REIT Investing Secrets Revealed:
The Top 3 High Yield REITs to Own Now
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What Is REIT Investing?
A real estate investment trust (REIT) is a company that owns and typically manages a portfolio of income-producing real estate investments. A REIT issues shares called “units” that trade on several national and international stock exchanges, making investing in real estate as easy as buying a stock.
Investing in a REIT is an investment in real estate; however, real estate is considered a very illiquid investment. It’ s difficult to quickly buy and sell a physical piece of property. Owning shares in a REIT, however, is a liquid way to invest in a typically illiquid asset class.
To qualify as a REIT, most of the company’s assets and income must be related to real estate investment. In addition, the company must distribute at least 90 percent of its taxable income to investors in the form of dividends. That is what makes these three picks high yield REITs.
By paying out distributions between 90 to 100 percent or more their taxable income, REIT investors benefit not only from high dividend yields but also from the elimination of double taxation. Profits aren’t taxed at the corporate or REIT level; they’re only taxed at the investor level.
Unique Benefits of REIT Investing
REIT investing offers several unique benefits for investors.
There are two ways an investor may benefit from a REIT investment: consistently high dividend yields and capital appreciation of REIT units. REITs tend to keep pace with the overall market, generating competitive long-term returns and consistently high income.
Owning units in a REIT is similar to owning shares of common stock in a corporation. Unit prices rise and fall during the day and are traded on exchanges. Buying shares in a REIT can be as simple as buying shares in a publicly traded corporation.
High Yield REIT Investing: Look North
Canadian REITs have weathered some of the worst conditions the North American property market in general has ever faced. Even those who bought on the eve of the crash have maintained their income streams. And while most are still at least slightly underwater from the damages of late 2008, our three High Yield REIT picks have far outperformed the broad market and are well on their way to making up the rest.
Before the late-2008 crash leveled everything in its path, We held three Canadian real estate investment trusts (REIT) in the Canadian Edge Portfolio. Front and center were three REITs we continue to hold today.
Our rationale then was simple and manifold. Canada’s property market was never built on leverage to the extent the US market was. Subprime and Alt-A loans were only a tiny percentage of mortgage loans, not bread and butter as it was to so many US banks. Rather, Canadian banks held loans to exacting standards for credit quality, and most were backed by large down payments as well.
We were also bullish on the fact that this conservatism extended to Canadian REITs. While their US counterparts were leveraging everything in sight to jack up returns, these companies focused on portfolio quality and controlling debt, expanding earning bases only when opportunities were particularly compelling. They just weren’t taking the risks US REITs were and therefore weren’t exposed to the same level of danger.
Starting with the residential market, nine major Canadian cities have shown an increase in property values over the last 12 months. Not too surprisingly, the biggest gains were posted in cities that have benefited to some degree by the resource boom.
Most Canadian cities are showing solid increases in permits filed – a clear sign that markets have tightened enough for construction activity to resume again. And in a country where the developers are as conservative as Canadians are, that’s a pretty strong vote of confidence indeed.
To be sure, activity hasn’t yet returned to the level prior to the crash. And the drag from the US--still the consumer of more than half of Canada’s exports--is still a factor on many sectors of the economy and regions of the country.
But these are solid signs that the action is moving in the right direction. Moreover, Canadian banks’ credit measures, already the strongest on the planet, are still getting stronger. And with the country’s inflation rate well behaved, mortgage rates remain at extremely low levels as well.
Coupled with low and falling unemployment and stable consumer confidence, that’s a powerful underpinning for Canadian residential property. And that’s reflected in improving fortunes for all property sectors, from apartments and shopping malls to office buildings and industrial properties. It is the perfect market for REIT investing.
REIT Investing Right and Wrong
Not every Canadian REIT is in good shape to profit from the sector’s improving health.
