Investors who want to bargain hunt in Canada’s battered REIT sector may want to consider five suggestions from CIBC World Markets.
InterRent REIT (IIP.UN), Canadian Apartment Properties REIT (CAR.UN), Granite REIT (GRT.UN), Killam Apartment REIT (KMP.UN) and Summit Industrial Income REIT (SMU.UN) all look attractive at their current levels, according to a report from Ian de Verteuil, head of portfolio strategy at CIBC.
More broadly, his research offers an intriguing look at the “factors,” or characteristics, that tend to identify winners among real estate investment trusts.
This is a timely topic given the hard times many landlords are enduring. Canadian REITs, as a group, are down more than 20 per cent since the start of January.
Their fading value reflects concern about how rental payments will hold up in a pandemic-stricken economy.
Lockdowns have hammered the bottom lines of bricks-and-mortar retailers and restaurants. A shrinking economy has also crimped demand for warehouses, offices and apartments. All of that suggests rental payments are going to fall considerably short of what most REITs were projecting at the start of the year.
Demand in some areas may not bounce back quickly. The need for office space, for instance, could remain depressed for a long time if the current trend to working from home becomes permanent. The same holds true for retail locations if the recent shift to online shopping never reverses.
Take a step back from the current troubles, though, and some REITs, particularly in the residential and industrial sectors, still hold long-term appeal for patient investors. (Indeed, each of CIBC’s five picks fall in one of these two categories.) Assuming the pandemic eases over the next few months, demand for apartments and industrial spaces should recover from today’s troubles.
So what should bargain hunters look for in choosing REITs in these areas? If the past few years are any guide, they should search for REITs that have achieved high increases in net asset value (NAV) and funds from operations (FFO), as well as above-average dividend growth, according to the CIBC report.
Smart investors should also bet on momentum – that is, they should buy the REITs that have enjoyed the biggest gains in recent months. This strategy has generated strong performance in recent years, Mr. de Verteuil finds.
He notes his conclusions are in keeping with a report last year from the REIT team at CIBC that found investors could do well by buying the previous year’s best performing REITs every January. This simple strategy of betting on winners generated better returns over the subsequent year than holding all REITs.
But forget about chasing yield in the sector. Contrary to what you might expect, REITs with higher-than-average yields do not generate superior returns. Just the opposite. In both Canada and the United States a strategy of buying the 20 per cent of REITs with the highest yields generated worse returns than simply buying an equal mix of all REITs.
Yield and momentum may be opposite sides of the same coin, Mr. de Verteuil points out. A high yield tends to go hand in hand with poor momentum.
“If a REIT has poor momentum and is well off its 52-week high, its yield is likely to be high – as long as the payout hasn’t been cut recently,” he writes. “A high yield may be a sign that the distribution is considered aggressive.”
If so, investors should steer clear on the assumption the yield will be trimmed. Instead, they should focus on REITs with moderate yields and rising momentum, like the five cited in the CIBC report.
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