Investors are fearful of a recession, and that has unleashed bears in the stock market. The TSX Composite Index fell double digits, and real estate took a big hit. Sky-high inflation has reduced the purchasing power of individuals. On top of that, rising interest rates have made mortgages expensive. And real estate prices that peaked in the pandemic recovery are now receding. Should the bear market scare real estate investors?
Should real estate investors be concerned about the bear market?
The United States has witnessed 20 bear markets since 1952, and real estate values increased in 18. Property prices depend on the health of the economy. House prices are above the pre-pandemic level. But they will fall as demand slows and new properties enter the market. When supply overtakes demand, many real estate properties would be on sale. And only those who hold cash would be in a position to grab this buying opportunity.
The stock price of real estate investment trusts (REITs) has dipped steeply, as the fair market value of their investment property has reduced due to weakness in property prices. REITs with ample cash reserves use the bear market to buy more income-generating properties. This could significantly enhance their rental income in the future if they manage to get the desired occupancy rate.
Adopting the income-first approach
The steep decline in REIT stock prices has created an opportunity to lock in higher distribution yield. Inflation increased rent renewal of almost all REITs, making up for the stable rent during the pandemic. While REIT distributions remained unchanged, the dip in their stock price inflated the yield.
For instance, CT REIT’s (TSX: CRT.UN) stock price has fallen over 20% since the first interest rate hike in March. Its distribution yield inflated to 5.9% from its five-year average of 5.2% and March yield of 4.7%. True North Commercial REIT’s (TSX: TNT.UN) 23% stock price dip has inflated its distribution yield to 10.4%, which is above the five-year average of 9.06%.
The two REITs have paid regular monthly distributions since they went public in 2013. CT REIT has also increased its distribution at a compound annual growth rate (CAGR) of 3.2%. The two survived the pandemic without distribution cuts, while other retail and commercial REITs slashed their distributions.
The above points make CT and True North Commercial buys in a bear market for secure passive income in a recession.
Look for real estate that can withstand a recession
The real estate industry has survived recessions, but the particular property you invest in should withstand them. A recession impacts everyone in the economy. Companies and shops close down, tenants default, and many offices vacate to save costs. Depending on the recession’s severity, a REIT could see higher vacancy rates, lower rental income, and slow demand.
REITs with deep pockets, lower debt obligations in the near term, and healthy distribution payouts that can withstand a recession. And if the REIT has a rich portfolio of hot properties, it could bounce back faster.
CT REIT is a REIT of the retail chain Canadian Tire. It is not worried about vacancy rates, as Canadian Tire occupies more than 92% of the REIT’s leased properties. The dependence on Canadian Tire reduces the risk of lower occupancy but increases concentration risk. Canadian Tire is among the largest retailers in Canada and has sustained past recessions. CT REITs distribution payout ratio is in the safer range of 75%, hinting at a higher probability of surviving a recession and recovering in a strong economy.
True North Commercial earns 76% of its rental income from the government and higher credit rating companies. Its distribution-payout ratio stood at 96% in the second quarter, which shows it could reduce distributions in the long term if the recession deepens.
Should you invest in real estate in a bear market?
REIT stock prices could continue their downtrend throughout the recession. Instead of exhausting your remaining Tax-Free Savings Account (TFSA) limit on the above two REITs, invest small amounts every month. This will give you ample cash and a TFSA limit to buy REITs throughout the bear market and reduce your cost.
