Over the past month, a very interesting thing has happened to many real estate investment trusts (REITs): they have declined in value.
As interest rates head higher, the cost on variable borrowings and new financing will increase as time moves forward. The beauty for investors is, the higher rates of interest which have been priced into the REIT sector may be overdone. Given that increasing interest rates make borrowing more expensive for everyone (including REITs), investors may simply be overreacting to the perception of the higher future costs to borrow money.
Given the decline in share prices for many REITs, the dividend yields have increased in tandem and continue to offer investors a comparable premium above the risk-free rate of return but currently carry less risk than in the past. Dream Office Real Estate Investment Trst (TSX: D.UN) completed a substantial issuer bid via dutch auction in the past few weeks, retiring close to 20% of the total amount of shares outstanding. Following this, the company proceeded to renew a normal course issuer bid with the potential to reduce the float by another 10%.
For investors holding shares of the office REIT, the current share price of slightly more than $20 is paying a yield of almost 5% while trading at a discount to tangible book value of 10%. As of the end of June, the tangible book value per share was no less than $22.25 per share. Given the higher rates of interest, this REIT, like many others, has experienced a headwind given the expected higher borrowing costs which are coming. The good news for investors in the next year: the company will be the rolling over debt which is currently costing the company more than 5% as interest rates are only beginning to rise. The company’s borrowings could still be refinanced at a lower rate of interest.
Another REIT investors will want to consider is the very well known RioCan Real Estate Investment Trust (TSX: REI.UN). After selling off by more than 5% over the past three months, RioCan currently offers a dividend yield of almost 6% while trading at a slight discount to tangible book value. Given the company’s trailing P/E (price to earnings) ratio of less than 11 times earnings, investors are not only getting assets of equal value to the share price, but they will continue receiving dividends on a monthly basis from their REIT in addition to paying a reasonable multiple for this investment.
For investors worried about rising rates, it is worth noting that, like Dream Office Real Estate Investment Trst, almost 20% of the current debt outstanding will be coming up for maturity in the 2017 fiscal year.
Although rising rates have led to a decline in the share prices for most REITs, investors need not be discouraged. Due to the higher rates, there are more names in bargain bin that offer a high level and value in addition to excellent dividend yields.
