The year 2024 will mark the beginning of interest rate cuts. The timing of the rate cut is still unknown, and many debt-heavy companies are waiting with bated breath for the Bank of Canada’s clarity around the road ahead. But waiting until that moment might make you miss the recovery rally of some fundamentally strong real estate stocks.
What to expect from real estate stocks in 2024?
The real estate sector is sensitive to interest rates, as REITs take mortgages and credit to acquire, develop, and intensify properties and earn higher rent. The rapid increase in interest rates increased REITs’ interest expenses faster than their rent.
Some retail REITs felt the financial stress and avoided taking new loans at higher interest rates. Moreover, expensive mortgages deterred real estate demand and pulled down property prices, affecting every REIT in Canada. A REIT’s unit price is determined by the fair market value of its property portfolio. Unit prices of many REITs fell to an all-time low throughout the rate-hike period.
Now that the interest rate trend is likely to reverse, the real estate segment could see a reversal in the stock price trend.
Two real estate stocks to buy today
Some real estate stocks may appear cheap but could be a value trap. However, two real estate stocks are a value buy on the TSX today.
CT REIT
CT REIT (TSX:CRT.UN) stock slipped 18% since the interest rate hike began in April 2022. While its interest expense increased, the REIT did not have difficulty funding its distributions from its operating funds flow. It maintained its distribution payout ratio below 75%, representing a healthy cash flow.
Behind this resilience was CT REIT’s parent, Canadian Tire, from which it earns 91.3% of its rent. Moreover, the REIT gets the preference to acquire or develop existing or new properties of Canadian Tire.
Unlike other REITs, CT REIT avoids taking a mortgage to fund the development projects. It uses working capital for the same. However, it used a short-term credit facility for an intensification project in 2023 that increased its interest expense. But more than 90% of its intensification projects are already occupied, which means it will start earning rent once the development work is complete. That could improve its net profit this year.
The CT REIT is committed to distributing 100% of its taxable income to unitholders to enjoy the tax benefit of an investment trust. It has been growing its distributions at an average annual rate of over 3% as it increases its cash flow from rental increments and the addition of new properties.
The REIT is fundamentally well positioned to continue growing its distributions in 2024. Moreover, a recovery in property prices could drive its stock price in the future. Now is the time to buy the stock while it trades at a discount and lock in a 6.1% distribution yield.
Riocan REIT
RioCan REIT (TSX:REI.UN) stock slipped 24% during the interest rate hike cycle. Unlike CT REIT, RioCan has a distributed tenant base, with no single tenant accounting for more than 5% of its rental income. The REIT has already cut distributions during the pandemic and brought its payout ratio to a comfortable level of around 50%.
The high interest rates did impact RioCan’s net profit. Hence, the management decided not to undertake any new major construction projects until the situation around construction financing improves. Instead of taking a new loan at high variable interest rates, the REIT would be better off repaying its existing debt of about $7.3 billion. A reduction in interest expense could add more value to unitholders in the short term.
However, the ongoing development projects for which it has already secured funding will continue as planned. It is a well-thought-out move to preserve the capital in the short term. When the financial conditions improve and property prices revive, RioCan REIT’s stock price could surge significantly as most of its properties are in the Greater Toronto Area, which fetches higher rent.
