The Canadian stock market is up about 70 per cent since the worst of the 2020 crash, which presents a problem for investors looking to branch into something new.
Take real estate investment trusts. “I’d like to buy some REITs or add REIT ETFs to my portfolio,” a reader told me the other day in an e-mail. “What are your thoughts on buying REITs at this time?”
My thoughts are this: It’s not an especially good time to buy REITs, but the same holds true for most of what trades on the TSX. Buy REITs for income and modest growth potential in the near term.
If you listed sectors that were hard hit in the pandemic, REITs would deserve a top ranking. When the pandemic first hit, it was not a great time to be a landlord of office and retail properties. The S&P/TSX Capped REIT Index plunged 26.6 per cent on a total return basis in the first quarter of 2020, compared with almost 21 per cent for the broad-market S&P/TSX Composite Index.
Since then, REITs have rebounded impressively with a 12-month total return of 39 per cent to July 31, compared with 29 per cent for the Composite. The timing for a return to normalcy in the economy is still in question, yet REITs as a sector are trading at levels close to prepandemic times.
Looking ahead, economic disappointments are one risk for REITs. Another risk is rising interest rates, which would occur if the economy gains momentum and inflation persists. Rising rates make the yields from REITs look less attractive and also raise the cost of financing properties.
However, a study done by Standard & Poor’s a few years ago found that REITs in the U.S. market have stood up to rising rates fairly well since the early 1970s. In most periods of rising rates, REITs either performed in line with the broader market or exceeded it. The most likely explanation is that the economic strength that pushes rates higher is also good for the real estate business.
Strong price growth for REITs has limited the income potential from their distributions, but you can still do much better than bonds and guaranteed investment certificates. Exchange-traded funds holding a diversified basket of REITs currently yield in the 2.8- to 4-per-cent range.
If you go the ETF route, note the comparatively hefty fees charged by some funds – management expense ratios can be as high as 0.8 per cent or more. A lower-cost option is the Vanguard FTSE Canadian Capped REIT Index ETF (VRE-T), at 0.38 per cent.
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