Rates Are Rising: Should You Avoid REITs?

The TSX shaved off less than 1% to start this week but remains in record territory. Besides energy (-2.59%), the real estate sector had the second-largest percentage (-1.08%) retreat on Monday. Only last week, Canaccord Genuity downgraded their recommendations and price targets for real estate investment trusts (REITs).

According to the global investment banking and financial services company, rising interest rates could impact on the expected future returns of REITs. It noted the 0.9% return of the TSX Capped REIT Index in the first calendar quarter of 2022.

Canaccord analyst Mark Rothschild said, “We attribute the underperformance of REITs relative to the broad market to rising long-term interest rates, widening credit spreads, and outsized returns for the Canadian energy and materials sectors.” While he reduced price targets for REITs, it wasn’t a sweeping downgrade.

BTB (TSX: BTB.UN) and Morguard (TSX: MRT.UN) are up year to date and aren’t included in the analyst’s list. Besides the relatively cheap prices, the dividend yields are very attractive. Real estate investors can consider investing in either REIT rather than purchasing investment properties at bloated prices today.

Keeping pace with inflation

Contrary to the recommendations of Canaccord, www.reit.com reports that the operating performance of REITs have kept pace with inflation over the past few decades. Long-term leases have built-in inflation protection, while and shorter-term leases are based on current price levels.

In 2020, the lockdowns and social-distancing measures affected sub-sectors like retail, office, healthcare, and hotels. Several diversified commercial and residential REITs were likewise affected. Industrial properties were in high demand due to the e-commerce boom.

Because rental contracts, including long-term leases, are negotiated yearly, REITs have opportunities to reprice. With rent and values likely to increase along with prices, REITs become reliable income providers, through dividends during inflationary periods. Moreover, the value of real assets or portfolios of these large landlords typically appreciate alongside price levels.  

Top prospect

BTB is a top prospect for real estate investors following its financial performance last year. Management said it was the best since inception as total asset value reached $1.1 billion. This $358 million REIT owns and operates 73 properties in eastern and western Canada.

Its president and CEO Michel Leonard added that the Q4 2021 financial results were the best in the last seven quarters. He said leasing spreads were strong due to higher rental and occupancy rates. Rental income and net operating income (NOI) increased 19.3% and 15.7% versus Q4 2020. If you invest today, the share price is $4.23, while the dividend yield is an ultra-high 7.09%.

Poised for the future

Morguard’s real estate portfolio (46 total properties) in Canada consists of retail, office, and industrial income-producing properties. The $347.75 million REIT reported a $357.41 million net loss in 2020. However, the business turned around in 2021, as net income reached $4.88 million. Funds from operations increased 3.02% to $68.94 million versus the previous year.

For 2022, according to president and CEO K. Rai Sahi, Morguard will re-envision and enhance its merchandising mix (industrial, office, and retail). At $5.42 per share, the dividend yield is 4.43%.    

Strong income returns

Nareit, the worldwide representative voice for REITs, said the asset class tends to outperform in high-inflation periods. Their strong income returns should offset falling REIT prices