A recent real estate outlook report from BMO Capital Markets is tamping down concerns that the generous income stream from real estate investment trusts (REITs) could turn into a trickle as the COVID-19 pandemic drags on.
In an age of rock-bottom interest rates, REITs are one of the few securities that provide older investors with decent, reliable cash payouts in retirement. Those payouts have come into question as the work force has abandoned urban offices for suburban homes and consumers avoid bricks-and-mortar retail for e-commerce.
The sector’s shake-up triggered a plunge in the S&P/TSX Capped REIT Index, which remains 22 per cent below its February, 2020, high, and dividend cuts or suspensions from several big real estate holders including First Capital REIT (FCR-UN-T), RioCan REIT (REI-UN-T) and H&R REIT (HR-UN-T).
Nevertheless, Jenny Ma, director of equity research at BMO Capital Markets, says that “REITs will still be a place to get higher-than-average yields, especially versus other fixed-income vehicles like bonds.”
The aforementioned 2021 outlook report she co-authored calls for a resumption of strong payouts from the REIT sector, although it cautions the conclusion is based on broad assumptions.
“It’s really hard to call, but it is contingent on most people getting vaccinated by September or October, with a somewhat return to a new normal around the end of the year,” Ms. Ma says.
One safe assumption, she says, is that low borrowing rates will continue to provide opportunities for yield growth from REITs such as Allied Properties REIT (AP-UN-T), CT REIT (CRT-UN-T), Granite REIT (GRT-UN-T), Interrent REIT (IIP-UN-T), Killam Apartment REIT (KMP-UN-T) and Minto Apartment REIT (MI-UN-T).
“We think that those REITs will still be positioned to provide a little bit of growth every year, perhaps a little bit more on the conservative side over the near term, but they still have some room to raise [dividends],” she says.
However, she adds that distributions will come under pressure from other REITs – especially those with already high yields.
“It is a cost of capital problem when they are trading at very high yields and they would be better off retaining that capital either to fund growth through other channels or even to buy back their own units,” she says.
Forward annual yields from some of the larger REITs range from 2.2 per cent to more than 5 per cent. Factoring in those distributions, BMO Capital Markets expects a total return from the REIT sector of 9.9 per cent this year – still well below last February’s presell-off level – but cautions that the kind of REIT matters more than ever.
“That’s an average. It takes into account all the different asset classes that fall under REITs. If you dig deeper, there is much variance among the asset classes,” Ms. Ma says, noting that multifamily REITs hit hard by the pandemic offer long-term value.
“When immigration starts to reopen – and it will, and when students go back to campus – and they will … the demand for apartment rentals will go up and fundamentals will improve,” she says.
Although the long-term outlook for office REITs remains murky for 2021, the biggest challenge is for bricks-and-mortar retail REITs hit by the double whammy of lockdowns and the continuing trend toward e-commerce, Ms. Ma says.
“We know that over the long term, e-commerce has already been nipping at its heels and the pandemic has really sped up all those barriers and the risks,” she says.
One positive outcome from the move to e-commerce, according to the report, is the growing demand for industrial space to meet logistic and warehousing requirements.
“Retail’s loss is industrial’s gain. We’ve seen a huge pickup in the demand for industrial space – particularly warehousing, logistics and distribution,” she says.
The report also singles out seniors housing as a good long-term investment as the bulk of the population ages.
The challenge in determining how much and which real estate subsectors belong in the portfolios of older investors who own their homes is made more difficult when determining how their residential real estate holding fits into the mix. The rapid rise in house prices over the past two decades and low interest rates have many tapping their homes for income through home equity lines of credit and reverse mortgages.
Lorne Zeiler, vice-president, portfolio manager and wealth advisor at TriDelta Investment Counsel, cautions homeowners counting on their homes for retirement income that too much of their fortunes could be confined to one subsector (residential real estate) in one geographic area (their neighbourhood).
“Things could always go bump in the night and to have 80 per cent or 90 per cent of your net worth tied to something is always a big risk,” he says, suggesting they consider diversifying into other areas of real estate.
“There isn’t necessarily a high correlation between industrial and residential real estate. When you own your own home, it’s a function of the residential market,” he adds.
Mr. Zeiler says he’s looking for real estate diversification in the U.S. southwest, where increased migration and immigration trends are pushing demand. He holds Tricon Residential Inc. (TCN-T), which currently pays out a 2.25-per-cent yield, and NorthWest Healthcare Properties REIT (NWH-UN-T), with an annual yield of 6 per cent.
Another option he suggests for real estate diversification is a REIT exchange-traded fund such as iShares S&P/TSX Capped REIT Index ETF (XRE-T), which currently pays a 4.5-per-cent yield after an annual fee of 0.55 per cent.
“The key is, are you in good areas and sectors where you see some visibility? I think there could end up being some phenomenal opportunities on the retail or office side,” he says.