The Motley Fool

Why REITs Are the Next “it” Sector

After several months of falling out of favour, the real estate investment trust (REIT) sector may once again be ready to roar!

As the country has experienced higher interest rates over the past several months, it is completely understandable that investors have sold out of these securities (which are known for their high dividends and dependable cash flows). The challenge that is brought on by higher interest rates is twofold.

First, the higher risk-free rate of return has made the dividends paid by each REIT seem less attractive. What was a gap of 4% between a 5% yield and a 1% treasury bill has become a gap of only 3%, as the risk-free rate of return has moved closer to 2%. To ensure that an appropriate risk premium is maintained, shares needed to decline in value to increase the dividend yield.

The second reason for the decline is due to the higher interest costs that must now be shouldered by each REIT, as properties are refinanced and/or purchased. Essentially, the value of each property becomes less valuable, as the financing costs have increased.

In spite of a justified decline, investors may now be in a unique position to benefit from a pause in rate increases, as the current rate of interest may be approaching an invisible ceiling. In spite of very prudent government, the reality is that there is a lot of debt outstanding, and like every person and company, the government must finance its borrowing by paying interest to those willing to lend. As the probability of additional interest rate increases declines, investors may finally be in a position to deploy their capital in names that will pay generous dividends (even if there is a high degree of exposure to interest rates).

The first name for investors to consider is none other than Slate Office REIT (TSX:SOT.UN), which offers investors a very generous dividend yield of 9.5%, as the company continues to undertake a share buyback to attain a payout ratio that is less than 100%. As shares trade at less than tangible book value, investors will be able to benefit from the pay down of the mortgages with each passing month.

For those willing to remain patient, the rewards could be huge!

The second name for investors to capitalize on is Dream Industrial Real Estate Invest Trst (TSX:DIR.UN), which is in one of the most desirable industries. As industrial real estate is characterized by fewer customers with longer-term contracts, the fluctuations in revenues (and expenses) is very minor. For this reason, there has been a number of acquisitions in this space over the past year. It would seem that the “smart money” wants in.

At current prices, investors will receive a piece of a quality asset and a 7% dividend yield for being patient.

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 Ryan Goldsman has no position in any of the stocks mentioned.

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