Don’t Bother With Investment Properties; Buy These REITs Instead

REITs offer a lot of advantages to investors compared to physical real estate.

| More on:
The Motley Fool
You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

It’s slim pickings for real estate investors in Canada’s big cities these days.

In most of our largest cities, investors have rushed in and bought condos en masse, driving up prices. This has driven down returns to the point where it’s common to see investors having to subsidize units that don’t collect enough in rent to cover the interest on the mortgage, condo fees, and property taxes. These investors are hoping for one thing — price appreciation.

Things are so overvalued that Boardwalk (TSX: BEI.UN), Canada’s largest apartment real estate income trust, came out with some interesting news. It would like to buy more units and expand its operations, but it can’t find apartment buildings that make sense. Valuations are just too high.

Let that sink in for a moment. There are tens of thousands of apartment blocks across the country — yet Boardwalk can’t find any to buy without paying too much. Am I the only one who finds this crazy?

For many real estate investors, the end of Canada’s housing boom is going to be a painful experience. Imagine buying a $400,000 condo with a $20,000 down payment. After a year, values have fallen 5%. Just this small decline wipes out the entire down payment. Suddenly, this investor is stuck subsidizing a property that’s not only going down in value, but also isn’t spinning off enough cash to pay for expenses. How long would you hold an investment like that?

If Canada’s real estate market sells off in a huge way, there’s no doubt REIT shares will suffer. In that type of situation, it’s very obvious that the REIT’s underlying properties are worth less than before.

How bad will it get? Most REITs are relatively conservative with their balance sheets, and have average loan-to-value ratios nowhere close to that of many individual investors. Most REITs give investors yields in the 6%-8% range, and should get gobbled up by income-hungry investors if yields get much higher. As Canadians fall out of love with real estate as an asset class, more folks should rent, increasing demand for rental property.

It’s obvious that REITs are the place to be during a real estate downturn.

REITs also give an investor one other huge advantage over someone who owns one or two physical units: diversification. If there’s a flood in the only condo someone owns, it could potentially be a disaster. In contrast, if a store closes down in a facility owned by RioCan (TSX: REI.UN), that’s 10,000-20,000 out of more than 80 million square feet of retail space. It’s such a minor issue that the company wouldn’t even bother disclosing it to investors.

RioCan is a terrific choice for investors looking for alternative real estate exposure. The company owns some of the finest retail space in the country, leasing to the heavyweights of the retail world. Even if Canada’s entire economy slows down significantly, huge numbers of stores aren’t about to shut down, especially in RioCan’s facilities, which are usually located in prime locations. The stock currently yields 5.1%.

Another terrific stock for real estate investors is Dream Office REIT (TSX: D.UN), the country’s largest owner of office space. The company owns 185 different office buildings, with more than 28 million square feet in space. Its top tenants are among the finest in the country, including Bank of Nova Scotia, Telus, and various levels of government.

Plus, investors are getting the shares cheap. The company is trading at just 10% above its 52-week low, and currently yields more than 7.6%. The reason the company is beaten up is because its current occupancy rate is a little disappointing, at 94%. Once the company gets it up above 95%, look for the shares to recover.

At this point, things are bound to end badly for investors who buy individual rental properties. Valuations have just gotten out of hand over the last few years. Investors should stick to REITs instead. Over the next few years, they’re bound to outperform any rental bought at the top of the market.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Nelson Smith has no position in any stock mentioned in this article. 

More on Investing

Profit dial turned up to maximum
Tech Stocks

$1,000 Invested in Constellation Software Stock Would Be Worth This Much Today

Constellation Software (TSX:CSU) is trading above $2,000 today. Why this stock is so expensive, and is it worth buying?

Read more »

Dividend Stocks

Passive Income: 3 Top Canadian Stocks to Buy for Monthly Dividends

Companies such as Pembina Pipeline and Killam Apartment REIT pay investors monthly dividends, making them top bets for income-seeking investors.

Read more »

Shopping card with boxes labelled REITs, ETFs, Bonds, Stocks
Stocks for Beginners

TFSA Investors: Top TSX Stocks to Buy With $6,000

Here are two safe, dividend-paying TSX stocks for your long-term portfolio.

Read more »

Gold medal
Investing

3 Growth Stocks That Could Be Huge Winners in the Next Decade and Beyond

Are you looking for growth stocks that could be huge winners in the next decade? Here are three top picks!

Read more »

Retirees sip their morning coffee outside.
Investing

Retirees: How to Make Over $95/Week in Passive Income TAX FREE!

Canadian retirees who are hungry for passive income should look to snag stocks like Sienna Senior Living Inc. (TSX:SIA) in…

Read more »

Man holding magnifying glass over a document
Investing

Where to Invest $500 in the TSX Right Now

Given the massive correction, long-term investors can start buying stocks like Shopify and goeasy to outpace the broader markets by…

Read more »

Aircraft wing plane
Investing

Air Canada Stock Is a Fantastic Deal Right Now

Air Canada (TSX:AC) is a great stock to own, as market fear turns into hope amid falling recession fears.

Read more »

Pixelated acronym REIT made from cubes, mosaic pattern
Investing

Beginner Investors: Get Passive Income by Investing in REITs!

You can get passive income by investing in REITs like Northwest Healthcare Properties REIT (TSX:NWH.UN).

Read more »