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.
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Fool contributor Kay Ng has no position in any stocks mentioned.