Good news for real estate investors! The Bank of Canada’s recent decision to cut interest rates by 50 basis points in October could breathe new life into the Canadian real estate sector. Real Estate Investment Trusts (REITs) could fare better as their net asset values recover from multi-year lows. One company that might benefit from this change is SmartCentres REIT (TSX: SRU.UN), which currently offers an attractive 7.1% distribution yield. But is it a smart passive income investment? Let’s take a closer look.
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A shopping centre giant with a Walmart connection
SmartCentres REIT is one of Canada’s largest real estate investment trusts, managing 195 properties across the country with assets worth approximately $12 billion. What makes it special? For starters, it has a 30-year strategic partnership with Walmart, which serves as an anchor tenant in 113 of its properties and provides about 24% of the REIT’s revenue. This relationship with the world’s largest retailer adds a layer of stability to its income.
SmartCentres REIT’s strong signs of strength
The REIT’s performance shows several encouraging signs. Its impressive 98.2% occupancy rate going into the third quarter, up from 97.7% in March, suggests sustained strong demand for its properties. The trust is also successfully increasing rents, with new and extended leases showing an 8.2% increase for non-anchor spaces expiring in 2024. This is particularly promising since the REIT’s current average rent of $23.14 per square foot is well below market rates of $29.29.
SmartCentres REIT’s open-air shopping centre model has proven its worth, demonstrating resilience during the COVID-19 pandemic. More than 60% of its tenants provide essential services, which also helped the REIT maintain its monthly distributions when many others had to cut back.
During the past decade, the REIT paid one of the most consistent and reliable dividends within its peer group, as shown below. Its payout increased by 15.6% and has remained steady since the COVID-19 era.
SRU.UN Dividend data by YCharts
Aggressively building for tomorrow
SmartCentres REIT isn’t content with the status quo. The REIT is actively expanding beyond traditional retail, developing a mix of residential properties, self-storage facilities, office spaces, and industrial assets. Their ambitious development pipeline shows potential for 86 million square feet of mixed-use property, which could generate significant additional recurring income in the future.
Is the distribution safe? Understanding REIT distribution safety
For income investors, the safety of SmartCentres REIT’s 7.1% distribution is crucial. This requires looking at the trust’s two important metrics: Adjusted Funds From Operations (AFFO) and AFFO with adjustments. AFFO measures the REIT’s most recurring distributable cash flow from operations, after accounting for non-cash income. The current AFFO payout rate of 98.8% in the second quarter of 2024 suggests the distribution is sustainable, though it’s higher than last year’s 93.8%.
However, SmartCentres provides an even more conservative measure: AFFO with adjustments. This metric factors out volatile elements like losses on derivatives and funds from condo and townhouse sales. Using this adjusted AFFO measure, the payout rate stands at 95.6% for the first half of 2024, providing additional comfort about the monthly distribution’s sustainability.
While funds from operations may fluctuate due to the timing of condo and townhouse sales, these developments generate significant income that can support both distributions and future growth projects.
A REIT with potential to double your capital
Using the “Rule of 72,” if you reinvest all monthly distributions, you could potentially double your money in just over 10 years, even without any unit price appreciation. However, REITs don’t always provide significant capital gains, and there are risks to consider. The high payout ratio leaves little room for error, and an economic downturn could lead to increased vacancies.
Investor takeaway
With lower interest rates on the horizon and a solid track record of maintaining distributions, SmartCentres REIT stock could be an attractive option for income-focused investors. Its partnership with Walmart, high occupancy rates, and growing rental income provide a strong foundation, while its development projects offer potential for future growth.
For investors seeking steady income and willing to accept some real estate market risk, SmartCentres REIT’s 7.1% yield might be worth considering as part of a diversified investment portfolio.
