Are Canadian REITs a good investment?
Many investors don’t know the first thing about Canadian real estate investment trusts (or REITs.)
What qualities are important?
Most new investors these days strictly focus on learning how to buy stocks. But, real estate exposure is very important as well, and a real estate investment trust is an excellent way to make that happen.
Real estate investment trusts – What should you look for?
First, let’s talk about earnings of Canadian REITs. Net income is pretty much meaningless in the REIT world. That’s because every quarter a REIT’s management must revalue the portfolio.
Most of the time values don’t change – because a real estate investment is boring – but every now and again they do, which shows up in the net earnings number. That impacts the bottom line, but not the true picture of profitability.
Best valuation metric to use instead for REITs
Instead, investors should use funds from operations (FFO) and adjusted funds from operations (AFFO) as valuation metrics with a Canadian real estate investment trust.
FFO is essentially a REIT’s earnings, while AFFO roughly translates into free cash flow.
Much of a REITs income will be paid back to unitholders. To judge the security of the distribution, an investor should look at the payout ratio based on AFFO.
Anything below 80% is considered ultra-safe, while anything above 95% is a little sketchy.
Next, I want to see a Canadian real estate investment trust that grows.
The total top or bottom line isn’t nearly as important as per share metrics. You want to make sure when a REIT issues shares to make acquisitions (which is common in the sector) that the deal is accretive to shareholders.
The best Canadian REITs have strong debt to asset ratios
Most Canadian REITs tend to hang out at a 50% debt-to-assets ratio. Many are lower, but that’s because the REIT plans to borrow to fund expansion plans. The ones that are higher are usually trying to pay down debt, something a REIT will usually do by selling non-core assets.
Now that we’ve gotten that out of the way, let’s take a closer look at 7 of the best Canadian REITs, the kinds of stocks that should provide a combination of solid dividends and some impressive capital gains as well.
If you’re looking for a list of REITs and their yields, check out our list of Canada’s best monthly dividend stocks and REITs.
Or even better, if you’re looking for a REIT ETF because you don’t want to pick individual companies, check out our list of the best Canadian REIT ETF.
**Metrics and research updated as of June 4th 2020**
What is the best REIT to invest in Canada?
We might as well start with the largest REIT in Canada.
RioCan REIT (TSX:REI.UN) owns 225 properties focused on Canada’s largest markets, a portfolio that spans more than 39 million square feet. The REIT has a total enterprise value of approximately $15 billion.
RioCan’s portfolio today is mostly in retail property, but that’s changing.
The company is in the beginning stages of an aggressive redevelopment program that will see it convert many of its retail properties into mixed-use properties.
Let’s look at the largest project, The Well. The development is in Downtown Toronto on Front Street and Spadina Avenue, and it will include 1.1 million square feet of office space, 500,000 square feet of retail and food services, and 1,800 residential units when completed. Needless to say, it’s an ambitious project.
The Well is just one of many projects RioCan has planned. The total development pipeline has the potential to add 27.4 million square feet to the portfolio. About half of the proposed projects already have zoning approvals.
RioCan’s debt-to-assets ratio is currently below 45%, giving it one of the best balance sheets in the entire sector.
That’ll help the REIT afford these projects without taking on too much additional debt. It should also help it get through today’s tough economy without too much issue.
Finally, let’s talk about RioCan’s dividend. A lot of investors are concered due to the fact it is so heavily invested in retail
The current yield approximately 10% and the payout ratio is just over 80% of 2019’s AFFO. Some of RioCan’s tenants are on thin ice right now, but most of these businesses are beginning to open back up.
The REIT should recover as its tenants become more stable. At this point, the dividend looks safe, but I’d be a little worried if the retail economy doesn’t bounce back relatively quickly.
H&R REIT (TSX:HR.UN)
H&R REIT (TSX:HR.UN) is more of a REIT value play than RioCan.
Shares are beaten up because of a combination of poor short-term results, a little uncertainty surrounding a key asset, the impact of COVID-19 on the portfolio, and, of course, a recent dividend cut.
Let’s start with The Bow, which is H&R’s marquee asset. The Downtown Calgary landmark is home to Ovintiv — the energy company formerly known as Encana — but that organization has announced plans to move its official head office to Denver.
Although the company is still responsible for the lease – which lasts another 18 years – investors are worried it will soon pull out of Calgary completely.
H&R also came out with some disappointing results lately, which included a dip in operating income caused by some unexpected vacancies.
