Watch: 2024 Real Estate and Renewable Energy Investing Insights
Transcript
[00:00:06] Ray Punn:
All right, well, welcome to everyone that’s joined. I’m Ray Punn, Vice President of Skyline Wealth Management.
Joining me today is Wayne Byrd. He is the CFO, Chief Financial Officer, of Skyline Group of Companies. Thanks for joining me today, Wayne.
[00:00:19] Wayne Byrd:
Yeah. Thanks, Ray. And thank you, and welcome everybody for joining us today.
[00:00:22] Ray Punn:
So, with that, let’s get right into things. We’re in the real estate and infrastructure space in Canada and not all real estate is created equally. Looking back to 2023, overall real estate investment activity was relatively muted compared to the previous cycle of, let’s say, about a decade or so. There were some disposition activities for various reasons, whether it was a shore-up of the balance sheet, strategic dispositions to lighten exposure to a certain asset class, or simply just free up cash flow for higher interest costs offset.
But we also saw the rise of foreign investment from private capital groups, specifically in the Canadian office space, which has seen vacancy rates as high as 20% in Ontario, greater in other markets, and a lot less in primary markets with Class AA and Class A type office. Wayne, we won’t spend too much time on this asset class since Skyline Group of Companies really has no exposure here.
Another interesting trend we saw was a shifting of cap rates, even as occupancy rates remained at record highs. In the multi-res asset class, we’ve seen the federal government loosen on [the] tax burden for developers to reignite supply development, not only to give Canadians a home but having enough supply to match and even play catch up for forecasted Canadian population growth, which is really fueled by new immigration. So, there’s quite a mixed bag, Wayne, of insights and trends and Canadian real estate. From your take as a CFO of a large real estate firm, what does this all mean?
[00:01:56] Wayne Byrd:
Well. Thanks, Ray. A lot to unpack, and we’ll try to cover as much of this as possible in as short a time frame as possible. I know you kind of preface and talk about 2023. Well, let’s actually step back to 2020. And, on a macroeconomic level really, what happened in 2020?
Well, since the onset of the pandemic in 2020, first step is economic shutdowns. And then shortly after that, the federal government had to take actions to support businesses and prop up the economy. And how? Well, by way of printing money. And this, of course, then leads to inflation, as we’re seeing, and then the need to raise interest rates to combat that. And during these unprecedented times, rates were hiked ten times from the Bank of Canada, a rate back in March ’22 of 0.25% to where we see today at 5%. And while today there are some signs showing stabilization, they as well have been somewhat muted so far in 2024, with no change on interest rate in the first announcement on January 24th.
However, there are still seven further interest rate announcements scheduled for the balance of this year, with the most recent upcoming one on March 6th. A lot of conjecture going on in the Canadian economy with the senior economists. Some are predicting another no-change announcement, and they are looking ahead to either April or June announcements for an interest rate cut. And when you think about it, we have not seen any interest rate reductions since March 2020 at the onset of the pandemic when there were three. So, you know, we are definitely in an unprecedented climate still, even though, you know, we would all, in varying levels, agree that we are coming out of the pandemic and seeing signs of improvement.
[00:03:56] Ray Punn:
Wayne, most economists are touting the same nose for interest rates that you just mentioned when we look at late ’23 and early ’24. We’re starting to see a level of stability with some signs of easing on inflation and talks of the Feds expected to drop interest rates, possibly, but you mentioned April, June summer, let’s see when that happens. But over the span of 18 months, again, we talked about the spike of about ten times on rates.
Skyline Group of Companies is owner, operator, manager of close to $9 billion in real estate infrastructure assets in Canada. The three REITs (Real Estate Investment Trusts) are packaged into multi-res, industrial and grocery-pharmacy retail. Then there’s a clean energy portfolio, which owns approximately $450 million in energy-producing assets, which are mostly backed by provincial contracts.
So, interest rates, inflation, Wayne, these are topics that we discuss at the office pretty regularly. Can you share how they impact valuation, debt management and cash flow? And then, as a spin-off question, how has Skyline and the Funds maneuvered through ’23 with the rapid rise of rates, and what’s going on in ’24?
