Many investors don’t know the first thing about Canadian REITs. What qualities are important?
First, let’s talk about earnings. 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 real estate 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.
Instead, investors should use funds from operations (FFO) and adjusted funds from operations (AFFO) as valuation metrics with Canadian REITs. 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 an REIT 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.
Let’s talk about debt next. Most Canadian REITs tend to hang out at a 50% debt-to-assets ratio. Many are lower, but that’s because they plan to borrow to fund expansion plans. The ones that are higher are usually trying to pay down debt, something they’ll 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 “bundle” of REITs, check out our list of the best Canadian REIT ETFs.
We might as well start with one of Canada’s largest REITs. 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 company 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 it afford these projects without taking on too much additional debt.
Finally, let’s talk about RioCan’s dividend. The current yield is 5.3% and the payout ratio is just over 80% of AFFO. You can count on this payout.
H&R REIT (TSX:HR.UN)
H&R REIT (TSX:HR.UN) is a little more of a value play than RioCan. Shares are beaten up because of a combination of poor short-term results and a little uncertainty surrounding a key asset.
Let’s start with The Bow, which is H&R’s marquee asset. The Downtown Calgary landmark is home to Encana, but that company 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 the company 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. Management is confident occupancy will return to the 95% range soon.
The company’s expansion focus today is on 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. It 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.
Shares are cheap on a price-to-FFO perspective, trading at approximately 12x that metric. That’s a fair value for one of Canada’s top REITs. The stock also trades at a slight discount to book value.
H&R REIT offers a 6.4% yield with approximately the same payout ratio as RioCan. The payout is a great combination of yield and security.
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 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.
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 6.6%.
Northwest Healthcare (TSX:NWH.UN)
Next up is another specialty REIT, Northwest Healthcare Properties REIT (TSX:NWH.UN), 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. Healthcare spending is growing faster than GDP around the world, 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.
Northwest’s management is quick to point out shares appear to be undervalued, with the company trading right around its net asset value. Comparable health care REITs in the United States trade at a 10-20% premium to book value. Shares also trade at around 13x trailing AFFO, a 20% or so discount compared to the average Canadian REIT.
The company also offers one of the better yields in the sector, with the payout checking in at 6.4%. The payout ratio is approximately 85% of AFFO.
Northview Apartment REIT (TSX:NVU.UN)
Northview Apartment REIT (TSX:NVU.UN) focuses on owning residential suites. Its portfolio consists of more than 27,000 units stretched across most provinces in Canada. Key areas include Southern Ontario, Atlantic Canada, and Northern Canada. It also has a small collection of commercial real estate.
Many investors like residential real estate the best because its easiest to understand, it’s more recession resistant, and expansion opportunities are virtually limitless. But we must also remember a few downsides, including more competition and lower returns on investment.
Northview has done an excellent job growing its portfolio lately, using both strategic acquisitions and development projects to grow the bottom line. It has grown the portfolio by more than 3,000 suites since the end of 2016. It has also increased rents from certain locations by renovating properties, a program that offers excellent returns on investment.
Because a big chunk of Northview’s portfolio is focused on smaller markets and Canada’s arctic, it consistently trades at a lower valuation compared to its peers. The current price-to-AFFO ratio is approximately 15x, compared to an average of 20-25x for the competition.
This also translates into a much better dividend yield. Northview’s distribution is nearly 6%, while its peers pay 2-3%. Yes, its payout ratio is a little higher, but it’s around 85% of AFFO. That’s a solid number.
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 company that was struggling just a couple of years ago.
Like many other Canadian REITs, Artis was weighed down by an oversized 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.
The company 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 company plenty of excess cash that can be spent on the share buybacks, acquiring new property, or further improving the balance sheet.
It’s easy to argue Artis shares are still undervalued, even after a 25% run-up from recent lows. Shares trade at just 11x AFFO, and well under book value. In fact, Artis has been a long-rumored takeover candidate for years now.
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 company 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.
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 company 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. 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.