With home prices at all time highs everywhere in Canada, investors are wondering how to play the sector. Expert think real estate investment trusts (REITs) could be the answer.
“REITs offer investors exposure to the real estate sector, but without the requirement for a large capital outlay or mortgage debt to buy equity in a physical property, while maintaining the benefits of a steady income stream,” says Ian Tam, director of investment research at Morningstar Canada.
Better Than a Condo
“I agree with Tam 100%,” chimes in Josh Varghese, Founding partner of Axia Real Assets, who claims that REITs are a long term value. Some have appreciated more than condos. “If you had bought InterRent (IIP.UN) or Minto (MI.UN) five or ten years ago, you would have outperformed the purchase of a condo. Interrent, for the five years leading up to January 2022 gave a return of 121.6%. Plus, the investment is liquid. You can get your capital out at any time,” he adds.
Can you check with REMAX or Royal LePage how much condos appreciated in Canada for the same time frame?
And Royal LePage forecasts that condos will grow at 8% in 2022. “Overall, 2022 should be a strong year, with strong chances of distribution growth in many areas, good balance sheets, growing cash flows and a lot of capital chasing the sector,” says Lee Goldman, co-manager of the bronze-rated CI Canadian REIT ETF (RIT).
And You Get Income
A REIT can be a strong source of income as well as growth. “The top 20 Canadian REITs in market cap pay dividends that start from under 2% to a high of 6.17% in the case of SmartCentres REIT (SRU.UN),” points out Goldman, who also expects key sectors to grow by 10% to 15% over the next two years.
Apartment REITs are a strong contender. “They had a lackluster 2020, mostly because of COVID, but 2021 saw a bounce back and we expect it to continue,” Goldman says. Immigration is a significant driver along with low supply. “Canada continues to shine for the high quality of immigrants it attracts thanks to its education system and job opportunities,” says Varghese, pointing out that a strong demand from this corner hits a significant obstacle: “We need more supply,” he adds, a deficit that, in the meantime, “puts landlords in a strong position” to fill up their vacancies and increase rents.
In this category, both Varghese and Goldman single out InterRent, Varghese also showing a strong preference for Minto which houses “some of the best capital allocators in the sector,” he notes. These two REITs are more geared toward growth than income. Their dividends are only slightly above 2%, but their growth prospects are in the 10% range for the next two years, Goldman expects.
Concerning the income, growth and total return aspects of REITs, Varghese considers that “if you’re not looking for the income, you should focus on total return. An investor should prefer companies that have lower yields and that reinvest the money in their development.”
Don’t Ignore Industrials
As it has been for a few years, the star sector for next year will be industrial properties, agree both Goldman and Varghese. “The fundamentals are very strong, Goldman says, and the vacancy rate is under 1% in the key area of Toronto. It’s an extremely tight market that gives landlords a lot of pricing power and leads to strong rent hikes.”
The key driver here is “the “new economy” of digitization and mobility, highlights Varghese. Supply chains will need to be closer to consumers; the last mile will be increasingly important and will drive demand.”
In this space, Varghese likes Granite REIT (GRT.UN), a choice Goldman also favours, adding the names of Dream Industrial (DIR.UN) and Summit (SMU.UN). Growth in the sector should hover around 12% for the next two years while some dividend yields are quite good, especially for Dream, at 4.5%, and for Granite, at 3.3%. “We expect yields of these firms to increase because of growing cash flows,” Goldman adds.
“The worst of bad news is over for the office sector, he notes. There’s a pretty strong desire from employers – and employees – to go back to the office. It’s clear that the office is not dead. In these two categories, some REITs offer quite honest dividends, notably Riocan (REI.UN) at 3.9%, and Dream Office (D.UN), at 3.7%.
Both commentators have niche sectors that they particularly like for their growth potential. For Varghese, it is self-storage, where demand is high, space, limited, and where landlords have a lot of pricing power. He points to Storagevault (SVI): great growth potential, insignificant yield (0.13%) For Goldman, his pet segment is senior housing, notably Chartwell Retirement Residences (CSH.UN), that is set to explode out of the pandemic drag, its yield quite substantial, at 4.87%.
Inflation and Rate Hike Defense
In a world where interest rates will be moving up, shouldn’t investors avoid REITs? “If rates go up quickly and unexpectedly, REITs will suffer, Goldman acknowledges. But if rates go up slowly, it usually means that the economy is good and REITs can do well. The rate increase happens as a gradual process through their portfolio in which about 15% of debt matures yearly. That process softens the hit on the balance sheet.”
As for inflation, “many see REITs as an inflation hedge, Goldman recalls. There’s a good chance that a REIT can increase its rents, and some can do it faster than others. Some even have built-in rent escalators linked to the consumer price index (CPI).”
