Publicly traded Canadian real estate stocks, especially real estate investment trusts (REITs), have been on shaky ground lately. REITs, which own and manage income-generating properties like office buildings or shopping centers, initially saw a recovery as interest rates began to stabilize.
However, that momentum has largely reversed, thanks to falling property values and a recent shift by the federal government to scale back immigration targets, dampening demand for housing and commercial spaces.
Let me be clear—when it comes to Allied Properties REIT (TSX:AP.UN) or SmartCentres REIT (TSX:SRU.UN), my pick is neither. I think both are suboptimal choices for real estate investments right now.
Here’s my bear case against each of these REITs and, most importantly, a better alternative for investors looking to play the real estate market.
Source: Getty Images
Allied Properties
I’m really not keen on owning some of the most economically sensitive office properties in urban Toronto—and that’s exactly what you’re getting if you invest in AP.UN
To be fair, there are some positives. The REIT’s price-to-adjusted funds from operations (AFFO), a key valuation metric for REITs that measures cash flow available to shareholders, is at 8.4—well below the sector average of 13.14.
The yield is high right now at 10.57%, although that’s mostly because the stock price has fallen so much. Allied’s payout ratio, which measures dividends paid as a percentage of AFFO, sits at 88.7%. While high, it’s still manageable given the REIT’s relatively modest 39.5% debt-to-assets ratio.
The real problem? Occupancy. The return-to-office trend has been sluggish, and Allied’s 87.2% occupancy rate is abysmal for a REIT. Over the past year, AFFO per share has dropped by 6.4%, which raises questions. COVID is over—why aren’t these towers filling up and generating more cash flow?
Right now, Canadian commercial real estate is the last place I want to park my cash. It’s a hard pass on this one.
SmartCentres
Retail REITs can be tricky. Generally, I prefer one with a dominant anchor tenant in a non-cyclical sector—think grocery stores, which tend to perform well regardless of economic conditions.
On the surface, SRU.UN seems to fit the bill. Its largest tenant is Walmart, which accounts for 23% of its rental revenue, and it boasts a strong 98.3% occupancy rate.
Debt metrics look fine, too, with a 42.2% debt-to-assets ratio, and it trades at 11.8 times price-to-funds from operations (FFO)—below the sector average valuation. The payout ratio is a high but manageable 89.8%, which helps support its current yield. So, why not?
The issue lies in growth—or lack thereof. SmartCentres’s FFO per share has been stagnant, with a three-year FFO/share growth rate of -2.3%. This is a red flag for me.
I want a REIT that grows, not one that’s just treading water. To make matters worse, the dividend hasn’t grown either, with a five-year dividend-growth compound annual growth rate of 0%. That’s not the kind of performance I’m looking for in a long-term investment. This one just doesn’t cut it for me.
What to buy instead
Save yourself the trouble, skip both SRU.UN and AP.UN and consider CI Canadian REIT ETF (TSX:RIT) instead.
This actively managed ETF gives you diversified exposure to Canada’s top REITs, spreading out risk across the sector. It can also hold a small portion of its portfolio in U.S. REITs. Funnily enough, the current top 15 holdings don’t include SRU.UN or AP.UN.
With a current distribution yield of 5.3%, RIT has delivered an impressive annualized total return of 8.5% over the last 20 years. It’s a simpler, more balanced way to invest in Canadian real estate without the headaches of picking individual REITs.
