Summary

Over the recent months, we have been bullish on Granite REIT (GRT.UN:CA/ GRP.UN) as a GARP play due to the attractive fundamentals benefitting the industrial real estate market and its attractive valuation relative to historical trading levels. Now, with a rebound in supply/demand leasing fundamentals anticipated in 2025 and the units trading at historically low valuations, we see Granite as being poised to generate sector-leading returns. Our upgrade to Strong Buy is based on sustained high-single-digit SPNOI growth driven by mark-to-market upside in rents and a further improvement in what were already strong balance sheet metrics.

Earnings Update

Granite's portfolio grew modestly in Q1, with 1 property moving out of the development portfolio into the income-producing portfolio, adding ~6% to Canadian GLA.

ABRs were weak in Canada, declining ~2% QoQ, but were relatively stable in most other markets. Austria stood out with ~13% QoQ rent growth, driven by a contractual renewal at the Graz facilities. Leasing spreads moderated to ~10% across the portfolio, which was expected given the elevated deliveries of new supply in key markets. Occupancy remained stable.

Despite some of the pressures noted above, Granite grew its topline by ~7% QoQ and NOI by ~4% QoQ. NOI margins compressed sequentially, but were in line with the comparable quarter in the prior year.

Core FFO per unit declined by ~3% on lower interest income than the prior quarter, though AFFO per unit grew ~1.5%, maintaining an attractive payout ratio in the low-70s.

Management marked up its IFRS cap rates across its portfolio, except for the US, resulting in a blended net expansion of ~3bps to 5.27%. Higher NOI assumptions drove a ~2% increase in the implied price PSF of the entire portfolio.

Beyond '26, we see the remaining interest cost headwind as manageable and likely to cause a ~7% drag on FFO spread across '26-'30 (n.b., averaging <2% of FFO p.a.).

Valuation

Investors' sentiment for industrial REITs has waned due to slowing rent growth, a shaky macro backdrop, and supply-driven occupancy declines. We believe these concerns are mitigated by the fact that construction starts have stalled, and the number of projects under active development has decreased sharply to ~2% of inventory (from ~6% in 2022) in Granite's key US markets and to ~1.5% (from 2.2%) in the GTA. This, plus a generally negative sentiment for REITs, has pressured Granite's unit price despite its strong relative growth profile. This has resulted in what we believe is an exceptionally compelling entry point. At ~13.7x AFFO, Granite is trading at ~<60% of the US peer group average (n.b., the lower-end of its historical range and 60%-70% average in recent years). Granite's P/AFFO multiple compared to DIR is also at ~98%, the low-end of its historical range, despite DIR's lower quality (see our views on DIR here).

Our revised NAVPU estimate assumes a weighted average cap rate of 5.92% and NTM NOI of ~$450.6MM. We see ~29% upside to our revised NAVPU estimate for the TSX-listed units and ~30% upside for the NYSE-listed units (n.b., a potential FX arbitrage opportunity).

Risks

The key risks to our target price include: (1) tenant concentration, with ~26% of revenue coming from Magna International, the auto-parts manufacturer, (2) the specialized nature of its properties, which can heighten re-leasing risk, (3) FX risk, with a majority of revenue denominated in EUR or USD, (4) local market competitive dynamics (incl. supply/demand swings, general economic conditions, interest rate movements, development cost pressures, etc.). We see these risks as largely mitigated by the attractive valuation, which we believe is pricing in many of these risks, providing an adequate margin of safety.

Conclusion

Granite is our core industrial holding, providing exposure to high-quality industrial property in strong markets across the US, GTA, and Europe. Its portfolio focuses on large bay distribution/e-commerce logistics properties, which we believe enhances the stability of its future performance and growth profile. In our opinion, the units are trading at highly attractive levels, which we haven't seen in many years. We are upgrading the units to Strong Buy.