Big tech stocks have been among the key forces driving markets higher, but as market conditions change and interest rates trend lower will other sectors become more in favour amongst investors? Jeff Evans, VP, Director and Lead of Empirical Research and PM Support at TD Asset Management, makes the case why real estate and infrastructure may provide opportunities.
Transcript
Greg Bonnell – Of course, big technology stocks have been in favor among investors for a while now. But interest rates are trending lower. Could we begin to see more opportunity in some of the other sectors of the market, like real estate, infrastructure? Joining us now to discuss, Jeff Evans, VP, Director, and Lead of Empirical Research and PM Support at TD Asset Management. Jeff, welcome to the program, your first time on the show.
Jeff Evans – Excellent. Great to be here. Thanks for having me on.
Greg Bonnell – All right. We always do this with new guests. Introduce yourself a little bit to the viewers. Discuss your coverage area.
Jeff Evans – Sounds great. I’ll give you the very high-level summary. So I spent about 20 years on the sell side, in quantitative and empirical research, at a number of different Canadian broker dealers. And about seven years ago, I had the opportunity to join TDAM and largely continue building out the same area, focusing on empirical research, focusing on equities.
At a very high level, what we do is we work very closely with our equity portfolio managers and our fundamental research analysts, really to try to make sense of all the noise that’s out there. There’s just an enormous amount of data these days on individual companies. Whether it’s the quarterly reports, income statements, balance sheets, all the different ratios, the sell side generates a lot of data. The media creates a lot of information, as well. So there’s just a lot for investors to process.
What we focus on in our team– and we’ve got a group of about five people that focus on this across the organization– we try to use statistical and mathematical techniques to really narrow down what the most important metrics are. Where should our analysts focus their attention? What are the most important metrics for companies that help drive outperformance and strong performance and returns? So it’s really about trying to figure out the best ways of allocating time, the best companies that have the best opportunities to outperform the market, and give our analysts the edge over time.
In addition to that, I’m also a portfolio manager on some of our global real estate and infrastructure products, where we use a lot of the same techniques, empirical research and quantitative screening to help identify a group of securities that we think can outperform. And then we layer in the insights of our fundamental analysts to help improve stock selection within the portfolios.
Greg Bonnell – All right, very fascinating stuff. So let’s start talking about some of those areas that you look into, apply your empirical research to. Real estate and infrastructure– we do have interest rates trending lower. Sometimes these sectors are not loved in a high interest rate environment. What’s the potential opportunity here?
Jeff Evans – Absolutely. It has been a challenging couple of years for these sectors. We’ve had, over the last two years, some of the largest and fastest increases in interest rates around the world that we’ve seen in probably 50 years. The reason why that’s important for these sectors is that these tend to be some of the highest-leverage sectors in the equity market. They also tend to be some of the higher dividend yield or income-oriented sectors.
From an investor’s perspective, when you have interest rates go from 0% to 5%, you can get basically risk-free GIC from a bank at 5%, the incentive to own a real estate stock or a utility-yielding 3 or 4 is much less compelling. And then from the perspective of the business, a lot of these companies are continuing to perform quite well over the last two or three years at the operating level.
But they’re operating with a lot of leverage. And as interest rates have come up, obviously they refinance that debt at higher rates. And it’s really made it harder for them to grow their bottom line, just faced with the interest rate pressure.
As we’re starting to see interest rate cuts come in– we had a couple from the Bank of Canada, starting to hopefully get one in the US in September here. We’ll get some updates from Jackson Hole later this week. We’re now on the other side of that. So all of that leverage flips upside down as those GICs continue to slide lower over time. It’ll be a gradual process.
But as investors start to have to replace that cash flow, you’re going to have to go back out on the risk spectrum, move into equities. And real estate infrastructure are usually some of the standard go-to sectors to help replace income when cash goes down. And then, of course, the companies, as well. Those tailwinds for financing now become– headwinds for financing becomes tailwinds. Just a much better operating environment.
Greg Bonnell – All right, let’s take those two sectors one at a time. Let’s talk about the outlook now for real estate. And this is a big bucket, as well.
