Is it Smart to Invest in REITs in 2018?

REITs, like RioCan Real Estate Investment Trust (TSX:REI.UN), offer strong dividend income along with solid dividend growth.

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Real estate investment trusts — REITs for short — are not the most popular investments in the world. But with high distribution income and solid (if not frothy) returns, they’re a worthy consideration for any long-term investor. However, the performance of REITs is tied to that of real estate as a whole, which means that these securities may do poorly when real estate is cooling off.

So, is 2018 a good time to invest in REITs?

To answer that question, we need to look at the state of the Canadian real estate market.

A cooling real estate market

Broadly, the Canadian real estate market is cooling (and expected to cool further) in 2018. A recent Reuters report said that rising interest rates and new mortgage rules have led to a situation where home prices will rise just 1.7% this year. That might appear to be a modest gain, but remember that inflation is running at about 2.8% this year. This means that real estate on the whole is expected to lag the consumer price index, which, in practice, means a negative return (not factoring in rental income).

Valuation

Valuation is an important consideration when investing in REITs, even more so than with other types of stocks.

The reason? Investing in a REIT is somewhat like investing in a rental property, but with added costs. If you could buy a rental property and manage it yourself, why invest in a REIT that has a similar business model but with added expenses for employee and management compensation?

The above was the reason that Warren Buffett gave for not liking REITs in a talk a few years ago with MBA students. However, Buffett included a stipulation: if the price is low enough, a REIT may be worth it. For example, if a REIT has a price-to-book ratio so low that it’s valued less than the properties it owns, than it may make more sense than investing in property directly. But such a low price-to-book ratio would be extremely rare.

High distributions 

One thing REITs have going for them — even in today’s cool market — is high distribution income (“distributions” are like dividends for REITs). RioCan (TSX:REI.UN) currently pays a distribution of about $0.12 per month, which gives a yield of about 5.86% annually. This is well above the average dividend yield for a TSX stock. RioCan is also seeing some growth in its distribution, as it is up from $0.1175 a month last year.

Bottom line

Between high distributions, “OK” capital gains, and attractive P/E ratios, REITs have many things going for them. However, with a cooling real estate market, 2018 may not be the best year to buy in. But if you have a passion for real estate and don’t want the hassle of managing a property, buying REITs can be a great way to own a slice of Canada’s real estate market.

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 Andrew Button has no position in any of the stocks mentioned.

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