A month back, True North Commercial REIT (TSX:TNT.UN) stock price dived 40% after the real estate investment trust (REIT) slashed its monthly distributions by 50%. This announcement indicates that the small-cap REIT is going through tough times. The instant reaction of a distribution cut is the right move, as sustainability and liquidity take precedence over growth. But investors have been overlooking this dividend stock since the distribution cut, as small-cap stocks are the most vulnerable to a recession.
The dividend stock yielding 8.8%
True North Commercial REIT slashed its dividend, as its 2022 occupancy rate reduced to 93% from 96% in 2023. Moreover, the 2023 lease renewal is seeing tenants reduce their space requirement or vacate the property, impacting the occupancy rate. For a REIT, vacant space is a headwind, as fixed costs like mortgages and maintenance cause cash burn. And when inflation is high, these fixed costs balloon.
As of December 31, 2022, True North REIT has ample operating earnings to service the interest on the debt. But this expense is increasing, as the REIT is refinancing its mortgages at a higher interest rate. Higher interest expense offsets the higher lease spread earned in 2022, eating up REIT’s profit margin. Instead of refinancing more mortgages, the REIT slashed distributions to use its rental income to repay mortgages and fund other capital needs.
True North is also selling properties with lower rent yields to reduce costs and improve efficiency and occupancy rate. The management is taking these steps to prepare for a weak occupancy rate as companies are cutting costs and moving to work from home amid a slowing economy.
These declining fundamentals have soured investor sentiment and pulled down stock prices of commercial REITs. Real estate analysts believe debt maturities may not be an issue for commercial REITs, but sustaining high distributions will.
Looking at the near-term fundamentals, True North may not seem like a good investment. But that is where the contrarian approach works. Buy when others sell, because the best and worst scenarios favour shareholders who buy the stock at the current all-time low.
The oversold dividend stock to buy
True North Commercial REIT’s Relative Strength Index (RSI) has fallen to 16. The RSI is a technical indicator that measures the speed and magnitude of the stock price in the last 14 days and categorizes them as oversold (<30 RSI) and overbought (>70 RSI). An RSI of 16 shows that the REIT has hit rock bottom. For example, Air Canada stock hit this low RSI in the March 2020 crash.
True North Commercial REIT might face challenges in the short term. But it has 46 commercial properties and earns 80% rent from the government and high-credit-ranking companies. A price of $3.37 per share is a distress sale. In my opinion, the only direction the stock can go from here is up. It may take time — probably five to six months. But when the growth begins, it would be a recovery rally. The REIT’s stock price surged 60% in 13 months during the recovery rally from the 2020 pandemic low.
Here are other stocks that rode the recovery rally. RioCan REIT stock jumped 50% within a year from March 2020, despite distribution cuts. Air Canada stock jumped 120% in 12 months. You may argue that RioCan and Air Canada are mid- and large-cap stocks, whereas True North is a young small-cap stock. But True North has investment properties that appreciate with time. In the worst-case scenario, it may sell these properties and use the proceeds to pay down debt. Or it could get acquired by a bigger REIT. In either case, shareholders are up for a treat. In the meantime, True North has to pay distributions to maintain its trust status.
Why buy True North REIT in April 2023?
The 50% distribution cut followed by a 40% stock price dip has brought the distribution yield to 8.8% (revised annual distribution of $0.297/$3.37 stock price). Buying the REIT in April has its perks. You get an 8.8% yield with a lower risk of a further distribution cut. Moreover, you can book your spot in a 60-100% recovery rally.