Jeff Evans – Exactly. Lots of different sectors. But at a very high level, if you’re thinking about the prospects for real estate, it comes down to, how full are the buildings? So the occupancy. What kind of rent can you charge? And is that rent growing over time? And then again, the financing on those buildings, given that it tends to be a leverage sector.
I think the financing is improving. So we’ve touched on that. It really comes back to occupancy and rent. If you go across the major sectors, whether it’s apartments, single-family rental, industrial, data centers, cell phone towers– those are the big buckets in real estate– they’re pretty much full. Occupancy is very tight. There’s maybe a little bit of slippage here and there, but broadly speaking, operating very close to peak occupancy.
And then what’s more important is that because of the inflation that we’ve seen in construction costs over the last couple of years, the increase in financing costs, nobody’s building new buildings right now. The math really doesn’t work aside from a few special cases.
There’s a little bit that’s still coming into the market. We’re seeing a lot of deliveries in ’24. That’ll start to slow down in ’25 and almost disappear in 2026. So we’re going to have an environment of very strong occupancy today that should just get even tighter, absent a recession. The operating fundamentals come very, very strong into 2026 here.
And that’s important for landlords because if occupancy is full, you can usually charge pretty good rents and push rent increases through to tenants. If there’s no space, tenants need the space, and you can increase rents at fairly healthy rates. We’re already seeing that today. Across the apartment REITs, particularly in Canada, where you’re seeing strong immigration, lots of demand for housing, we’ve underbuilt for 10 years, there’s still pretty healthy rent growth across the country.
A little weaker in the US because they built a lot of supply in the sunbelt. So it’s a little more regional. But generally, again, healthy rent growth in apartments. Industrial, there’s some dynamics going on there too, but a very good path for industrial REITs to raise their rents over the next couple of years and bring them up to market.
This whole dynamic of being able to price, particularly in retail, where there’s been no supply for 10 years, lots of opportunity to raise rents across the board. And so really, it comes down to interest rates have been masking a lot of these very strong fundamentals. And we think as you get into 2026, the setup remains very, very favorable.
Greg Bonnell – What about office, though? This is what I always hear as the standout. Retail returns strongly. Industrials– we need warehouses for all these goods we’re buying all the time. But people actually going back into the office.
Jeff Evans – Exactly. So that is the one standout, where there clearly is an occupancy decline. Historically, office was– these were great assets, historically. You’d have 5- to 10-year leases. People generally held on to them. Occupancy was pretty high, in the mid-’90s. It slipped down, depending on where you’re at, to the low to mid-’80s. So there really has been a lot of occupancy loss, but it’s regional.
When we look at Asia, a lot of the Asian office markets continue to be fairly healthy, particularly the newer buildings. And generally, culturally, people want to be in the office. It’s held in fairly well in those markets.
Same thing in large parts of Europe. Spain’s a great example, a very fast-growing economy, one of the best in Europe. Office vacancy has held in incredibly well. You’re seeing 92%, 93% vacancy, where maybe it was 95% at the peak. So lots of strong demand in certain submarkets.
It’s really the West Coast US, which is tech. So the tech sector has been the area where things have struggled. And that’s reducing occupancy, in some cases well below 80%. And landlords are really struggling to fill up their buildings. We are seeing a few little green shoots here and there. The AI startups in San Francisco, starting to take some space. So that’s been helping to chip away at vacancy, get rid of some of the sublet space in the San Francisco market.
And you’re also seeing within the apartment REITs– last year, where there were tech layoffs, it was very difficult to rent out apartments and particularly get good rents. We’re seeing that come back. So it’s much stronger than it was a year ago. It tells us at the margins, something is starting to improve in the tech space.
And then where we’re really starting to see it is in the traditional office markets, like New York and Boston. That’s where you have your financial, insurance, real estate tenants. You’re starting to see picking up in leasing activity in those markets. And we’re actually even seeing some tenants take more space as these leases come up for renewal. There was one of the big landlords in the States was talking about one of their tenants, a big consulting firm that took 20% extra space than what they had before.
