20, even 30 years. I just met with one of the CEOs of a shopping center earlier this week, and he said this is the best leasing in our shopping centers that I've seen in over 30 years. So this is a really strong time, in terms of demand for space.
The other thing about the sector is that it's a liquid way for investors to access this type of an asset class. Traditionally, income-producing real estate has been the purview of wealthy families or just pension funds, life insurance companies and the like. The REIT structure was basically created about 25, 30 years ago to enable public market investors to access that type of an asset class in the same way that an institutional investor would. So it's a unique and, we think, an attractive way for many investors.
Today, as I say, they are trading at excessive discounts. We have the average NAV discount today-- NAV, net asset value discount-- at about 25%. And that's near an historic high. And the reason for that, one of the main reasons for that is the high interest rate environment we're in today.
Individual investors are able today, thanks to the inverted yield curve, to get a 5%-ish yield on their GICs. We haven't seen that in-- I don't know how many years, but a long time. That has made the yield appeal of the REIT sector less attractive. So it's more competitive. So that has pulled a lot of funds out of the REIT sector and caused a lot of investors to sell down the REIT exposure, pushing that money into other things like GICs.
As a matter of fact, we track one measure of GIC fund flows. The Bank of Canada published this. And the total amount of money invested in term deposits, which includes GICs, is up by $200 billion over the last 14 months. And you can just imagine any small portion of that that would have come out of the REIT sector would have a sizable impact on valuation.
And that's what we're seeing across, I think, the REIT sector and some other yield-oriented sectors on the TSX. That is a challenge, but what we do say to investors today, yes, that is an unfortunate situation, but across our coverage universe, because of the depressed valuations, you're actually getting a 5% or higher yield on about 2/3 of our coverage universe today. So you're getting a comparable or better yield than a GIC, with the added benefit of potentially participating in some valuation upside, hopefully in the near term, but who knows when.
AMY VAN ARNHEM: Well, I mean, I can see how that would definitely be challenging to wrap your mind around, because with that growth also is, obviously, it's risk, right? So it's not--
SAM DAMIANI: Exactly.
AMY VAN ARNHEM: Yeah. So it could go down, too.
SAM DAMIANI: It just has.
AMY VAN ARNHEM: Yeah.
SAM DAMIANI: We're down a lot.
AMY VAN ARNHEM: Yeah. So yeah, that's a really great overview of all the things you're considering today. And I think what I wanted to do was just dive a little bit into each of the sectors that you've talked about and really understand some of the key trends that we're starting to see.
To start off with, I think a topic near and dear-- you know, every client I go in and see, we're always talking about return to office, work from home, hybrid, you know, how many days a week are you in. Have companies been able to sell some real estate, or maybe not renew leases? So maybe we can start there and talk a little bit about the office sector. What have you seen in the trends and what you're observing, and what do you think the future is for the office REIT sector?
SAM DAMIANI: This return to office and remote working thing has obviously lasted a lot longer than many people expect. It's certainly a lot longer than we anticipated three years ago. It is improving. The challenge is the office property sector is facing-- it's well-known and well-documented, and it's been a challenge.
That being said, there are some improving trends going on. The actual sort of physical census of people in the downtown cores has been steadily increasing, generally across the board, including here in Toronto. Today, Toronto is averaging about 50% of pre-pandemic sort of census population, census occupancy in the downtown core. And that's up nicely year-to-date. I can't remember what it started the year, around 35% maybe. But it has been steadily improving.
And the other thing that's happening is that nobody's started construction of a new office building in the last three years. Anything that was under construction obviously is being finished and whatnot, but the pace of new supply is quickly dropping off a cliff. So the demand/supply imbalance has been way out of whack the last three years, but it's getting better. We're getting way slower supply growth. The deliveries are slowing to a trickle. It usually takes about three years, sometimes four, to build a new office building.
The other thing that's happening is, with the economic uncertainty, the job market may be a little less certain today for some people. When a manager of a department says I need you guys in three days a week, I think employees are probably more likely to abide by that request today than they might have been a year ago. And so I think that will help the stats that we've been seeing further accelerate in the months ahead.
AMY VAN ARNHEM: And have you seen some of the REITs repurpose office property into residential, into some of the other areas where we might see a bit more demand?