[00:05:09] Wayne Byrd:
Okay. Sure. So, let’s just dive right in here on the current interest rates. So, while the current interest rates in place are significantly higher than where they were previously, our position is that those rates will not likely be seen again. And, for the mid-term future, we believe that borrowing rates in the 4 to 5% range is where we would see normal. And, so with that, as much as we enjoyed, in 2020, rates in the low to mid ones, sometimes 2% rate, we don’t see that coming in any foreseeable future.
Talking about interest rates, what I do feel it’s important to clarify is, as homeowners, myself being one, specifically those of us that have mortgages on our properties, I feel it’s important to state that the rate that I may have, or you may have on your mortgage today isn’t indicative of what our Funds would be facing on the institutional/commercial mortgage loans. So, today I reached out to Pete Roden, our Vice President of Mortgage Financing in-house. If we were to secure a 5-year mortgage today across our Funds, what would [be] the rates we would face? So, on the Apartment REIT, CMHC insured, this would be about 4.5% range. On the Industrial REIT, about 5.6%, and Retail REIT 5.6%.
So these rates are starting to come down a little, even though we haven’t heard much from Bank of Canada
[00:06:47] Wayne Byrd:
but they are definitely a little bit different from what we would know in the single-family dwelling space. So, you know, from that side, I think that’s important to see that we are starting to see some stabilization and we’re looking ahead through 2024 to see some rate reduction.
With respect to cap rates and valuations, what does that mean? Well, investors may be hearing of softening cap rates as a result of the rising interest rates and rising vacancy rates due to inflationary pressures. Both of these, while contributors to a decline in valuations in the real estate markets, I would like to pause and dig into this a little below the surface of just this blanket statement and what of the real estate sectors were hardest hit. And Ray, as you kind of opened and talked about certain sectors, office real estate, enclosed malls, hotels, condos, and single-family dwellings, I think everybody would agree that those are the markets that we are hearing as valuations coming down, softening, have been the hardest hit. So, if those are the answer, then in Jeopardy fashion, the correct question is, what are the real estate markets that Skyline Investment Funds do not invest in?
So, I want to dig into these a little bit. Skyline Apartment REIT. Very simply, focused on multi-residential real estate in secondary/tertiary markets, nationwide. Today, an average in-place rent of approximately $1,400. Stable heading into the pandemic and stable coming out of the pandemic.
[00:08:26] Wayne Byrd:
At the closing of 2023, an occupancy of 95.7%.
Skyline Industrial REIT, focused on light industrial assets in logistics and warehousing along major transportation routes across Canada, ensuring that goods are getting to their consumers to their markets. Stable heading into the pandemic and further fortified during the pandemic. And now stronger coming out of the pandemic. Closing 2023 occupancy of 98.1%, weighted average lease terms of 7.6 years. Again, fortified and very stable.
Skyline Retail REIT, focused on everyday essentials retail in secondary/tertiary markets. Grocery, pharmacy, quick service restaurants, all unfazed by the pandemic. Strong heading into the pandemic and just as strong and stable coming out. At the closing of 2023, occupancy of 97% and weighted average lease terms of 5.3 years.
Skyline Clean Energy Fund, focused on energy production through solar assets and biogas facilities. As [the] Canadian population grows, this country’s energy demands continue to rise, and, as the global leaders are looking at further investment in green energy production, Skyline Clean Energy Fund is poised for continued growth.
So overall, demand for our services offered within our Funds are still at a high. The asset composition of the Funds has proven to be resilient or neutral to these recent cycles. With continued demand and geographic and demographic strength, our asset values have not declined despite interest rate pressures, economic downturns and then inflation. Very stable.
[00:10:24] Ray Punn:
So, thanks for giving that sort of overview on the Funds. Let’s maybe hone in on Skyline’s four Funds a little bit more.
So, earlier, we touched on interest rates. We touched a little bit on inflationary cooling and the expected impact to real estate. Let’s talk a little bit more about another “I”, and that “I” is immigration. Arguably, immigration and newcomers are really responsible for economic growth and improved productivity. And that’s really not a monetary policy. And Canada remains one of the fastest growing nations in the world for population growth with immigration policy. So, as of June 23rd, 2023, Canada has a population of approximately 40 million. So, there’s various trajectory studies on what this looks like moving forward. So, you can really take a report of your pick, and for my purposes, I’ll use 500,000 growth annually. So, this results in [a] 45 million population by 2034 and [let’s] call it 50 million by 2044 at the current growth rate. Wayne, you’ve spoken to this publicly a few times, honing in on the ecosystem of immigration and how it fuels investment in real estate. Let’s talk about that.
