When times are uncertain, you really want to stick to quality assets that you know will appreciate over time. Frequently, these stocks are situated within industries that have stable demand and offer a product or service that customers need. Groceries, power, and now the internet are all examples of investments that could fit into this list.
Another major need, most people would agree, is to have a place in which to live. In Canada, a lot of people own their own homes. But over time, as asset inflation continues to rage on, homes are increasingly beginning to climb out of reach of most people’s ability to buy. Rental units, then, become the best alternative. This REIT will generate $138 in passive income on 100 shares every year tax-free in your TFSA.
A low-risk REIT
The best Canadian REIT to own for rental income by far is Canadian Apartment Properties REIT (TSX:CAR.UN).This REIT is focused solely on rental properties, significantly reducing its exposure to economic shocks. It also has exposure outside Canada, increasing its overall diversification.
One of my favourite aspects of this REIT is the fact that it has heavy exposure to large Canadian urban centres such as Toronto and Vancouver. Usually, this exposure would be negative for me due to elevated real estate prices. For rental properties, however, elevated prices are a long-term positive.
Living conditions are sticky, after all. Families tend to stay in the same area due to factors like schools, friendships, and work. People are unlikely to leave their homes and move around. Furthermore, real estate prices would have to drop significantly for people to switch from renting to owning. Any economic weakness reducing home prices will most likely affect wages as well, reducing buying power. These factors will probably keep people in their rentals.
This REIT has one of the smallest yields in the entire Canadian REIT space. Currently, Canadian Apartment REIT has a yield of about 2.86%. On an absolute basis, this low yield seems attractive compared to the yields of 7-12% you can find elsewhere. There are a number of factors, however, that make this lower yield very attractive.
First of all, its payout ratio is remarkably low for the sector. It maintains a payout ratio of between 65% and 75%. The company also aims to increase its distribution. On Feb. 26, 2020, the company announced a 3.8% increase to its monthly distribution. Also, as I mentioned earlier, its income is much more stable than REITs focused on retail or office properties.
Exposure to economic weakness
In spite of it providing a core need for many individuals, Canadian Apartment REIT is not immune to negative economic shocks. It will, for example, most likely report negative impacts of rent deferrals or delinquencies in the coming months. It may also be forced to drop rental rates if deflation becomes a reality, the economic slowdown continues, and jobs are lost.
As a real estate-focused organization, Canadian Apartment REIT also has a lot of debt. This leverage is par for the course for this type of company, but large amounts of debt are still a factor would-be investors should consider. In its Q1 2020 report, the company reported an increase in debt to gross book value of 36.14% from 34.99% on Dec. 31, 2019. The increase was the result of its continued acquisitions.
With interest rates so low, cash flow and debt repayment should not be a problem, but net debt always increases risk in an investment and should be considered.
The Foolish takeaway
Canadian Apartment REIT is the most stable REIT you can own. It has a very stable customer base and a diversified strategy. The distribution is very secure and its debt is manageable. If you are looking to invest in real estate, this is probably as secure as you can get.
You may not get as high of an initial yield and will probably not get the near-term capital gains you might get from another REIT, but this is a sleep-easy investment you can hold for steady gains over the long run. Buy Canadian Apartment REIT in your TFSA and collect $138 a year tax-free.