Any diversified dividend portfolio should consider having a real estate investment trust (REIT) in it because REITs typically provide above-average income. The following REITs pay one to two times more income than the iShares S&P/TSX 60 Index Fund today.
Other than the immediate high income that’s paid out monthly, there are other advantages to buying REITs over rental properties. First, a REIT’s properties are diversified geographically, and second, they are managed by professional teams.
A residential REIT with a 5.9% yield
First, there’s Morguard North American Residential REIT (TSX:MRG.UN). Since its initial public offering in April 2012, the residential REIT has doubled its portfolio size to 12,850 suites across 30 apartment communities in the United States and 14 Canadian residential apartment communities in Alberta and Ontario.
Its occupancy rate in the U.S. is 94% and 98% in Canada. High occupancy levels and a low payout ratio of about 65% implies its yield is safe.
The REIT’s price-to-book ratio (P/B) is only 0.5, and its price-to-funds-from-operations ratio (P/FFO) is 10.2. Both ratios indicate it is trading at historically low levels and indicates good value.
An office REIT with a 9.7% yield
Second, there’s Dream Office REIT (TSX:D.UN), which rents out office properties to about 2,200 tenants. Its central business district properties generate roughly 70% of its net operating income (NOI). Geographically, the Greater Toronto Area generates 44% of its NOI, and Calgary generates 19%.
In March 2015 its occupancy level was just under 93%, and with a payout ratio of 80%, its 9.7% yield is safe.
The REIT’s consensus net asset value was around $30 in March 2015, while its shares today are close to $23, indicating a discount of over 23%. To confirm the shares are cheap, its P/B is at a decade low, which occurred in 2008 during the recession.
A healthcare REIT with a 10.2% yield
Lastly, there’s Northwest Healthcare Properties REIT (TSX:NWH.UN), which receives rent from medical office buildings, clinics, and hospitals. In July 2015 it merged with its international counterpart. The combined portfolio consists of 122 income-producing properties across major markets in Canada, Brazil, Germany, Australia, and New Zealand.
Because it just combined with its international counterpart, it wouldn’t be a fair comparison to compare with historical valuations. However, one indication that Northwest Healthcare’s shares are cheap is that the REIT is acquiring up to 10% of its public float for cancellation in the next 12 months starting from July 10, 2015.
In March the REIT calculated that after the merge, the occupancy rate would be just under 94%, and its payout ratio under 92%. The payout ratio is a bit high for my liking, so interested investors should keep that on their minds, but for the time being, the yield is sustainable.
Tax on the income
REITs pay out distributions that are unlike dividends. Distributions can consist of other income, capital gains, foreign non-business income, and return of capital. Other income and foreign non-business income is taxed at your marginal tax rate, while capital gains are taxed at half your marginal tax rate.
So, to avoid any headaches when reporting taxes, buy and hold REIT units in a TFSA or an RRSP. However, the return of capital portion of the distribution is tax deferred. So, it may be worth the hassle to buy REITs with a high return of capital in a non-registered account.
Of course, each investor will need to look at their own situation. For instance, if you have room in your TFSA, it doesn’t make sense to hold investments in a non-registered account to be exposed to taxation.
In conclusion
All three REITs are priced at low valuations, indicating they have capital gains potential no matter if they experience organic growth or not, while providing an above-average yield. The iShares S&P/TSX 60 Index Fund only pays a 2.8% yield, so these REITs pay one to two times more income.