[00:11:42] Wayne Byrd:
Yeah. Thanks, Ray. Yeah, definitely. I’ve touched upon this several times before and the impact of Canada’s target of welcoming half a million immigrants into Canada each year. This is just, it’s like a continuous loop for our Funds. And as you said, it’s our economic ecosystem, if you will. As we open our doors to a half a million new Canadians each year, this is simple Economics 101: supply and demand. And while we all agree that in Canada, we do have a housing shortage, a housing crisis, therefore the demand for housing is growing.
So, Skyline Apartment REIT, it currently supplies approximately 22,000 apartment suites into the Canadian market, home to an estimated 50,000 Canadians. And whether our apartments are home to new Canadians, home to young Canadians on their way to home ownership, home to everyday Canadians, or home to downsizing Canadians, the demand continues. As [the] population grows incrementally each year, well, then so too does the demand for essentials retail, grocery, pharmacy, quick service restaurants, etc. Skyline Retail REIT continues its strategic decision to focus on essentials retail tenants, many with national brand. This fortifies its presence in the growing communities it operates.
[00:13:02] Wayne Byrd:
Continue this. As population growth continues and the demand for housing continues and the demand for essentials retail continues, these essential goods need to be warehoused and then transported to the consumer. Skyline Industrial REIT, continuing its strategic decision to focus on warehousing and logistics-based real estate, also fortifies its presence in the industrial real estate market.
Let’s close the loop. Finally, as the population continues to grow, demand for housing grows and the economy surrounding the population, therefore the demand for power, energy, is also growing. And when the environment is finally being considered and steps to take care of it being put into action, governments are increasing their investment in green alternative energy production. Skyline Clean Energy, today offering solar assets and biogas assets as producers of green energy, is continually poising itself to, as well, grow for the future, grow with population. A sustainable future is ahead of us.
So, immigration and natural population growth are the common link and a catalyst to be part of the success of our four Skyline Investment Funds. Powered by people, we do grow for the future.
[00:14:28] Ray Punn:
So Wayne, let’s go maybe a little off-topic here. You talked a little bit about Skyline Clean Energy Fund, and we know, we talk about this all the time, that this Fund is focused in on solar assets and biogas. Can you just give maybe a little bit more of an overview of sort of how this portfolio comes together and how it works, and maybe a little bit more on how it’s funding sort of infrastructure and utility for Canadians?
[00:14:50] Wayne Byrd:
Yeah, sure. So, in the Skyline Clean Energy Fund, when this was launched, it started off as being solely focused on solar assets. And in the past couple of years, we have augmented our focus and we have two biogas facilities in the portfolio, one located here in Ontario and the other in Alberta. Right now, it’s around a 50% revenue stream mixture between solar and biogas. Both are supplying and producing energy. For the most part, it is electricity that is being sold either into the grid through government-backed contracts, or sold to the likes of a FortisBC. We are also in the sector of producing renewable natural gas from one of the biogas facilities and investing further into another facility to provide us the ability to just essentially flip a switch between selling to the grid and electricity or converting to renewable natural gas, whatever is in the best interest of our investors. Either way, it’s clean, green energy being transmitted through the through the lines.
[00:16:10] Ray Punn:
Great. Thanks for cleaning that up, Wayne. Let’s switch gears one more time here. We’re all over the place, but this is good. So being in the private alt space, Skyline’s four Investment Funds are well-established with both advisory firms, with institutional, and also the indirect investor. As we worked on this, Wayne, for quite some time, happy to share that in January 2023, the Funds issued and released the Series F about a year ago, which, as an aggregate, has grown to about $160 million in AUM in just one year. Wayne, on the exempt market side, the EMD side, Skyline Wealth Management manages over, close to 6000 relationships with high-net-worth Canadian investors. We manage about $4 billion in equity for them. Here’s some recurring questions that come up regularly, and I’d like for you to give some context on this. The first one is, how are the unit prices derived? Where do the unit prices come from for Skyline’s REITs. Secondly, this is more of a generic question, and this is sort of the difference of private to public REITs? And lastly, what makes Skyline’s Investments one of the leaders in the Canadian alt space?
