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investor clinic

In a recent column you included real estate investment trusts (REITs) in a cluster of dividend-growing companies. I always give them a glance, but then move on, as their rates of dividend growth seem so paltry. Am I missing something?

It's true that many REITs raise their distributions at a snail's pace – and some not at all. Crombie REIT (CRR.UN), for instance, hasn't raised its distribution since 2008. The tradeoff for investors is that Crombie offers an above-average yield of about 6.7 per cent.

Another stodgy distribution grower is RioCan REIT (REI.UN), which last raised its payment in 2012, and before that in 2008. RioCan's yield is about 5 per cent, but that's still nearly twice as high as the weighted average yield on the S&P/TSX composite index.

Not all REITs are dividend growth slouches, however. I set up a Watchlist on Globeinvestor.com with the 15 components of the iShares S&P/TSX Capped REIT Index exchange-traded fund (XRE). I then selected the "Dividends" view and ranked the REITs by their five-year distribution growth rates. The top distribution grower on the list was H&R REIT (HR.UN), with a five-year annualized growth rate of 13.4 per cent. That number is deceiving, however, because H&R cut its distribution in half in 2009

Second on the list was Canadian REIT (REF.UN), whose distribution has grown by 4.85 per cent annualized over the past five years. Canadian REIT is one of the steadiest distribution growers in the REIT space, having raised its payment six times in the past five years (disclosure: I own the shares personally). But again, there's a tradeoff here: Canadian REIT's yield is third-lowest on the list at about 3.9 per cent. So investors are getting a lower-than-average yield now in exchange for larger-than-average expected increases later.

Just four other REITs in XRE have annualized five-year distribution growth rates of more than 1 per cent – namely Boardwalk REIT (BEI.UN) at 2.53 per cent, Allied Properties REIT (AP.UN) at 2.04 per cent, Northern Property REIT (NPR.UN) at 1.96 per cent and Canadian Apartment Properties REIT (CAR.UN) at 1.79 per cent.

Generally, with REITs you get an attractive yield up front and the possibility of modest distribution increases in the future. Assuming the unit price rises at the same rate as the distribution, your total annual return – all else being equal – will be equivalent to the yield plus the distribution growth rate.

For instance, a REIT with a yield of 5 per cent and a distribution growth rate of 2 per cent would be expected to deliver a total annual return of about 7 per cent. It doesn't always work out that way, of course, because market forces, interest rates, occupancy levels and other factors can all affect a REIT's unit price.

When investing in REITs, yields and distribution growth rates aren't the only factors to consider. The payout ratio is also important because it provides a clue to the distribution's sustainability. Payout ratio is usually defined as the distribution divided by funds from operations (FFO) or adjusted funds from operations (AFFO) and can often be found in a REIT's financial statements. Generally, the lower the payout ratio, the more sustainable the distribution will be if the business takes a downturn.

Another thing to keep in mind: REIT distributions aren't technically dividends and therefore don't qualify for the dividend tax credit. Distributions usually consist of capital gains, return of capital, other income and, in some cases, foreign non-business income and a small amount of dividend income. To save yourself headaches at tax time, you can always keep your REITs in a registered account, where the tax treatment is moot.