Canadian real estate investment trusts (REITs) have been experiencing an early Santa Claus rally since late October. Namely, the sector (using iShares S&P/TSX Capped REIT Index ETF as a proxy) witnessed a correction of about 17% from peak to trough from September to late October. So, it popped by about 14% from the bottom.
CAPREIT
Canadian Apartment Properties REIT (TSX: CAR.UN), or CAPREIT, is the largest holding in the XRE. The fund has a weight of about 18% in the REIT. Since late October, the stock has made a strong comeback by climbing about 23%.
It is in the defensive residential REIT space and has its portfolio primarily in key Canadian markets, such as the Greater Toronto Area, Ottawa, the Greater Montreal Region, Quebec, the Greater Vancouver Area, Calgary, and Edmonton. The REIT is diversified with about 64,500 residential apartment suites, townhomes, and manufactured home community sites across Canada and the Netherlands.
So far, CAPREIT has reported resilient results for the first three quarters of the year. Its overall occupancy is 98.4%. It increased its operating revenue by 5.7% and net operating income (NOI) by 6.2% year over year. In this period, it also increased its funds from operations (FFO) per unit by 2.7%.
At $50.52 per unit, analysts believe the Canadian REIT is fairly valued, and it offers a cash distribution yield of 2.9%. Investors looking for a defensive Canadian REIT can buy units, especially on any dips this month.
RioCan REIT
The XRE exchange-traded fund (ETF) has RioCan REIT (TSX: REI.UN) as its second-largest holding. It has a weight of about 11% in the retail REIT. RioCan REIT is more discounted than CAPREIT because there is a more negative sentiment in retail real estate investing. That said, the retail REIT’s year-to-date results have been resilient.
Its FFO is flat, but its FFO per unit rose 3.1% thanks to share buybacks. Its committed occupancy was 97.5%, while its committed occupancy for its retail portfolio was 98.3% at the end of the third quarter. It can also benefit from mark-to-market rents, as the blended leasing spread for the quarter end was 11.2%.
At $17.92 per unit, analysts believe the retail REIT is discounted by about 16%. It also offers a cash distribution yield of 6%. Its payout ratio is sustainable at about 60% of FFO year to date.
Management expects the 2023 FFO per unit to be $1.77 to $1.80, same-property NOI growth of 3%, and the FFO payout ratio to be between 55% and 65%. It also anticipates development spending to be $400-$450 million. At the end of the third quarter, it had about 1.7 million square feet of development projects under construction, which is about 5% of its portfolio.
The retail REIT stock could be a good multi-year turnaround investment. Meanwhile, investors get paid well to wait.
Income tax on Canadian REIT cash distributions
Canadian REITs pay out cash distributions that are like dividends but are taxed differently. In non-registered accounts, the return-of-capital portion of the distribution reduces the cost base. The return of capital is tax deferred until unitholders sell or their adjusted cost base turns negative.
REIT distributions can also contain other income, capital gains, and foreign non-business income. Other income and foreign non-business income are taxed at your marginal tax rate, while half of your capital gains are taxed at your marginal tax rate.
If you hold Canadian REITs inside tax-advantaged accounts like a Tax-Free Savings Account, Registered Retirement Savings Plan, Registered Disability Savings Plan, Registered Education Savings Plan, or First Home Savings Account, you won’t need to worry about the source of income other than foreign income which may have foreign withholding tax. When unsure of where best to hold REIT units, seek advice from a tax professional.
