In a column last summer, I discussed the benefits of owning apartment real estate investment trusts.
Apartment REITs provide steady cash flow that grows over time, without the hassles – such as problem tenants and maintenance headaches – of being a landlord. What’s more, because apartment REITs provide exposure to a large and diverse collection of rental units, a few vacancies here and there won’t have a material impact on your cash flow.
If you invest directly in a rental property, on the other hand, even missing out on a couple of months of rent could put a serious dent in your finances.
Since the column appeared in August, the three REITs I featured have posted solid gains. Canadian Apartment Properties REIT (CAR.UN) is up 8.6 per cent on a total-return basis (assuming all distributions had been reinvested), InterRent REIT (IIP.UN) has gained 28.4 per cent and Killam Apartment REIT (KMP.UN) has returned 7.6 per cent.
Today, I’ll provide an update on Canadian Apartment Properties REIT – CAP REIT for short – and discuss why I believe it’s a solid choice for investors seeking income with a dash of growth. I plan to revisit the other two REITs in future columns.
(Disclosure: I own InterRent and CAP REIT personally, and I also hold CAP REIT in my model Yield Hog Dividend Growth Portfolio.)
A diverse – and growing – portfolio
One of Canada’s largest residential landlords, CAP REIT owns more than 50,000 residential rental suites and leased-land sites. If real estate is all about location, CAP REIT has a big advantage: About 44 per cent of its apartment units are located in Ontario, with more than two-thirds of those in the fast-growing Greater Toronto Area. Outside of Canada, it has a growing presence in the Netherlands and owns a 15.7-per-cent stake in Irish Residential Properties REIT PLC. Further enhancing diversification, its rental portfolio is spread across the “affordable,” “mid-tier” and “luxury” segments. The REIT has a long track record of making profitable acquisitions, having grown from just 2,900 units when it went public in 1997, and there’s lots of growth to come.
A strong – and flexible – balance sheet
Earlier in March, CAP REIT closed a $172.6-million offering of units, with most of the net proceeds going to pay down a credit facility. This reduced CAP REIT’s leverage – the ratio of debt to the gross book value of its properties – to 42 per cent, which is down from 43.6 per cent at the end of 2017 and “the lowest (we believe) in the REIT’s history,” Raymond James analyst Ken Avalos said in a note. “In our view, the balance sheet is as flexible as it has ever been and growth is still ripe for the taking given strong apartment fundamentals across Canada.” In addition to making acquisitions, CAP REIT has the flexibility to grow through developments or intensifications of existing sites.
A growing distribution
CAP REIT has raised its monthly distribution in each of the past six years, at a compound annual rate of about 2.9 per cent. Yet, thanks to the REIT’s rising cash flow – driven by acquisitions and rising rents – the distribution payout ratio has been falling. For 2017, CAP REIT paid out 71.7 per cent of funds from operations (FFO) – a cash-flow measure used in the REIT industry – down from 73.7 per cent in 2016. Using adjusted cash flow from operations (ACFO) – a more stringent measure that deducts non-discretionary capital expenditures and other items – the payout ratio fell to 84.4 per cent in 2017 from 88.7 per cent in 2016. The yield of 3.6 per cent is modest for a REIT, but the falling payout ratio indicates that the distribution is well-protected and has room to grow.
High occupancy – and rising rents
When people can’t afford to buy homes, they rent. That’s good news for CAP REIT, whose overall occupancy was 98.7 per cent at the end of 2017. What’s more, strong demand for apartments is pushing up rents, particularly when new tenants move in and CAP REIT can implement increases above rent-control guidelines. In the fourth quarter, for instance, average monthly rents rent jumped 9 per cent on suite turnovers, compared with about 2 per cent on lease renewals. Reflecting favourable supply and demand dynamics in the GTA and other major markets, “leasing spreads on turnover … have been accelerating rapidly over the past seven quarters,” RBC Dominion Securities analyst Neil Downey said in a note. That’s not good for tenants, but it’s good for CAP REIT investors.
Reasonable –but not cheap – valuation
Trading at about 19 times estimated 2018 FFO, CAP REIT’s units aren’t cheap, but analysts say the premium valuation is warranted given the REIT’s high-quality portfolio that churns out stable cash flows. This is not the sort of stock that is likely to generate huge returns, but if you’re looking for relatively safe, solid and growing distributions – and you like the idea of owning real estate without getting your hands dirty – CAP REIT may be worth a closer look.
Remember to do your own due diligence before investing in any security.