Now, that’s not everybody is doing that, of course. But there are these little anecdotal signs that people are starting to figure out their space needs. There’s maybe another three or four years of leases that need to roll over still before we get completely comfortable that the COVID environment is sorted out. But we are seeing some green shoots.
We’re not quite at the bottom. There is still a little bit of occupancy slippage. But this acceleration in leasing probably won’t help this year. But as you get into, again, 2025 and 2026, you should start to see some of this leasing activity that’s happening now show up in the occupancy statistics. So I think it’s still probably a little too soon for office, but it’s certainly more optimistic than it has been for the last couple of years.
Greg Bonnell – An interesting breakdown on the real estate. How about– we haven’t touched on the infrastructure side yet. What are we thinking about the opportunities here?
Jeff Evans – So lots of different subsectors within infrastructure. Maybe let’s start with the transport side, so the rails, trucking companies, all sorts of things, which are a little more economically sensitive. There were some green shoots earlier this year. We started to see the ISM picking up. The leading indicators were showing better signals.
And then unfortunately, that’s rolled over in the last month or two. So it’s created a little bit of uncertainty on whether the economy is truly recovering or not. And as you said, the payroll numbers being revised down doesn’t help that dynamic.
And then when we look at inventories– that’s the other key thing. There was a lot of inventory destocking over the last couple of years. Just anecdotally, as one example, if you talk to the cold-storage REITs that handle food and food processing, they’re operating at some of the lowest inventory levels in occupancy that they’ve seen, pretty much, on record. And it’s just reflective of the challenges for the consumer.
We’re not eating out as much. People aren’t using restaurants as much as they were eating from home. It’s really changed the amount of demand for some of these cold-storage companies. And that just feeds through, again, into the transports, that we’re just not seeing that restocking cycle accelerating as quickly as people had thought.
So it certainly seems like it’s coming. The inventory levels are relatively low. The ISM, hopefully, has bottomed out and should benefit from interest rate cuts. But we need to see a little bit more strength before those sectors will come back.
And then on the pipeline side, I think what’s interesting here is, there’s a lot of concern as to whether these even needed to exist five years ago. We’d just be off of oil and gas. Everything would be renewable. I think what we’ve seen, with all the geopolitical noise in the last few years, is that there really is a need for oil and gas. It’s going to be around for a long time. We can’t build the renewables as fast as governments want us to.
And particularly for relatively clean and secure energy, as we produce in Canada– it’s kind of silly to say that energy’s green. But the energy companies have spent a lot of effort making their products as ESG-friendly as they can, trying to take out as much carbon from the extraction process as possible, and make the pipelines very efficient.
So what we’re seeing on the infrastructure side is just a very long-term demand profile and then also other things like LNG exporting to Asia, exporting to Europe to meet some of their energy security needs. All of that’s come together to create a much more attractive profile.
And then layer in this AI and data-center theme in the last year. We can’t meet that with nuclear and renewables. It really comes down to natural gas, which has created another incremental demand driver to support the value of these pipelines. So in general, I think it’s a very healthy sector with a strong backdrop.
And then the other component of this would be utilities. A couple of years ago, this was the backwater, the boring little area of the equity market that didn’t do too much. Electricity demand wasn’t growing, maybe half a percent a year for the last two decades. We’re now seeing, at the low end, seeing 1% per year growth, which is a doubling of electric demand. I’ve seen estimates as high as 4% per year growth for electricity over the next decade.
A lot of that is data centers. But a lot of it is bringing battery plants for EVs back into the States. It’s bringing chip plants back into the US and even just manufacturing facilities, high-end stuff, airplanes and those sorts of things. Those facilities use a lot of energy. And we’re now seeing a much more constructive demand outlook for utilities.
So I think it’s a sector that’s gone from a relatively low-growth, boring sector a few years ago to one that’s really now supporting all of the fun on the Nvidia (NVDA, NVDA:CA) and Microsoft (MSFT, MSFT:CA) side. You can’t have that AI build-out if you don’t have the power. So it’s become a much more compelling sector.
The earnings growth rates are still about the same. We haven’t seen companies upgrade guidance dramatically. But it’s the certainty in that guidance, over a much longer period of time, which makes it a
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