REIT Yields Are Currently Very Attractive

Higher interest rates in Canada, the U.S. and many other parts of the world have made high-yielding securities, including real estate investment trusts (REITs), much less appealing compared to bonds for income-seeking investors. In fact, over the past two years or so, ETFs focused on U.S. and Canadian REITs have dropped significntly.

Going forward, the outlook for industrial, multi-family and retail properties is positive—although a recovery in office properties is unfolding more slowly.

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All in all, with interest rates in the U.S. and Canada possibly at or close to their peak levels, the prospects for many high-quality REITs are now quite attractive.

REITs have lost substantial value

Over the past two years—a time when interest rates moved up significantly—REITs, and the ETFs that hold them, suffered significant losses in value.

At the same time, looking at the price movement and total return of an ETF that tracks 7- to 10-year U.S. government bonds: large losses were also recorded by this ETF as interest rates moved up and pushed bond prices down.

Are REITs undervalued?

The valuation of real estate can be a complex exercise, with metrics such as price-to-net asset value and price-to-cash flow being the most prominent.

Nevertheless, many individual investors simply compare the distribution yields of REITs to the interest rates on savings accounts, bonds, or GICs. This is the approach that we will take here in our comparative analysis.

As the unit prices of REITs have declined sharply over the past two years, the distribution yields have increased for those REITs maintaining or lifting their distributions.

Notably,  the distribution yields currently available on a selection of REITs are significantly higher compared to their average yields for the past decade. (Canadian Apartment REIT is the only exception.)

The current average yield on the six REITs is 5.31%, much higher than the average yield of 3.99% that prevailed over the past 10 years.

Comparing the current REIT yields with government bond yields shows that the average REIT yield of 5.31% is much higher than the 4.17% average of U.S. and Canadian 10-year government bond yields. However, the spread of 1.14 percentage points is less than the spread of 1.90 that prevailed over the past decade.

Where to from here?

With inflation and interest rates appearing to be at or near their peaks, we think this is now a good time for income-seeking investors to buy high-quality REITs or the ETFs that hold them. And should interest rates begin falling, REITs could add capital gains to the attractive distribution yields currently available.

The best REITs give you exposure to real estate that would be difficult for an individual to buy on their own. Meanwhile, here are two key ways to cut your REIT risk: look for REITs with broad exposure to many different geographic regions; and focus on REITs with high-quality tenants in a variety of industries.

4 REIT investing questions to ask before buying

1. Did the REIT buy its assets in the midst of a recent boom, or has it owned them for some time? Bidding for assets in the midst of a boom tends to be risky, since it can lead to unpleasant investment surprises.
2. How much debt is the REIT carrying? This is an important question for both Canadian REITs and others. You need to gauge the debt in relation to all assets, including those that are hidden and those that appear on its balance sheet. Too much debt in relation to assets can lead to a steeper downturn in distributions when the business hits a snag.
3. Are there any special factors worth considering? With REITs, you need to look at the quality of tenants, length of leases and the possibility of improving the use or expanding the occupancy of existing properties. That applies to Canadian REITs as much as their region or city of focus.
4. Is the REIT the subject of a lot of favourable broker and media attention? If so, investor expectations may be excessively high, and that leaves the trust vulnerable to a steep downturn on any hint of bad news.

We still advise against overindulging in REITs, including Canadian REITs. But if you stick with high quality trusts, they can make attractive, low-risk additions to your portfolio.

Do you or will you invest in REITs? Are REIT yields a factor?