SAM DAMIANI: It is starting to happen. It's not going to be a big thing. It's gotten a lot of attention over the last few months. The city of Calgary is actually subsidizing those types of conversions to the tune of $75 a square foot, which is significant.
And so there's been several successful conversions either completed or underway in the downtown core of Calgary. We haven't seen Toronto do that as of yet. But there's very specific attributes of a building that work for a residential conversion. So we don't see that as being a major trend that's going to move the needle in a big way.
AMY VAN ARNHEM: Maybe moving on, I mean, going back to the comment you made earlier around shopping centers, I really wanted to ask you how the growth in e-commerce and then just other trends that we've seen in commerce in general have impacted the shopping center REITs, and the industrial REITs, for that matter. Talking a little bit more about that and what you've seen, and what you think the future looks like.
SAM DAMIANI: Canada's fortunate to be having very strong population growth. That's well-publicized and documented. The benefit there is the retail square footage per-capita is going down. So there's a demand/supply evolution that's garnering more favor to the owners of the shopping centers.
As a matter of fact, we did a quick calculation over the last five years. The population of Canada has grown at two and a half times the pace of the growth in retail space. So you've got more people shopping at less space, basically. And that helps the retailers make their space more productive. It incentivizes them to want to maybe add stores.
You know, Dollarama, they're opening stores across the street from each other because there's such great demand for what they're selling and a lack of competition because of a lack of available retail space for other retailers to occupy. So where they can grab that location, they're jumping at it and in many cases paying up. So that is a really interesting dynamic.
The other thing that happened was the retail tenant base of a shopping center, a typical shopping center, is arguably the healthiest it's been in about 10 plus years. You think back, you know, 2015 or whatever year it was-- or 2012, I guess-- Zellers shut down. Target announced they were going to buy like 125 locations.
They came into Canada, tried to open up all these stores all at once, and 18 months later, they were all closed. Whatever happened, it didn't work for Target. A couple years later, Sears Canada shuts all their stores. HBC has been shutting a few of their stores--
AMY VAN ARNHEM: Nordstrom recently.
SAM DAMIANI: --every year. Yeah, Nordstrom, which was a bigger shocker. So what we've seen is the department store model is less relevant for consumers. But the good news is we have far fewer department stores today than we have ever had. So we've gone through that washout. And today, HBC is really the last one standing in the traditional department store sector.
So that headwind is probably behind us. We have washed out the weakest retailers, both through the department store turnover earlier in the last 10 years, but also at the beginning of COVID. In 2020, with the shutdowns, even with the government support, a lot of retailers and businesses just couldn't make it. And so you basically, in 2020, you had such an elevated amount of retail failures, bankruptcies, store count reductions, it basically brought forward, I would say, three to four years of store closures in the retail space.
And so in the last two years, people have gone back to in-person shopping. The retailers have realized that they need a mix of a physical and digital presence to maximize their customer acquisition and retention. They need the space. As I just discussed, there's less space available per-capita. And so there's been a race to reengage with the consumer at the physical store level.
At the same time, the turnover is far, far less than it's been. So we've seen like just a rebound in occupancy over the last sort of 24, 36 months, and at almost an unprecedented pace. And so here we are today. Yes, we're going into some sort of economic slowdown, everyone will tell you, but our view is that, within the shopping center space, it will be able to weather this economic slowdown that's coming in a better way than it has in my memory.
AMY VAN ARNHEM: And then maybe touch on a little bit about the e-commerce side. So you did mention that there is that right mix of physical versus e-commerce, but when you think about how much the population in Canada has grown versus the actual physical presence of retail, how has the e-commerce space sort of worked its way into satisfying some of that additional population? And then what do we see from an industrial REIT perspective, where you've got your distribution centers and other sort of key--
SAM DAMIANI: Yeah, like e-commerce--
AMY VAN ARNHEM: [INAUDIBLE]
SAM DAMIANI: --I've got to be clear, I mean, that's still a growth area. And it is eating away at retail sales growth, for sure. But the pace of that, from the numbers I see, it's really basically in line, maybe slightly faster than overall retail sales growth. So it's no longer eating the pie, eating the share of the pie that the physical stores really had in a noticeable way.
