Canada is in a housing crisis. House prices fell almost 13% year over year in January, as rising interest rates dried up liquidity, and very high prices made housing unaffordable. In the midst of a property bubble, two small-cap commercial real estate investment trust (REIT) stocks fell more than 30% after they cut distributions by 30-50%. Many more small- and mid-cap companies could follow, as they feel the pressure of rising interest rates.
Once-in-a-decade opportunity to buy troubled income stocks
A recessionary environment impacts small-, medium-, and large-cap stocks. Toronto-Dominion Bank has become the most shorted stock, because of its high exposure to the U.S. banking industry. Another rise in interest rates could severely impact property prices. This bearishness has created a once-in-a-decade opportunity to buy real estate stocks at distressed prices and book a spot in the recovery rally.
Buying stocks at distressed prices has risk as the company’s recovery from the crisis depends on the management. It is the first time the two commercial REITs are facing a 2008-like crisis. The challenge is if management can preserve shareholder value. If the management comes with flying colours, these two REITs could double your money.
The two income stocks available at heavy discounts
The two commercial REITs that have lost value in the last 20 days are Slate Office REIT and True North Commercial REIT (TSX:TNT.UN).
True North Commercial REIT
True North Commercial REIT fell 40% on March 14 after the company announced the decision to halve its distribution to preserve cash. The REIT released tepid 2022 earnings result, as its occupancy rate fell to 93% from 96% in 2022. Unlike the pandemic, this decline is likely to last longer, as many tenants downsized their space requirements during renewal. Companies are cutting costs, which is reducing the demand for office space.
In light of the current developments, TrueNorth Commercial is disposing of properties, where the lead tenant has given the notice to vacate at the end of the lease term. The REIT could face difficulty finding tenants and increasing the occupancy rate for some time. In the meantime, it has a leasing cost to meet. The REIT maintained its distribution on a +100% distribution-payout ratio.
But with tenants vacating and downsizing, the management decided to take the harsh step and halve distribution. It will free up cash for the REIT to maintain its mortgage payments instead of refinancing them at higher interest rates.
Is this the bottom of the two REITs? Nobody can tell. True North Commercial REIT still earns 80% of its revenue from government offices and high credit rating companies. If large companies start downsizing, the REIT could have difficulty surviving. But if its large tenants stay, the REIT can sell off low-yielding assets and make up for the debt. It needs cash to sustain itself till the business environment recovers and companies start occupying office space.
Slate Office REIT faces a similar fate as True North Commercial REIT.
The opportunity to double earnings
A distribution yield is an annual distribution as a percentage of the share price. The yield of the two REITs normalized, as their stock price fell in tandem with the distribution cut.
| Stock Price | Revised Distribution/Share | Revised Distribution Yield | |
| True North Commercial REIT | $3.4 | $0.297 | 8.7% |
| Slate Office REIT | $2.37 | $0.12 | 5.1% |
If the property bubble bursts, these REITs would see a single-digit decline, as they have already dropped 30-40%. If the economy starts recovering by the end of the year, these stocks could jump 50-60%, as they did after the March 2020 slump. Only this time, they will likely trade near their bottom for a few months before riding the recovery rally.
The upside is more than the downside, making a compelling case for buying these stocks at their all-time low.
Diversify your risk with large-cap income stocks
Investing in the above two commercials exposes you to risk. Do not leave your wealth to chance. Diversify your portfolio across stable large-cap income stocks like Enbridge and BCE. These stocks might take time, but they will give you stability.
