As interest rates continue to climb, mortgage rates in Canada are hitting record highs, posing challenges for potential homeowners.
According to the Canada Mortgage and Housing Corporation (CMHC), the average monthly payment on new mortgages in the first quarter of 2023 was $1,984, up a staggering 40% from $1,415 in 2019. Similarly, the average monthly payment on existing mortgages during the same period this year increased to $1,551 — a jump of 20% from $1,277 just four years ago.
For many Canadians priced out by these escalating costs or unable to cobble together a down payment amid soaring property prices, real estate investment trusts (REITs) like Canadian Apartment Properties REIT (TSX: CAR.UN) may seem like an appealing alternative. After all, REITs offer a way to tap into real estate markets without having to buy and manage properties directly.
While Canadian Apartment Properties has its merits, I believe there’s a more diversified alternative that offers a better risk-to-reward profile for investors looking to gain exposure to the Canadian real estate market. Here’s what I would personally buy instead.
The risks of REIT investing and how to mitigate them
The key thing to remember here is that REIT investing isn’t done in isolation. What I mean is that the particular industry or sector served by the REIT also introduces extra risks investors need to be aware of and may not be compensated for. Here are some examples:
- Residential REITs: For REITs like Canadian Apartment Properties, the focus is primarily on residential properties. While this may seem like a stable bet, remember that residential REITs can be sensitive to rent controls, local housing regulations, and the economic cycles affecting their geographic focus areas. In downturns, even residential properties can face high vacancy rates and declining rental incomes.
- Industrial REITs: These trusts often specialize in warehouses and distribution centres, making them sensitive to economic cycles. In a sluggish economy, businesses might cut down on production or storage needs, impacting the occupancy rates and, by extension, the revenue of industrial REITs.
- Healthcare REITs: Investing in healthcare facilities like hospitals, nursing homes, and medical office buildings may seem like a safe bet given the essential nature of healthcare. However, these REITs are not immune to changes in healthcare policy, insurance reimbursements, or unexpected shifts in patient volumes, all of which can influence their revenue streams.
- Office REITs: These REITs are particularly vulnerable to commercial lease and occupancy rates, which have been fluctuating even more in the era of remote work. If businesses downsize or opt for more flexible working arrangements, the demand for office space may decline, affecting the revenue for office-focused REITs.
Given these inherent risks, it becomes apparent that betting on individual REITs exposes investors to additional sector-specific vulnerabilities that may not be immediately apparent, in addition to the usual idiosyncratic risk of picking a single stock.
What I would invest in instead
The most effective way to mitigate these risks is through diversification. Instead of investing in a single REIT, consider a diversified real estate exchange-traded fund (ETF) that tracks a broad index of REITs from various sectors.
This approach can offer you a more balanced exposure to the real estate market, thereby mitigating the sector-specific risks that come with individual REITs. You still benefit from the overall long-term growth of the sector, though.
When it comes to REIT ETFs, my favourite is BMO Equal Weight REITs Index ETF (TSX: ZRE). Unlike other REIT ETFs, ZRE holds its portfolio of 23 REITs in equal proportions. This means that no single REIT can overly affect the ETF’s performance, which reduces risk.
Canadian Apartment Properties is part of the ETF right now with a 5.16% weight. For those of you seeking consistent, above-average income, this ETF also pays dividends on a monthly basis and currently sports an annualized 5.20% distribution yield as of August 25, 2023.
