The Canadian housing market has been slowing as owning a house becomes an unachievable dream for average Canadians. After reaching a peak of almost $713,500 in December 2021, the average home price started falling. The House Price Index fell 15.5% year over year in March. But it is still not affordable as mortgage rates have increased. As Canada’s property prices remain stressed, share prices of REITs have been in a downtrend. Are there any safer REITs that can withstand a property bubble burst?
To find a safer REIT, investors should understand the housing market, risks, and fundamental strengths.
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The current situation of the Canadian housing market
Despite a 15.5% correction, house prices are still above the pre-pandemic level. The record low-interest rate in 2020 and 2021 encouraged many to take mortgages. And now they are feeling the pinch as mortgages are up for renewal. A mortgage eats up 30% of a household’s income. As this single largest expense grows significantly, it is straining household finances. Meanwhile, the big six banks have increased their provisions for credit losses as they fear loan defaults to increase.
Commercial properties have also come under pressure as companies are reducing office space to cut costs. Some commercial property REITs even slashed their distributions as their occupancy rate fell significantly. Allied Properties REIT’s stock price has fallen by 55% since the first rate hike in March 2022. The REIT has high debt and even posted a loss because of high-interest costs. It is now looking to sell some of its properties to reduce debt.
The housing market will take a year or two to ease, provided the Bank of Canada reduces interest rates. Most REITs prices are low as they reflect a reduction in the fair market value of their properties. In these bearish times, two REITs are a great bargain.
CT REIT
CT REIT (TSX:CRT.UN) is the real estate arm of Canadian Tire. While the retailer is reducing its store count, it has no impact on the occupancy rate of CT REIT. Canadian Tire occupies over 92% of the REIT’s gross leasable area. The remaining area is leased by other essential retailers. Its occupancy rate remains above 99% even in these uncertain times.
The high occupancy rate secures its rental income and maintains its distribution payout ratio within a safe zone of 74.5%. On the debt front, 94% of the total debt is at a fixed rate, reducing the burden of rising interest rates.
All these factors make CT REIT a safer bet in real estate that you can buy at a bargain, as macro factors have pulled the stock down 14% since March 2022. You can lock in a 5.5% distribution yield. The REIT is likely to continue growing its distribution at an average rate of 3%, irrespective of what happens in the housing market.
RioCan REIT
RioCan REIT (TSX:REI.UN) has a different strategy. While CT REIT’s rental income depends on Canadian Tire, RioCan’s is diversified, with no single tenant accounting for more than 5% of its rental income. RioCan is urban-focused and earns 92% of its rent from six major cities in Canada. Within these cities, 39% of its properties are in prime areas with a population density of more than 250,000 within a 5km radius. And 23% of these residents have an average household income of $135,000.
The diversified tenant base but concentrated leasable area in six cities helps RioCan maintain a high occupancy rate and efficiency. But these tailwinds became headwinds during the pandemic, and RioCan had to slash distributions. The REIT now has an average payout ratio of less than 60%, giving it the flexibility to handle higher vacancy rates.
RioCan REIT’s share price is 20% below the March 2022 level. Now is a good time to buy its shares and lock in a 5.23% yield. The two REITs can provide a relatively stable source of passive income in a weak housing market.