[00:17:28] Wayne Byrd:
Yeah. Okay. So, definitely a very common question, but on the flip side, sometimes an unasked question because the investors believe valuation is consistent between public and private alternatives. So, is that belief true? Well, yes and no. Let me start by making, a few broad statements. One, the underlying basis of real estate asset valuation is consistent, both public and private. I’m saying that. Two, unit valuation in public market is based on emotion and is somewhat disconnected from asset valuation. Three, unit valuation in the Skyline private alt funds are based on underlying asset value [and], therefore connected.
So, three statements here. Let’s take this a little deeper. If you were to pull out the audited balance sheet of a public fund, the value of the assets are deemed accurately reflecting their market value. Absolutely. Audited statements, they go through their IFRS (International Financial Reporting Standards) accounting standard reporting, they go get fair value assessment for the value of the assets on the balance sheet. Pull out the audited balance sheet of any Skyline Fund, and under the same reporting, the value of our assets are deemed accurately reflecting their market value.
So where is the disconnect? As I alluded to in my second and third statements, in the public market, unit prices are traded on emotion, and they aren’t necessarily reflective of the asset value shown on the balance sheet.
[00:19:05] Wayne Byrd:
So, publics are either trading at a premium to NAV (Net Asset Value), or at a discount to NAV, or at par with NAV. In the private alt space for Skyline, unit prices are established, and set based upon NAV coming off of our balance sheets. Our unit values are, therefore, not emotionally influenced. Accepting that our Investment Funds are resilient to economic cycles as they are all needs-based: shelter, food, distribution, and energy. It has always been our position, our view, that real estate and energy infrastructure is better suited as a private alt investment, rather than traded on emotion and unit value subject to global volatility influences unrelated to our underlying assets. That is the key significant distinction between us in the private space and those in the public.
So, I know a lot of our investors are always looking to us to see what is happening with unit price. I just heard that this was trading in the public space. Well, ours is just based upon mathematical equations. NAV divided out by the outstanding units. That is unit price. We are traded at par to NAV, not traded with emotion and pricing it up as a premium or pricing it down as a discount.
[00:20:33] Ray Punn:
Thanks, Wayne. So institutional allocations, whether direct or indirect investment in real estate, has grown in the investment sleeve within the large institutional pension plans. I’m specifically speaking to Canada, not to say it’s not happening in North America, but for research purposes, that’s what I focus on. CPPIB (Canadian Pension Plan Investment Board) itself has a seven-point asset strategy, which includes private equity, infrastructure, and real estate. And this makes up about 50% of their overall investment portfolio. Public equities are, as of the last time I checked, maybe 2022, was in the 28% range. And that’s down by about 50% from a decade prior to that.
So, you can also look at some of the other large Canadian pension players as well, Wayne, and their investment strategy is very closely aligned with CPP (Canadian Pension Plan). So, the point that I’m trying to make is that institutional investing is largely seen as somewhat of a trendsetter with breaking the norms of the traditional asset mix. And I guess you can say most can agree that the standard 60/40 has evolved to include other assets and investment classes.
So, a higher weighting in private alts and real estate, and more recently, private credit, has ignited with investors. Credit for obvious reasons, as we’ve seen the rise of bond yields, but we’ve recently also seen a cooling off in that market. Wayne, what’s the value for an investor or a portfolio to long-hold private alts and also share your insights on the rise of alternatives, specifically real estate in the institutional space.
[00:22:16] Wayne Byrd:
Yeah. It’s interesting. So, to back things up, I mean, you know, to say that institutional investing is largely seen as a trendsetter. In our case, I would like to say the near 6000 strong investors have been the trendsetter in looking at the private, the alt space, and now the institutionals are hearing a lot about us and catching up. But, you know, as I alluded to on the value side, is this value disconnect why large institutional investors in Canada are rebalancing their investment portfolios and increasing their exposure and weighting in the private alts, specifically real estate and infrastructure?
