Over the last six weeks or so, just about every interest rate-sensitive stock in North America has gotten crushed thanks to fears of the Federal Reserve finally increasing interest rates after nearly a decade of inactivity. Shares are down anywhere from 10-20%, sometimes more.
I’m of the opinion that some of this decline is overdone. Canada’s economy continues to be weak, with speculation that the Bank of Canada might actually cut rates dominating headlines. In that scenario, the price of REITs and other interest-sensitive stocks will likely rally as investors flee to safer assets.
RioCan Real Estate Investment Trust (TSX:REI.UN) is one of the stocks affected in this downturn. Is now the time for investors to buy the stock, or is there still more pain to come?
Quality assets
One of the main things investors look for is a sustainable competitive advantage. RioCan boasts a great one, owning billions of dollars of real estate that can’t be easily replaced.
The company owns 340 different shopping centres, boasting nearly 80 million square feet in gross leasable area. It’s also incredibly diversified, with no tenant accounting for more than 5% of its revenue. This makes it a reliable proxy for the economy in general.
The type of assets that RioCan owns will always be attractive to potential investors. Thus, it’s easy to make the argument that investors should buy the company at just about any point.
Is it all about rate?
Lately, the entire REIT sector has become a proxy on interest rates. Canada’s largest REITs sold off some 20% during 2013 when the Federal Reserve announced it would no longer be buying large amounts of government debt. It appears something similar is happening now.
But over time the relationship between REITs and interest rates is less pronounced. Remember, rates rose during the mid-2000s as well, and REITs performed well during that time. Of course, most REITs traded at a lower valuation back then, which adds another variable into the analysis.
And when you compare its valuation with the last few years, RioCan is reasonably valued. In 2014 the company earned $1.65 in funds from operations (FFO) per share. Shares currently trade hands at $26.69, which puts the price-to-FFO ratio at approximately 16.5. If you combine that with the company’s 5.3% dividend yield, there’s an argument to be made that shares are actually pretty cheap, at least compared with recent valuations.
Growth
RioCan has a couple of interesting growth projects on the horizon.
The first is a partnership with Hudson’s Bay Company. The two companies have teamed up in an attempt to monetize some of HBC’s vast real estate assets. After making a few more acquisitions to beef up the portfolio, the new company will go public with RioCan both managing it and having a sizable equity stake.
The other growth area is using some of its existing space to build high-rise condos. These condos will be in high demand because they’re close to shopping, public transit, and other amenities. They’re attractive for the company to develop because costs are significantly lower than building from scratch because much of the infrastructure is already in place. Management hasn’t decided whether the company will keep these condos and rent them out, or just sell them.
Either way, it’s a nice thinking-outside-of-the-box idea from management.
Should you buy?
RioCan looks to be pretty attractively valued. Shares offer a dividend north of 5%, and the price-to-FFO ratio is relatively cheap. But over the short term, the story of interest rates will dominate this stock. For investors with a long-term view, this is just noise, but patient investors might be looking at a better entry point down the road.
