Passive income lovers have long been attracted to Canada’s top REITs, enticed by the combination of attractive distributions and capital gains as the value of underlying properties go up.
The average REIT in Canada offers a yield in the 5% range. That’s a great payout — especially when compared to traditional income sources like GICs or government bonds — but it doesn’t cut the mustard for some investors.
Today let’s take a look at how you can use Northview Apartment REIT (TSX:NVU.UN) and the options market to generate an eye-popping 12.5% yield.
I’ve been recommending Northview to investors for years now, enticed, like other investors, by its interesting portfolio and above-average yield versus other apartment REIT peers.
Northview’s portfolio has long focused on Northern Canada, with approximately 30% of its net operating income coming from the Northwest Territories and Nunavut. The company has used these earnings to help fund expansion into other parts of the country, including a big push into the Ontario market. Some $333 million worth of assets were acquired in 2018, which Northview did while dropping its debt-to-assets ratio below 54%.
It is also expanding into other asset classes, which include more than 1.1 million square feet of gross leasable commercial space and 344 executive suites.
Northview’s current yield is just over 5.9%, and it also comes with an attractive payout ratio. In 2018, the company earned $2.11 per share in funds from operations while paying out just $1.63 per share in distributions, which gives us a payout ratio of approximately 77%. Some investors are even speculating the distribution will go up in the near future.
Investors are getting all this for a lower multiple than Northview’s peers. Shares are trading at approximately 13 times trailing funds from operations, versus an average of closer to 20x for the company’s competitors.
Here’s how investors can use the options market to really goose their dividends from Northview.
The strategy we’re going to use to more than double Northview’s existing 5.9% yield is something called writing a covered call option. It seems complicated, but it’s actually quite simple.
The first step is to buy Northview shares. This is important because part of writing a covered call option is creating an obligation to sell shares if they surpass a certain price on a certain day.
It’s easiest if we look at a real-life example. As I write this, Northview’s $30 June 21st call options are selling for $0.15 per share. The first step is to sell this option, which gives the Northview shareholder income of $0.15 per share immediately.
In exchange for this income, the shareholder has created an obligation to sell their shares if the price surpasses $30 per share on June 21st.
There are two ways this trade can possibly end. The ideal solution would be to keep the $0.15 per share while the stock languishes under $30. The other outcome is the stock surges past $30, which would lock us into a profit of 10.6% (including Northview’s monthly dividend and the option premium); that’s not bad for a little over a month.
The combined income from Northview’s monthly dividend and the option premium gives us an annual return of 12.5%. The only thing stopping investors from getting more than 1% on their Northview investment each month is the underlying share price cooperating. But as I explained earlier, that’s not such a bad outcome.
The bottom line
Covered calls can be an incredibly useful income generation tool, something that countless investors have used over the years to really goose their income. As demonstrated with Northview, the strategy can generate some pretty impressive yields. Perhaps it’s time to add this type of trade to your repertoire.
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Fool contributor Nelson Smith has no position in any of the stocks mentioned.