What are we looking for?
Last quarter, the Canadian REIT sector experienced its largest quarterly decline since 2013. This pullback has created what appears to be attractive valuations by historical standards. With tax-loss-selling season coming to an end, my associate Allan Meyer and I thought we would take a closer look at the sector using our investment philosophy focused on safety and value.
The screen
We started with Canadian-listed real estate investment trusts with a market capitalization of $1-billion or more. REITs are known for their high dividend yields; we like to get paid while we wait and dividends generally reflect safety and stability.
When analyzing REITs, adjusted funds from operations (AFFO) is a key metric. It is the funds from operations with adjustments made for capital expenditures used to maintain the quality of the underlying real estate. It is considered a more accurate predictor than other earnings- or cash flow-based measures.
Payout is the dividend payment divided by the AFFO. A lower number is preferred and implies the dividend is safer. A low number could also signal the ability for a future dividend increase, while a number over 100 could signal the potential for a dividend cut.
Price/AFFO is the current share price divided by the AFFO. It is a valuation metric. The lower the number, the better the value.
Lastly, we looked at debt to equity. A smaller ratio indicates a company has lower levels of debt and can be viewed as a sign of safety. A number under 100 implies that a company has enough equity to pay its debt obligations.
What did we find?
H&R and Artis look interesting as they have high dividend yields, low payout ratios and reasonable debt levels, and attractive value. Dream Office REIT looks particularly enticing on these measures, but with a double-digit yield, a payout close to 100, and the lowest price/AFFO, one wonders whether Mr. Market is trying to tell us something. It could be great value – or a "value trap."
ETFs are an option for investors who like the sector but prefer to diversify away individual security risk. BMO offers an equal weighted ETF (ticker ZRE), while iShares offers a market-cap weighted ETF (XRE).
Investors should contact an investment professional or conduct further research before buying any of the securities listed here.
Sean Pugliese, CFA, is an investment portfolio manager at Wickham Investment Counsel, helping individuals, families and other investors.