When Choice Properties Real Estate Investment Trust reported its second-quarter financial results this week, one of the key takeaways was that more of its retailing tenants are paying their rent. Does the upbeat news apply to other REITs?
The REIT sector is languishing amid uncertainty over the financial health of its tenants. REITs that are exposed to the retailing sector – which has been devastated during the pandemic by the triple whammy of store closings, the threat of bankruptcies and surging levels of unemployment – have been hit particularly hard.
RioCan REIT, which owns 222 retail and mixed-use properties, has seen its unit price collapse 46 per cent since February, even as much of the Canadian economy has reopened and the S&P/TSX Composite Index has recovered to within 11 per cent of its record high.
SmartCentres REIT is down 37 per cent. First Capital REIT is down 39 per cent, CT REIT (which has Canadian Tire stores among its anchor tenants) is down 21 per cent and Crombie REIT is down 22 per cent.
The tumbling unit prices – and stable monthly distributions – have raised dividend yields to a range between 5.8 per cent (CT) and 9.4 per cent (RioCan), underscoring why the sector may appeal to investors wondering if there is potential for a turnaround here: You get paid handsomely while you wait.
The second-quarter results from Choice Properties suggest that there is a compelling bullish case for retail REITs at today’s beaten-up prices.
First, the rate of rent collection is improving as the economy reopens. Choice Properties (where Loblaw stores are the principal tenants, accounting for 56.6 per cent of gross leasable area) said that it has collected or expects to collect 93 per cent of monthly contractual rent from its retail tenants in July.
That’s up from successful rent collection of 88 per cent in the second quarter ended June 30, and a low of 86 per cent in April.
Rent collection from industrial tenants improved to 99 per cent in July, up from 97 per cent in the second quarter. Although rent collection from office tenants held steady at 89 per cent, these tenants account for a small slice of the revenue pie.
The takeaway here: “This is an encouraging sign as our rent collections are steadily improving each month, as more tenants are getting back to business,” Rael Diamond, Choice Properties’ chief executive, said on a conference call with analysts.
Second, expiring leases this year are nothing to worry about. Just 1.9 per cent of Choice Properties’ gross leasable area is expiring by the end of 2020, and the average base rent for this space is $11.85 per square foot. That’s well below the average base rent of $14.69 per square foot for the entire portfolio, which implies that renewals could be lucrative.
Third, Canadians are buying again. Statistics Canada estimated that retail sales increased 24.5 per cent in June, following an 18.7 per cent increase in May. This could be owing to pent-up demand after the lockdown, but it’s an encouraging sign for struggling retailers and their landlords.
No doubt, there’s a lot of uncertainty ahead because of the continuing pandemic and its longer-term impact on the economy. Retail bankruptcies are among the biggest threats to REITs.
Dean Wilkinson, an analyst at CIBC World Markets, noted this week that retail bankruptcies are probably heavily weighted toward small businesses. Retail REIT exposure to these tenants, though, is less than 10 per cent, on average.
“We found that retail-centric REIT valuations are reflecting a much worse outcome than that which is likely to prevail,” Mr. Wilkinson said in a note.
Choice Properties is arguably one of the safer bets in the retail REIT sector, given the fact that Loblaw is a healthy, stable tenant. The REIT’s relatively low dividend yield of 5.9 per cent suggests some confidence among investors.
RioCan and SmartCentres, on the other hand, have yields above 9 per cent, reflecting greater risk because of a broader tenant base. But the opportunity in this sector, especially after Choice Properties’ financial results, is hard to ignore.