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A little-known REIT I’m now recommending as the sector makes a surprise rebound

Real estate investment trusts should be taking a beating right now. They’re interest-sensitive securities, which means when rates rise, they should fall in value.

They followed that rule early in the year, as the S&P/TSX Capped REIT Index dropped to below 156 in March. But since then, the sector has been on a roll, with the index closing on July 13 at just over 171. That’s a gain of almost 10 per cent at a time when we would normally expect to see a loss.

Why the turnaround? Interest rates are still moving up, after all. There appear to be two main factors driving this recovery and both relate to the expanding global trade war. The first is that REITs are relatively immune to trade battles (although not to the economic fallout if the end result is a recession). The second is that investors appear to be increasingly concerned that the impact on global trade may result in reduced GDP growth and slow, if not reverse, the interest-rate trend.

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Whatever the reason, the net result is that REIT investors are experiencing a much better year than originally anticipated.

As a result of all this activity, I am adding a new REIT to the recommended list of my Income Investor newsletter. Here are the details.

Summit Industrial Income REIT (SMU.UN)

Current price: $8.86

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Annual payout: 51.6 cents

Yield: 6 per cent

Risk rating: Moderate risk

The business: This REIT invests in a portfolio of light industrial properties. Its prime focus is on Ontario and Quebec. As of the end of March, the REIT owned 84 income-producing properties totalling 8.9 million square feet of gross leasable area.

The security: Technically, a REIT is an open-ended mutual fund trust. Monthly payments are in the form of distributions, not dividends, so are subject to a different tax treatment (more on this below).

Why we like it: The REIT has been on a steady upward trend for the past 18 months. Payouts are steady, with an occasional bonus thrown in, and the yield is attractive.

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Financial highlights: First-quarter results showed strong growth, due mainly to acquisitions and high occupancy rates. Funds from operations (FFO), the primary measure of financial health for REITs, increased 75.7 per cent to $9.7-million compared with $5.5-million for the same period in 2017. On a per-unit basis, that worked out to 14.5 cents compared with 13.8 cents a year ago. The average number of units outstanding increased to 67.2 million from 40 million as the REIT issued new shares to raise money to fund acquisitions.

The company has been actively acquiring new properties. The latest deal, announced in June, is for five warehouse and logistics properties located in Markham and Burlington in Southern Ontario, and Calgary, at a total cost of $127-million. Together, these properties total 798,673 square feet of gross leasable area.

Risks: Although they have not been significantly affected to date, REITs are sensitive to rising interest rates for two reasons: They are heavily leveraged (that’s the nature of the business) and higher returns on safe government bonds put downward pressure on the unit price. Another risk to consider is a recession, which could result in lease defaults, lower occupancy rates and affect the trust’s ability to raise rents.

Distribution policy: Payments are normally made monthly and are currently running at 4.3 cents a unit. In addition, the REIT made a special distribution of 1.8 cents a unit in May.

Tax implications: In 2017, all the distributions were classified as return of capital. That means they are not taxed in a non-registered account, but the amount of the payment is deducted from the cost base, which increases the capital gain when the unit is sold. For example, if you paid $8 for your units last year, you would deduct the total distribution of 51.6 cents from that amount, giving you an adjusted cost base for tax purposes of $7.484.

Who it’s for: This REIT is suitable for investors who are willing to accept a moderate amount of risk in exchange for an above-average yield.

Summing up: This REIT is not well-known, but it is focused on an area of high demand and the track record suggests strong management. It is aggressively expanding its portfolio and the market performance in recent months has been very positive.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.

Follow Gordon Pape on Twitter at twitter.com/GPUpdates and on Facebook at facebook.com/GordonPapeMoney.

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