Wall Street’s Best Editor’s Note: Thanks to Gordon Pape for this timely article about the Real Estate Investment Trust (REIT) industry. Gordon is an income expert and a regular contributor to our Wall Street’s Best newsletters, focusing on both U.S. and Canadian stocks.
REITs Are Losing Steam
By Gordon Pape, Editor & Publisher, The Income Investor and Internet Wealth Builder
After posting big gains in the first half of the year, real estate investment trusts (REITs) appear to be running out of steam. As of the close of trading on August 19, the S&P/TSX Capped REIT Index was down 2.9% for the month, breaking a six-month winning streak that began at the end of February. Still, the index is ahead 15.9% for the year, so investors can’t be all that unhappy.
The upsurge in REITs this year has been fueled by investor demand for yield. With interest rates at their lowest levels in living memory, any security that provides decent cash flow has been a magnet for new money. REITs distribute almost all their cash flow to unitholders, and virtually all have yields in excess of 4%. Compare that with yields of around 1.6% on five-year GICs and you can see why investors have been piling in.
The Best Canadian REITs in 2016
Some of the biggest REIT gainers so far this year are on our Recommended List. They include the following. Prices are as of the close on August 19.
Allied Properties REIT (TSX: AP.UN). Recommended by Gavin Graham. Opened 2016 at $31.57. Current price: $38.49. Gain to date: 21.9%.
Canadian Real Estate Investment Trust (TSX: REF.UN). Recommended by Gavin Graham. Opened 2016 at $42.06. Current price: $50.45. Gain to date: 19.9%.
Chartwell Retirement Residences (TSX: CSH.UN). Recommended by Gordon Pape on Jan. 14/16 at $12.34. Current price: $15.62. Gain to date: 26.6%.
Crombie REIT (TSX: CRR.UN). Recommended by Tom Slee. Opened 2016 at $12.80. Current price: $15.70. Gain to date: 22.6%.
Milestone Apartments REIT (TSX: MST.UN). Recommended by Gordon Pape. Opened 2016 at $15.05. Current price: $20.75. Gain to date: 37.9%.
Pure Industrial REIT (TSX: AAR.UN). Recommended by Gordon Pape. Opened 2016 at $4.37. Current price: $5.60. Gain to date: 28.1%.
Smart REIT (TSX: SMU.UN). Recommended by Tom Slee. Opened 2016 at $30.10. Current price: $36.54. Gain to date: 21.4%.
Some that Didn’t Fare as Well
That’s a good record; however, not all REITs have benefitted from this cash inflow. For example, Boardwalk REIT (TSX: BEI.UN) is up less than 5% from its 2015 close and has lost almost $10 per unit in the past five weeks. The reason is its heavy concentration (about 60% of total assets) in economically troubled Alberta.
H&R REIT (TSX: HR.UN) has also been held back by its Alberta exposure, although not to the same degree as Boardwalk.
How to Find the Right REITs
There are a lot of REITs on the market these days with more coming on stream all the time. So if you’re shopping for one or two for your portfolio, what should you look for?
Here are some guidelines.
Increasing cash flow. In REIT terms, this is described as funds from operations (FFO), and it is one of the most important indicators of financial health. Any REIT that has a history of steady FFO growth is worth a look.
Distributions. Some REITs increase their payouts on a regular basis. Others do so only rarely and with apparent reluctance (e.g., RioCan). Stagnant payouts often translate into a stagnant share price.
Geographic diversification. REITs that concentrate their assets in one region are likely to run into trouble if a local economic downturn hits. Boardwalk REIT is a prime example, as is Northview Apartment REIT to a lesser degree.
Tax treatment. Some REITs structure their payments so as to provide tax advantages to investors with non-registered accounts. Others are less tax-friendly. Check the REIT’s website for details on how the distributions from previous years were taxed.
Look at the underlying assets. Currently, REITs that invest in apartments, retirement residences, and industrial properties are in favor. Those that focus on shopping malls are coming under greater scrutiny because of the shift in consumer buying to e-commerce.
If you’d prefer to simply hold a basket of REITs, the iShares S&P/TSX Capped REIT Index ETF (TSX: HRE) is a viable option. It is ahead 19.5% year-to-date and shows an average annual compound rate of return of 7.85% over the past decade. I believe you will do better by creating your own REIT portfolio, but if you prefer one-stop shopping, there it is.
You can follow Gordon Pape’s latest updates on Twitter here: http://twitter.com/GPUpdates
While Gordon’s article focuses on Canadian REITs, his advice regarding the most important characteristics in choosing a Real Estate Investment fund applies to both Canadian and U.S. REITs.
As of July 31, 2016, according to the FTSE NAREIT All Equity REITs Index, U.S. REITs have also performed well this year, gaining 18.1%, year-to-date. The top three categories are: Free Standing (40.36% return), Data Center (33.17%) and Single Family Homes (32.99%).
As for yields, double-digit dividends are not uncommon, but investors should realize that those high yields often come with a dose of risk. Consequently, some of the highest yielding REITs have middling ratings from analysts, as you can see from the following chart:
REITs with the Highest Yields
Likewise, the highest rated REITs—while still offering handsome dividend yields—do typically have lower yields than some of their riskier peers:
REITs with the Highest Analyst Ratings
REITs can be tremendous investments—especially when investors feel uncertain about market and economic conditions. We often feature REITs in Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks because their yields can substantially add to your overall gains. As you can see, yield is not the entire story. However, a REIT with fundamental strengths and diversification—accompanied by a good yield—can help you build a winning portfolio.
