Real estate is a huge investment for most people commonly in the context of purchasing a home. However, real estate investing doesn’t necessarily have to be a huge investment. In fact, if you’re investing passively in real estate through real estate investment trusts (REITs) or REIT exchange-traded funds (ETFs), investors don’t even need to take on debt.
REIT investors can feel a much lighter weight on their shoulders by investing with cash (and no debt). That said, they’re still indirectly affected by rising interest rates, which increase the borrowing costs of REITs. However, REIT investors can reduce their risk by building positions over time (versus buying in a lump sum) and investing in a diversified portfolio of quality REITs.
Canada’s housing sales are cooling from rising interest rates
The cost of borrowing is increasing from rising interest rates. Although Canada’s “average home price is forecast to rise by 10.8% on an annual basis to $762,386 in 2022,” the Canadian Real Estate Association (CREA) highlighted that “with interest rates on the rise, and with five-year fixed rates getting well out ahead of what the Bank of Canada is expected to do later this year, home sales have cooled sharply in recent months.” This pertains to the volume of sales. And “the national average home price is forecast to rise by a modest 3.1% on an annual basis to $786,282 in 2023.”
Rising interest rates are cooling off the Canadian housing market. Because real estate properties are very long-term investments (with 25 years being the most common amortization period for a mortgage), the average housing prices have only “halted in their tracks following a record setting five months of growth between October 2021 and February 2022,” noted CREA.
What about in hot cities like Vancouver and Toronto?
For British Columbia, in which Vancouver resides, BCREA “forecasts 2022 home sales to drop 22% with prices may be somewhat volatile but will ultimately flatten out through 2023.” The volatility is caused by the housing market adjusting to changes in interest rates.
Storeys reported in June that “GTA home prices have fallen nearly 10% from their 2022 peak.” However, the Canadian Real Estate Magazine published in April that “despite measures to slow the market, analysts predict that 2022 will still see price growth in the City of Toronto, but this price growth will likely be smaller than in previous years. RE/MAX, in their 2022 Toronto market forecast, anticipate steady price growth of up to 10%, lower than previous years’ figures.”
Passively invest in REITs
The stock market tends to react faster to macro changes. Rising interest rates have triggered a bear market of more than 20% in iShares S&P/TSX Capped REIT Index ETF. Now that many REITs are trading at below book value, it’s a good time to consider easing in for passive income.
For example, Dream Industrial REIT’s (TSX:DIR.UN) fundamentals remain strong. Yet the high-yield dividend stock has lost about a third of its value from its 52-week high. And now it trades at a discount of about 28% from its book value.
The REIT enjoys a high committed occupancy rate of approximately 98.7%. Its diversified portfolio is comprised of 244 industrial assets in Canada (63% of portfolio based on investment value) and 37% in Europe. It also has a 21.5% stake in a U.S. industrial fund. Its gross rent is diversified across distribution (57%), urban logistics (30%), and light industrial (13%).
Dream Industrial’s yield of close to 5.9% is safe on a sustainable payout ratio. Through its debt strategy, it’s enjoying an ultra-low weighted average interest rate of 0.85%.
While your home tends to be a super-long investment, REITs don’t necessarily have to be. Canadians can buy REITs when they’re undervalued and choose to sell for price appreciation when their valuations normalize. Alternatively, you can hold units for passive income if the REIT fundamentals remain strong.