Remember, H&R owns a lot of regional mall real estate in Canada, a segment of the market that is getting hit especially hard by online retailers and COVID-19. Investors are nervous about these assets, and rightfully so.
The REIT plans to expand in the U.S. residential market. The two-pronged approach includes acquiring already-built properties in states like Texas and Florida, as well as developing new property with partners.
The Canadian REIT recently completed a large project in Long Island City, New York, and has developments in various stages of completion in places like Miami, San Francisco, Seattle, and Austin.
Investors are being well compensated for this uncertainty. H&R is one of the cheapest REITs in Canada with a price-to-trailing FFO ratio of approximately 5x and a steep discount to book value. Book value exceeds $22 per share.
The current share price is under $10. That’s a terrific bargain for this REIT, assuming you believe book value is accurately stated. Some investors think aggressive write-downs are coming.
Even after the dividend cut, H&R REIT offers a 7.1% yield. The payout ratio is under 50% of 2019’s net income. It looks to be one of the safer dividends in the sector today.
Automotive Properties REIT (TSX:APR.UN)
When it comes to pure growth potential, Automotive Properties REIT (TSX:APR.UN) is the clear winner.
This small-cap specialty REIT has loads of potential. It’s exactly why we’ve included it in our piece of the best Canadian small-cap stocks for 2020.
Automotive Properties REIT buys car dealership real estate, and then rents these locations back out to operators. The company locks tenants into long-term agreements of a decade or longer with rent escalators because the operators value stability. It’s a lot harder to move a car dealership than it is a clothing store.
Since the company’s 2015 IPO, it has more than doubled the size of its portfolio to 61 dealerships and 2.3 million square feet of leasable space.
There’s still ample growth potential, too. Various dealer operators are using Automotive Properties to accelerate their own growth prospects, since they can expand much faster if they don’t have to buy the underlying real estate.
Dilawri Group, Canada’s largest group of car dealerships, gives the REIT first dibs at any dealerships it sells. Automotive Properties’ portfolio will expand as more dealerships get sold to these big operators, a trend that should continue over the next decade.
Yes, COVID-19 could slow these expansion plans of the REIT. Some dealers might even try to negotiate reduced rents. But these are long-term businesses that value stability. They won’t abandon these locations just because of a few lean months.
Over the last year Automotive Properties has both improved its balance sheet – reducing its debt-to-assets ratio from 53% to under 50% — as well as bringing its dividend payout ratio from 90.5% to 84.8% of AFFO. That’s a solid payout ratio for a REIT that yields 9.1%.
Northwest Healthcare (TSX:NWH.UN)
Next up is another specialty REIT, Northwest Healthcare Properties REIT (TSX:NWH.UN). Northwest is a worldwide owner of medical real estate.
Assets include hospitals in Brazil, medical office buildings in both Canada and Europe, and hospitals, retirement homes, and long-term care facilities in Australia and New Zealand. The total portfolio is 171 properties spanning more than 14 million square feet.
Growth should continue to be strong for a few important reasons. Northwest has a history of partnering with major institutional investors, taking on the role as manager and minority partner. This allows it to grow its assets at a much quicker pace. Canadian Healthcare spending is growing faster than GDP, too. And it can always expand into new markets, like the United States.
Top tenants include leading hospital operators in both Australia and Brazil, as well as Germany’s largest rehabilitation provider and Alberta Health Services. These are solid tenants that aren’t going anywhere.
Shares are quite undervalued thanks to COVID-19 and the uncertainty it brings to the healthcare space. The stock is down approximately 25% compared to the 52-week high, which was set right before the world changed. It’s also cheap on a price-to-FFO basis.
The REIT also offers one of the better yields in the sector, with the payout checking in at 7.6%. The payout ratio is approximately 85% of 2019’s AFFO.
Crombie REIT (TSX:CRR.UN)
A new addition to this list is Crombie REIT (TSX:NVU.UN). Many retail REITs are suffering because of their exposure to tenants like movie theaters, gyms, and restaurants, parts of the economy that may be impaired for months to come.
Crombie REIT is not focused on retail tenants, which immediately gives it a big advantage over its peers.
Approximately 55% of Crombie’s rents come from Sobeys and Safeway grocery stores. These businesses are booming today as folks load up on essentials from the supermarket rather than eating out. Other top tenants include pharmacies, banks, and other essential businesses. This focus on COVID-resistant businesses has helped support Crombie’s share price during this volatile time for the sector.
