Some investors avoid real estate investment trusts (REITs) because they grow at a snail’s pace.
However, REITs are excellent income vehicles because they pay monthly cash distributions. Moreover, there’s a way to boost both the income and the price appreciation potential from your REIT investment.
The number one rule is to buy it at a discount. In doing so, you get three benefits. Here’s an example with Artis Real Estate Investment Trust (TSX:AX.UN).
When you buy shares of a company at a lower price, and if the company maintains its payout, you’ll get a higher yield. One year ago, Artis REIT traded at about $13.40 per unit and yielded a little over 8%.
At the current, lower price of $11.70 per unit, Artis REIT yields 9.2%. Its annual payout of $1.08 per unit hasn’t changed, but thanks to the lower unit price, investors buying now can get an income increase of more than 14%.
Higher price-appreciation potential
Now, just because the share price falls doesn’t necessarily mean the company is discounted. That’s where valuation metrics, such as the price to book ratio (P/B), can be useful.
Artis REIT trades at a P/B of 0.75, which means it trades at a discount of 25% from its book value. For comparison, its average P/B over the last five years was 0.92.
In the last decade, it has traded between a P/B of 0.66 and 2.17. It reached the low end of the spectrum during the financial crisis in 2008. It’s evident from the wide range in the spectrum that there’s a chance that the units can trade at a P/B of one again.
In any case, the less you pay for Artis REIT’s units, the higher your price-appreciation potential.
Should the presumed depressed units be affected by temporary issues or macro events, the lower the valuation you pay will be for the units; not only will you increase your price-appreciation potential, but you will also reduce your investment risk.
Artis REIT can trade north of a P/B of one again if the Albertan economy recovers. If so, then the REIT has at least 30% upside potential. Investors can get a 9.2% yield that’s supported by an adjusted funds from operations payout ratio of about 91%.
The bigger the discount when you buy, the lower the risk you take on and the higher your price-appreciation potential.
Since Artis REIT earns about 30% of its net operating income from Alberta, its unit price is affected by the cyclical nature of energy prices. So, some investors may require a discount of at least 30-50%, equating to a price range of $7.80-10.92 per unit, before investing.
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 Kay Ng has no position in any stocks mentioned.