Everyone needs a place to live. But not everyone can afford to buy a home – especially at today's dizzying prices.
That, in a nutshell, is why I included Canadian Apartment Properties REIT in my Yield Hog Dividend Growth Portfolio.
Today, I'll take a closer look at CAP REIT and explain why I believe it's an attractive pick for investors seeking steady income with a dash of growth potential.
CAP REIT is Canada's largest multiunit residential landlord, with a portfolio of about 50,000 apartment units, townhouses and land-lease sites spanning eight provinces and targeting consumers across the "affordable," "mid-tier" and "luxury" segments.
Further enhancing CAP REIT's diversification, it owns about 2,000 apartments in the Netherlands – including 540 suites it acquired this week – and holds a 15.7-per-cent stake in Irish Residential Properties REIT, Ireland's largest private landlord.
One of the key things I look for in a REIT is a high occupancy level, and CAP REIT stands out in that regard. As of June 30, occupancy across its portfolio was 98.6 per cent, up from 98.2 per cent a year earlier. In Ontario – CAP REIT's largest market, accounting for slightly more than half of its units – occupancy was 99.4 per cent. In British Columbia – which accounts for about 10 per cent of units – occupancy was 99.9 per cent.
Such extraordinarily tight market conditions work in CAP REIT's favour because management can hike rents significantly when new tenants move in, supplementing the modest rent-controlled increases allowed when existing tenants renew leases. This trend was evident in the second quarter, as same-property revenue rose 3.3 per cent over all, up from an increase of 3 per cent in the first quarter and 2.5 per cent in the fourth quarter of 2016.
"The top line is gaining momentum," Michael Markidis, an analyst with Desjardins Capital Markets, said in a note. "Given [CAP REIT's] geographic weighting, which favours Ontario, Quebec and British Columbia, we expect this momentum to carry into 2018."
Rising rents – combined with property acquisitions and expense controls – have steadily boosted CAP REIT's cash flow, enabling it to hike its distribution for six consecutive years, including a 2.4-per-cent increase announced in February. Yet CAP REIT's payout ratio remained conservative at 71.8 per cent of normalized funds from operations – a cash-flow measure that excludes certain non-recurring items – for the first six months of 2017.
Given CAP REIT's track record of growth and its stated objective to acquire 1,500 to 2,000 units annually, I expect to see more distribution increases in the years ahead. Future distribution growth is an important consideration when looking at CAP REIT's current yield of about 3.7 per cent, which is modest for a REIT.
There is one thing that concerns me about CAP REIT, however: its valuation. The units have posted a total return of more than 19 per cent (including distributions) in the past year and now trade at a premium of about 8 per cent to 12 per cent over the net asset value per unit of the REIT's properties, based on analyst estimates.
This, in and of itself, isn't a reason to avoid the shares, as residential REITs often command a premium to other property types because of the stable cash flows from apartments. However, it may signal more muted returns ahead: According to a dozen analysts surveyed by Thomson Reuters, the average 12-month price target is $35.92 – only about 4 per cent higher than Tuesday's closing price of $34.49. Nonetheless, eight of those analysts still have CAP REIT as a "buy," and the other four – including Desjardins' Mr. Markidis – rate it a "hold."
"We view [CAP REIT] as a core holding for income investors – especially for those who favour stocks with lower volatility. Our neutral stance is predominantly driven by relative valuation considerations and total return expectations," said Mr. Markidis, who has a $35 price target on the units.
Analysts are expecting CAP REIT's strong performance to continue when it releases third-quarter results on Nov. 6. Ken Avalos of Raymond James & Associates estimates that funds from operations (a measure of the cash generated by a REIT's business) will rise by 4.3 per cent to 48 cents a unit for the quarter ended Sept. 30, up from 46 cents a year earlier.
Analysts will also be looking for an update on CAP REIT's succession process following the death in August of chief executive Tom Schwartz. Chairman Michael Stein, who co-founded CAP REIT with Mr. Schwartz in 1996 and was its first CEO, has been overseeing the management team until the board of trustees appoints a successor.
Investors needn't worry about the transition to a new CEO, Mr. Avalos said in an August note.
"Tom co-founded and built one of the most highly regarded companies in Canada," he said. "Part of his leadership was surrounding himself with an experienced team that we believe will continue to build on the vision and success that Tom has left behind."
Disclosure: The author owns shares of Canadian Apartment Properties REIT personally.