You have been hearing for almost a year that a recession is coming. The macroeconomic data hints at a 2008-like recession, yet employment has been stable. Is the recession really here? This fear has pulled down prices of some dividend stocks with strong fundamentals.
Canada’s falling house prices make real estate stocks cheap
The higher interest rates take time to impact the existing consumer and business loans. Monthly debt payments are reset at the time of contract renewals. Mortgage payments take up a significant portion of household income. When this single largest expense increases, purchasing power could fall, and delinquencies could increase. The big six banks have already increased their provision for credit losses.
The rising interest rates have started impacting new home purchases. After rising at its fastest pace of 26.6% year over year in December 2021, Canada’s housing prices dropped 13.7% year over year in March 2023. This decline is a correction as house prices are still 20-25% above affordability levels. While March saw a month-over-month increase in house prices, it could fall once monthly mortgage payments price in high-interest rate.
The falling housing prices have reduced the stock price of retail REITs while their rental income remains intact.
RioCan REIT stock
RioCan REIT (TSX:REI.UN) stock price slipped 17% after the central bank started interest rate hikes in March 2022. The REIT took a beating during the pandemic. The pandemic significantly impacted its rental income, and it could not keep up with high distribution yields, forcing it to slash distributions. But the distribution cut has reduced its payout ratio to 59%, which is sustainable and gives the REIT liquidity if occupancy falls.
RioCan is well-placed to withstand a property bubble without any more distribution cuts. It has high exposure to prime markets with a dense population and higher average household income. The REIT earns 92% of its rent from six major urban markets, including the Greater Toronto area. The prime location helped RioCan retain 92% of its tenants at an 8.2% higher lease in 2022.
RioCan’s rich mix of income-generating properties is supported by a diversified tenant base, with no single tenant accounting for more than 5% of rental income. It is focusing on maintaining its current distribution per share and developing residential properties in the Greater Toronto area. Its stock price will surge when house prices return to growth. A glimpse of the surge was visible in the last 20 days when RioCan REIT’s stock price surged 9.1% as house prices surged.
RioCan is an unjustifiably cheap dividend stock as its price is moving alongside the interest rate. While other REITs are seeing tenants reduce occupancy, RioCan’s occupancy rate remains above 97.4% because of a stable and strong tenant base. The fundamentals are in the REIT’s favour, making it a buy at its current price.
CT REIT stock
CT REIT (TSX:CRT.UN) stock price has slipped 11% since March 2022 as falling property prices reduced the value of its investment properties. But the market failed to price in the strengths of CT REIT parent Canadian Tire.
Canadian Tire occupies 92.3% of CT REIT’s gross leasable area and contributes to 91.4% of the rent. The remaining area is occupied by third-party retail tenants (91.4% occupancy rate). CT REIT’s overall occupancy rate is 99.3%, with a weighted average remaining lease term of 8.9 years because of its high exposure to Canadian Tire.
The retailer has been reducing its store count, but it did not impact CT REIT’s occupancy rate or rental income. This is because the REIT can lease that property to a third party. Its 74.5% payout ratio gives it the flexibility to sustain its distribution even if its occupancy rate reduces.
Unlike RioCan, CT REIT does not have a diversified tenant base or asset portfolio, exposing it to Canadian Tire’s business risk. But the REIT makes up for the risk by increasing distributions at a compounded annual growth rate of around 3%.
Final thoughts
RioCan and CT REIT come under retail real estate and are exposed to similar industry challenges. But both have a different business approach that changes their risk-reward ratio.