E-commerce was accelerating going into the pandemic. And then, of course, it spiked in 2020. It actually came off significantly as stores reopened, as you could imagine. And it's at a level where I'd say there's an equilibrium and it's back to its growth mode again.
Again, these retailers, the ones that were created online, they're opening up stores for the first time. And they have been for the last couple years. So it's still a growth sector. On the shopping center side, both the retailers and the landlords have learned what the reality is, what works. And it's no longer a major challenge for the shopping center sector.
For the industrial warehouse sector, of course, it's been a huge boon for demand heading into the pandemic and then accelerated into the pandemic. But then the demand for space has evolved at additional support from supply chain resilience. Reshoring of manufacturing and distribution, all this kind of stuff has really strengthened the demand for industrial warehouse logistics space within North America or within whatever home country your business is.
So today, we've seen the vacancy rates plummet at a record pace over the last five years. The industrial warehouse development industry, the municipalities clearly have not been able to meet the demand growth that was there over the last five-plus years. That's why the vacancy rates have plummeted. And they've plummeted basically to unsustainably low levels.
So there's still pent-up demand that hasn't been met. And so what that has resulted in is a wall of demand that's still there. Even with a slowing economy, we don't think the vacancy rates are set to go back to anything that worrisome in the industrial space.
We're confident in the rent growth. And we're seeing it this year, despite the inflation in everything else. Rents have grown despite the higher interest rates, which have increased costs for businesses, as well. The rents have continued to grow. It is, in my mind, a uniquely attractive sector within the property business, offering very attractive risk-adjusted returns for investors, and continues to do so today.
AMY VAN ARNHEM: Wow, so, so much to talk about. I think the last sort of area I wanted to talk to you about or focus in on is housing. Housing is a huge hot topic right now, especially with interest rates hitting recent highs. How have you observed the behavior of renters in the apartment segment? And are there other key trends that you're sort of watching to get an indication of what the future holds?
SAM DAMIANI: Absolutely. So housing, obviously, a critical thing for society. What we've seen is, with our population growth and the growth in foreign students, the demand for rental housing has been very, very strong. And similar to what we've seen in the industrial space, there has been an inability on the development industry to meet that demand.
And so vacancy rates, which were already low going into the pandemic, have stayed low and gotten a little lower. But what's really changed is the rent. We're starting to see anecdotes of three people in a two-bedroom apartment, four people in a three-bedroom apartment, for example, because there's just very little available.
So the rents have really, really spiked. It's caused turnover to slow to a trickle. Like if 15 years ago in Toronto you might have seen 25% turnover in a typical apartment building, today it's like 10% to 12%. So people are staying in their units because, as you know, the rent control environment in the city of Toronto, for older buildings anyways, is that the rent can't be increased more than the guideline. And that is capped at 2 and 1/2%.
So if you have a rent today that you signed, a lease signed maybe five years ago, it's an asset. And you're reluctant to move. And that's actually a problem for the economy, because if the talent can't relocate to where the jobs are, that hurts the economy's productivity. It's been a bubbling issue in recent years.
I think now, and as we've seen earlier this month with the federal government's offering a rebate of GST and some provinces, in turn, offering a rebate of the PST for the total HST on the construction of new apartment buildings, that's the government's showing that they actually need to do something on this file, the housing file. So we're now, I think, hopefully on the cusp of an increased amount of development to meet the demand that's there as a result of our strong immigration and foreign student growth.
So it's a market that we'd almost characterize as unhealthy. I would even call it a broken market because people can't afford the space. They can't afford to rent the units that are there, and the developers can't afford to build new units. So that's kind of a broken market. But we're seeing signs now of ways to fix it and government's getting involved in ways to enable those repairs to happen.
AMY VAN ARNHEM: Well, Sam, thank you so much for coming in today. I think the reason the REIT sector is so interesting and why you probably have been doing it for as long as you've been doing it is that you really are looking at multiple sectors and really trying to get a feel for what's happening around the economy. And thanks for coming in and joining us today and talking about the sector.
SAM DAMIANI: It's my pleasure, Amy. Thank you so much, and just really appreciate the opportunity.
AMY VAN ARNHEM: Great. Thanks.
SAM DAMIANI: Thank you.
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