Like RioCan, Crombie is in the middle of its own redevelopment program. It plans to convert current grocery store sites into mixed-use facilities with residential apartments on top. Crombie has a couple dozen development projects planned for the next few years, new real estate that will add nicely to its new asset value when completed. The portfolio — which stands at 285 properties and nearly 18 million square feet of space — will be expanded to approximately 30 million square feet when these growth initiatives are completed.
Crombie’s dividend is secure, thanks to the strong grocery store weighting in its portfolio. That’s reflected in its relatively low yield. Crombie’s dividend yield is currently 6.8%, which is one of the lowest yields on this list. It’s still an excellent passive income source, especially in today’s world of low interest rates.
Artis REIT (TSX:AX.UN)
While I’m not normally a fan of REITs that have cut their dividend, I have to give Winnipeg-based Artis REIT (TSX:AX.UN) and its management team all the credit in the world. Management has done a great job turning around a REIT that was struggling just a couple of years ago.
Like other Canadian REITs, Artis was weighed down by an over sized exposure to the Downtown Calgary office market. It also had too much debt and it was paying out more than 100% of cash flow in dividends. The dividend was cut, non-core assets were sold, and Artis embarked on a new strategy, one that emphasized stability.
Management did a masterful job after the dividend cut was announced. The news sent shares cratering as yield-hungry investors looked at the company’s new 4%ish yield and hit the sell button. It then spent some $270 million buying back undervalued shares. Exposure to the Alberta market is just 20% of the portfolio today after some asset sales, with Calgary’s office market just 6% of the company’s total income. It’s a much better mix.
The REIT is now focused on expanding in the U.S. 45% of income today comes from the United States, with management projecting that number to increase to 60% over the medium-term.
The new payout ratio is 55% of AFFO, which is one of the lowest in the whole REIT sector. And it gives the REIT plenty of excess cash that can be spent on the share buybacks, acquiring new property, or further improving the balance sheet. That’s a nice position to be in today, especially as other REITs struggle with unaffordable payouts.
It’s easy to argue Artis shares are still undervalued, especially after being crushed by recent investor doubt. Shares trade at just 5.1x 2019’s FFO, and well under book value. In fact, Artis has been a long-rumored takeover candidate for years now. Perhaps this will finally happen when the world returns to normal.
Dream Office REIT (TSX:D.UN)
Most REITs offer diversification across different types of real estate and locations. Dream Office REIT (TSX:D.UN) tried that, and the strategy came back to haunt management when the Calgary office market slumped in 2015. The REIT now has a new strategy – a focus on the Toronto office market.
After selling off non-core assets and cutting its dividend to a more reasonable level, Dream was left with a portfolio consisting of more than 4 million square feet of Downtown Toronto office space. 85% of its total rents come from Downtown Toronto office towers, with 89% of rent coming from the Greater Toronto Area.
The fundamentals of the Toronto office market look great. Vacancy rates continue to plunge, with occupancy at the 98% range. Rents, meanwhile, continue to march higher. And as anyone who lives in Toronto can attest, downtown is where everyone wants to be.
Even as new supply comes on the market, demand is still there. The only issue could be COVID-19 impacting the office as we know it, but I’m confident the Downtown Toronto market will still be hot even if overall office demand goes down.
Dream has transformed its portfolio and has improved its balance sheet at the same time. It has a debt-to-assets ratio of under 40%, with just over $150 million worth of debt to refinance in the next year. It’s well-positioned to grow the portfolio. The only thing stopping it is a lack of assets available for sale in Downtown Toronto.
Finally, the REIT has an interesting hidden asset. It owns just under 20% of Dream Industrial REIT (TSX:DIR.UN), one of Canada’s leading owners of industrial property. That stake is worth a little under $400 million.
The bottom line
One of the fun things about Canada’s top REITs is they’re a diverse group of companies and you’ll find a little bit of everything on the Toronto Stock Exchange. Whether you’re looking for a retail, industrial, commecial or residential REIT, it’s got a bit of everything.
Some, like Artis and H&R, are cheap turnaround stories.
Others, like Automotive Properties and Dream Office REIT, are specialty plays with great long-term growth potential. And others, like RioCan, Northwest Healthcare, and Northview Apartment REITs, are just excellent operators that do everything right.
Canadian REITs have been traditionally known as yield plays. But these top picks go to show that significant capital gains are also possible if you choose the best.
If you’re looking for some high potential growth stocks, check out our list of Canadian stocks to buy for 2020.