The first rule in picking REITs is the same as it is for any company: Buy the business. The single most important number is distribution coverage by distributable cash flow (DCF), which is cash flow less capital costs needed to pay for property maintenance. Because of the general reliability of revenue from rents, distributions paid by any REIT with a payout ratio of 90 percent or less to be very safe. Meanwhile, distribution payout ratios over 110 percent are considered dangerous.
The second most important number is debt, expressed commonly as a percentage of the book value of the REIT’s properties. Again, property is generally financed at least in part with debt, so REITs generally have higher debt ratios than companies in other sectors. Ratios under 60 percent, however, usually indicate financially strong firms with a lot of room to finance more growth. REITs with 80 percent or more should be considered very weak financially.
Structure of debt is perhaps even more important. Look for REITs that have little or no refinancing needs through the current year. That’s the best possible protection against a potential second credit crunch, which we believe is highly unlikely but remains a major fear for many investors. The safest, however, have also staggered their obligations so no really significant amount comes due in any given year.
Canadian high yield REITs generally have had much lower vacancy rates than US high yield REITs. In fact, only the weakest REITs have seen occupancy dip below 90 percent. But in general, the higher the occupancy rate, the better.
Finally, there’s no more reliable measure of underlying business strength than the ability to raise distributions. The extraordinary conditions of the past several years have crimped payout growth. As overall conditions continue to improve, however, there are real signs dividend growth is set to resume, particularly for the lower- payout REITs.
We anticipate more high-yield REITs to boost their distributions over the next year, starting with stronger and lower-payout-ratio fare but eventually including even those with higher payout ratios. That’s a major reason I’m bullish on the sector.
For now, however, it’s a clear sign of a high yield REIT that’s head and shoulders above the competition and suitable enough for even the most conservative accounts.
Focused High Yield REIT Investing Picks
Some overleveraged Canadian REITs have been driven nearly to bankruptcy by the reversal of fortune. Happily, that’s a sharp contrast to the experience of most Canadian REITs during this downturn. That includes all three of our high yield REIT selections, each of which has either maintained or increased dividends since the crash.
In fact, these three REITs have been able to use the resulting lower property prices to make acquisitions of solid assets at levels that virtually guarantee strong returns. Some have used superior access to capital markets and low interest rates to raise billions of dollars, which they’ve since used to buy property on the cheap.
Here is a sneak peek of what we cover in much more detail in the report:
High Yield REIT #1
Rent growth is a primary driver of cash flow. So how a REIT’s current rents compare to market rents is a key determinant of value. This high yield REIT has been able to continue raising rents even in depressed property markets such as Calgary, mainly because it had been charging well below market rents.
This REIT has come back a long way from its lows of late 2008, when investors feared an implosion of the property market in Alberta where virtually all of its assets are. As it turned out, its high-quality portfolio of below-market rents saved it the worst from that market and allowed the company to expand rapidly with acquisitions.
High Yield REIT #2
The primary appeal of this high yield REIT remains an ultra-conservative financial and operating strategy that ensures its distribution will remain intact almost no matter what happens in the Canadian property market. It has broad geographic diversification, which is an advantage because a problem in one particular market won’t sink the ship.
Reflecting the high portfolio quality, the company reported strong rent growth in all markets except Alberta, which remains burdened by oversupply and the deliberate recovery of energy patch spending. Even there, however, the company has been effective at cutting expenses and holding margins strong.
Cutting expenses and strong margins have been the secret to this REIT’s 22 consecutive quarters of stable or improved net operating income growth, and it looks set to produce similar results going forward.
High Yield REIT #3
This REIT focuses on strong customers--including provincial governments—to make cash flows and therefore dividends pretty much recession-proof. Management has used the improved market to further bullet-proof against future fiascos. Today this real estate investment trust is again growing gangbusters.
The units have been hot over the past year. There’ s a possibility that this REIT’s stock market success has induced investors to set stops that could turn a mild disappointment into a selling wave and produce another prime buying opportunity.
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Best wishes for success in your REIT investing,
Chief Investment Strategist, Canadian Edge
7600A Leesburg Pike
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