Why moving into apartment REITs makes sense right now
One of my friends just bought an investment property. It’s an older, run-down house near the university where his son is living in residence. The plan is to fix it up and have his son and some roommates move in next year.
He got the house for a good price, and it may well turn out to be a great investment.
But you won’t catch me buying an investment property.
Don’t get me wrong. I love the idea of investing in real estate. It’s just that I have no interest in the hands-on aspects, such as collecting rent, fixing toilets or evicting tenants who build a grow-op in the basement.
Fortunately for people like me, there’s an asset class called apartment real estate investment trusts. These businesses, also known as multifamily or residential REITs, give investors the benefits of owning real estate – namely steady income and long-term capital appreciation – without the hassles.
Residential REITs invest primarily in apartment buildings but some also own townhomes and leased-land communities. Now is an especially interesting time to consider apartment REITs, for a few reasons.
First, a tight rental market is driving up rental rates. Rent controls limit annual increases for existing tenants, but when suites turn over rents adjust to higher, market rates, providing an earnings tailwind.
Second, even as rents are rising, unit prices for apartment REITs have fallen substantially. This reflects surging inflation, which raises operating expenses for REITs, and higher interest rates, which increase borrowing costs and decrease property valuations. Also weighing on unit prices is the federal government’s 2022 budget pledge to explore “potential changes” to the tax treatment of corporate owners of real estate.
The silver lining? Because unit prices are down, distribution yields have risen. What’s more, with a lot of the bad news about inflation and interest rates already baked into unit prices, further downside risk may be limited. All of this means that, just like my friend’s rental house, REITs are selling at bargain prices.
“We’ve been adamant that there is a window to buy Canadian multifamily REITs at a once-in-a-decade discount, a window that closes” once Ottawa drops its review of the asset class, said Johann Rodrigues, an analyst with iA Capital Markets, in a recent research note. “The window is closing so take advantage quickly.”
Here are three apartment REITs worth considering:
Canadian Apartment Properties REIT
Price: $44.56
Yield: 3.3 per cent
Canadian Apartment Properties REIT is Canada’s largest residential landlord, with about 67,000 rental suites and land-lease sites in Canada and the Netherlands. Thanks to strong expense controls and an 11-per-cent lift in rents on suite turnovers, CAP REIT’s same-property net operating income – essentially rental income minus operating expenses for suites in the portfolio – rose 2.7 per cent in the second quarter.
Yet the units have plunged about 28 per cent in the past year and now trade more than 15 per cent below the REIT’s estimated net asset value per unit. “We believe CAP REIT’s discount valuation remains compelling,” Brad Sturges, an analyst with Raymond James, said in a note to clients.
Even in a recession, CAP REIT should hold up relatively well, analysts say. The REIT’s “size, liquidity and stable cash flow profile are attractive in the event of slowing economic activity,” Kyle Stanley of Desjardins Securities said in a note.
InterRent REIT
Price: $12.15
Yield: 2.8 per cent
InterRent REIT owns more than 13,000 apartment units in major metropolitan areas including Toronto, Hamilton, Ottawa, Montreal and Vancouver. One of the REIT’s specialties is acquiring older buildings and upgrading suites, common areas and exteriors to increase revenue “while extending the useful life of buildings that would otherwise be heading for demolition,” InterRent said in its second-quarter earnings presentation. More recently, the REIT has also purchased newly built assets and has several developments in progress.
Even as InterRent’s average rent per suite jumped 7.1 per cent in June from a year earlier, the unit price has tumbled about 31 per cent in the past year. One factor is elevated vacancies in Montreal, reflecting weakness in the flow of international students because of COVID-19. But with universities returning to in-person classes, demand for rental housing should improve, particularly as student visa-processing delays are resolved. Ottawa, another soft market, has also started to bounce back as people return to offices downtown.
Boardwalk REIT)
Price: $48.48
Yield: 2.2 per cent
When energy prices were collapsing and Alberta’s economy was on the ropes, Boardwalk REIT was the undisputed dog of the residential REIT market. Not any more. Thanks to higher oil and gas prices, Calgary and Edmonton are once again experiencing population and employment growth.
That’s great news for Boardwalk, which has about 62 per cent of its portfolio in Alberta. It also explains why Boardwalk’s unit price has risen slightly in the past year even as other apartment REITs have been getting crushed.
Mr. Stanley of Desjardins Securities recently upgraded Boardwalk to a buy rating, citing second-quarter results that topped expectations, good cost controls and an attractive valuation.
But he warned that Boardwalk isn’t without risks. For one thing, the REIT is more leveraged than its peers, which “presents a risk in the current interest rate and macro environment,” he said.
Full disclosure: The author owns CAR.UN and IIP.UN personally and holds CAR.UN in his model Yield Hog Dividend Growth Portfolio.