As interest rates have gone up since 2022, the cost of capital has increased. In turn, the stocks of Canadian real estate investment trusts (REITs) have come down, driving up their cash distribution yields. Since Canadian REITs are a good source of monthly income, investors can look to them as one of the first stops for monthly passive income.
As income is your focus, you might want to zoom in on Canadian REITs with stable cash flows and sustainable payout ratios as a way to passively invest in real estate. If interest rates start coming down, there could be a rally in Canadian REITs and stocks in general.
Stocks of retail REITs have been generally weak. For example, CT REIT (TSX:CRT.UN) has declined about 8.5% in the last 12 months, underperforming the Canadian stock market and Canadian REIT sector.
CRT.UN, XIU, and XRE one-year data by YCharts
Even when accounting for cash distributions, CT REIT still underperformed.
CRT.UN, XIU, and XRE one-year Total Return Level data by >YCharts
Interestingly, though, CT REIT outperformed them over the last decade. So, it could be a good opportunity to buy the REIT on the recent weakness for monthly income as well as the potential to deliver good long-term returns.
CRT.UN, XIU, and XRE 10-year Total Return Level data by YCharts
Based on the gross leasable area, CT REIT’s assets are 85% retail and 14% industrial. The REIT has strong ties with Canadian Tire, which is its largest tenant. Therefore, it enjoys a top-notch industry occupancy rate of approximately 99.1%. As well, it has one of the longest-weighted average lease terms of about 8.5 years in the sector.
So far, CT REIT has reported three quarters of results for the year. Its net operating income rose 4.6% year over year to $327.4 million. It also increased its funds from operations (FFO) per unit by 3.8%, equating to a payout ratio of about 67%. Its adjusted FFO payout ratio in the period was also sustainable at 73.2%.
Notably, the REIT has increased its cash distribution for at least eight consecutive years. For your reference, its five-year cash distribution growth rate is 4%.
At $14.18 per unit, CT REIT yields 6.3%. A reversion to the mean valuation represents a price target of about $17 for upside potential of approximately 20%.
Dream Industrial REIT
Generally, Dream Industrial REIT (TSX:DIR.UN) has been a more resilient Canadian REIT because there has typically been more growth in the industrial real estate sector. In the last 12 months, the stock is up about 10%. And in the last decade, it outperformed CT REIT.
DIR.UN Total Return Level data by YCharts
Unlike CT REIT, though, Dream Industrial REIT doesn’t typically increase its cash distribution. In fact, it has maintained the same distribution since 2015. That said, its current yield of close to 5.2% at $13.55 per unit is not bad.
So far, it has reported three quarters of results for this year. Year over year, its rental income increased 21% to $249 million, while its FFO per unit rose 12% to $0.74, resulting in a sustainable FFO payout ratio of about 70% in the period. At the recent price, analysts believe the stock has about 19% 12-month upside potential.
Income tax on Canadian REIT 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, as are 50% of your realized capital gains.
If you hold Canadian REITs inside tax-advantaged accounts like a TFSA, RRSP, RDSP, RESP, or FHSA, 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.