Despite the uncertain economy, Jonathan Gitlin, president and CEO of RioCan, believes that retail landlords like the one he leads are sitting on property that is more expensive to build today.
RioCan, one of Canada's oldest real estate investment trusts, has a defensive portfolio with stable tenants holding 80% of the Toronto-based REIT's 35 million square feet of leasable space.
"The Canadian economy has shown modest growth; however, there is little doubt of pending slowing due to interest rate hikes and elevated inflation," said Gitlin on a conference call with analysts Friday.
Gitlin said replacement costs of well-located retail are above market value and the implied value of RioCan's current retail properties based on unit price is $335 per square foot, compared with the cost to build new retail of $650 per square foot in the Greater Toronto Area.
"The scarcity of quality of retail in areas of strong demographic health further protects our operational health," said Gitlin, adding RioCan doesn't believe new retail construction will dramatically increase.
Nevertheless, a report from CBRE found cap rates are increasing for almost all aspects of the retail world, from regional malls and power centres to neighbourhood malls and urban street fronts.
"The largest quarterly increases in cap rates were recorded in the regional and neighbourhood retail formats," said the real estate company in its report.
The rising interest market is affecting RioCan's plans, and the REIT said it is prepared to adjust the timing of new construction based on market conditions.
RioCan recorded a fair value loss of $122.3 million in the third quarter as the cap rate on its portfolio was four basis higher on a quarter to quarter basis to 5.37%, said Jenny Ma, an analyst with BMO Capital Markets, in a note to investors.
"Investors should be pleased that management reiterated its 2022 funds from operations per unit growth guidance of 5% to 7% with the kicker of management expecting it to come in at the high end," Ma said.
Asset Sales
The REIT continues to sell assets. As of Nov. 3, RioCan said it had $702.1 million in deals at a weighted average cap rate of 6.8%, including $219.6 million of completed dispositions during 2022. RioCan said during the past week it was instituting a normal course issuer bid to buy up to 10% of its public float.
Toronto-based First Capital REIT, one of Canada's largest retail REITs with 22.2 million square feet of leasable space, reported its same property net operating income was up 5.3% in the quarter from a year earlier.
The REIT plans to continue looking at asset sales, First Capital's president and CEO Adam Paul said during a conference call with analysts last week. The move comes after activist investor Ewing Morris & Co., backed by the REIT's former CEO Dori Segal, called out some of those sales.
"We have an abundance of assets primed for development or monetization," said Paul on the call, noting the sales will rebalance the portfolio to create a higher proportion of income-producing properties.
Ewing Morris, which wants the sales to stop, has focused on the property at 1100 King St. W known as King High Line in Toronto as an example of something the REIT sold too cheaply.
"Paul described King High Line as a 'generational' asset that would be 'near impossible to acquire.' Ewing Morris supports the regular disposition of non-core assets within the framework of a thoughtful capital allocation strategy. But we vehemently oppose the sale of 'generational' assets below replacement value," Ewing Morris said in a statement last week before First Capital reported earnings.
Paul addressed the sale on the conference call with analysts and called the deal a perfect example of the $1 billion in assets it wants to sell.
"King High line is a great example. It offers no additional intensification opportunities. It is a great asset in a great neighbourhood, but that is not enough to keep our capital invested," said Paul, noting the 3% cap rate on the $149 million sale allows the company to take the cash from the sale and use it to buyback its shares.