Yes. Sounding like a skipping record, Skyline Investment Funds are best suited in the private space, as they are incredibly well positioned in their respective sectors of real estate and infrastructure. Institutional investors who are looking for stability in their investment portfolio are turning to these foundation investment sectors, bricks and mortar and infrastructure. So, to me, that’s a bit of a stamp of approval and understanding that the type of real estate that we hold, and this goes back to multi-res, essentials, retail, logistics-based industrial and energy production, green energy production, are something that very solidly should form and compile a foundation to institutionals and to retail investors.
[00:23:43] Wayne Byrd:
So what’s the Skyline proposition? What’s our value prop? Taking our respective Skyline Funds and the sectors that they focus on, the value prop that we deliver is the detachment from volatility of the public market, created from emotion or events unrelated to the Canadian real estate and infrastructure markets occupied by Skyline. Stability in the short-term and mid-term during the ebbs and flows of the market is real value. Value preservation. I’m sure that we can all agree that, in general terms, the types of investment strategies that Skyline Funds hold, value is inherent and then grown in the long-term.
Within our real estate portfolios, tenant turnover, yes, it still occurs. And despite our very solid occupancy numbers that I reported on some 20 minutes ago, on turnover when the mark to market gaps can be closed, that being what is a market rent versus what are we currently renting at market, that can be closed. And then the value growth is realized. Then, it can be priced into our units, not forward priced. And, secondly, organic revenue growth still is realized throughout our Funds, either through contracted lease step-ups in the industrial space and retail space or annual allowable rental increases in apartment.
[00:25:11] Wayne Byrd:
On the Clean Energy Fund, these are solidly priced and based upon government-backed contracts or private contracts with the likes of FortisBC.
The tax efficiencies of Skyline’s Investment Funds exist in both the public and the private alt space in our industries, so that isn’t unique. However, it is the historically proven stability of our investment offerings that are the foundation of Skyline’s value prop. Recognizing that a little earlier, I referenced the public’s potentially trading at a discount to NAV, the risk-tolerant investor will definitely see this as a value prop for growth versus Skyline stability. Absolutely. However, I even now, today, I definitely can’t pinpoint and predict when is the bottom of the market. Nor can I predict and say today is the top of the market. So, I mean, very generally, rather than swinging for home runs in any given inning, I’ll take nine innings of Skyline singles over the entirety and go to bed at night to sleep well and know in the morning that my value hasn’t been negatively affected without my knowing.
So, our proposition, our foundation, is value is created by stability today and then grown in the future.
[00:26:31] Ray Punn:
We should have probably started this, the call with this, and, listen, we’ve talked a little bit about Skyline’s Funds, and sort of the value. We’ve talked a little bit about macroeconomics. We haven’t talked about Skyline, the Group of Companies, and really who we are and how we operate and where we began. Maybe we’ll close it out with that. I mean, we should have started, but let’s just close it there. Can you just give an overview of Skyline Group of Companies, who we are?
[00:26:56] Wayne Byrd:
Yeah, so Skyline Group of Companies, it’s interesting. Just two weeks ago, we celebrated our 25th official anniversary of the creation of Skyline in 1999. The history of it dates well back prior to 1999. The three co-founders, my partners, began in the early ’90s getting wrist-deep and knee-deep into real estate. So this business was built upon bootstrapping and starting from the ground up and not starting from [the] top down and deciding that this is a good thing to invest in.
The Skyline Group of Companies, we talked a lot about our four Funds. Well, we’re vertically integrated. We don’t then outsource to a third-party asset manager. We don’t outsource to a third-party property manager. We don’t outsource to outside legal counsel. We have internalized, within our Skyline Group of Companies, vertical integration. We are property managing. We’re asset managing. We’re mortgage financing. We have our own in-house legal. And then, obviously, Ray and his very deep team at Skyline Wealth look after that connection between the Funds and then through to our Class A investors, our Class F investors, and the Institutionals. It’s something that we take great pride in continuing to grow our overall group of companies and do the best that we can, all with the best interest of our investors in mind.
[00:28:31] Ray Punn:
Thanks for sharing that, Wayne. We can probably go longer, but I’m being told that we’ve hit our time for now. We’ve hit that 30-minute mark. So, I’m going to say that this concludes our webinar. I do really appreciate all of those [who] joined live today and appreciate those that will watch this back recorded. This has been great. And thank you for joining. And, Wayne, we’ll do it again. Thank you.
[00:28:53] Wayne Byrd:
Yeah. Thanks very much, everybody.