Canada’s real estate sector could see a tepid recovery in 2025 after two years of steep correction triggered by high interest rates and unaffordable house prices. Is now a good time to invest in Canadian real estate stocks? If yes, which stocks present a better investing opportunity? To answer these questions, we have to understand the current real estate scenario.
Canada’s real estate stocks with high leverage
In the last two years, many REITs saw a steep dip in their unit prices as the fair market value of their property portfolio fell. Moreover, rising interest rates made it difficult for REITs with significant leverage to pay high-interest expenses. In response, several REITs slashed their distributions.
Northwest Healthcare REIT (TSX:NWH.UN) slashed its annual distributions and suspended its dividend reinvestment plans in September 2023 due to high debt. Such drastic measures pulled the REIT’s stock price down 68.5% between September 2023 and February 2024. The REIT has been selling its properties to reduce debt and using interest rate cuts to refinance debt at lower interest rates.
As of September 30, 2024, the REIT owns and manages interests in 186 hospitals, medical office buildings, and healthcare facilities in Europe, North America, Brazil, and Australasia. This is lower than 219 properties a year ago. Its debt is now 49.2% of its gross book value, down from 51.9% in 2023. The debt reduction is still in progress but the improvement in fundamentals is visible.
Although Northwest Healthcare REIT’s net asset value (NAV) is $9.02, the unit is trading at $4.96. The unit price is trading at a discount as the REIT continues to sell properties, which could reduce its NAV. The slashing of the distribution has helped the REIT reduce its payout ratio from 122% to 99%. While the REIT could see more downside amid global economic weakness, it is a good investment for its 7.3% yield.
Canada’s commercial real estate stocks
Commercial REITs were the worst hit as they could not revive their occupancy rate to the pre-pandemic level. True North Commercial REIT (TSX:TNT.UN) first slashed dividends and then stopped paying them altogether in November 2023 to pay its interest expenses. The REIT continues to see falling net income with no signs of resuming distributions.
The REIT continued to sell properties and has reduced its portfolio to 40 properties as of September 30, 2024, from 44 a year ago. Its leverage is 61% of its gross book value, which is pretty high. Even though the real estate market is seeing recovery, it is better to stay away from commercial property REITs for the time being.
Canada’s retail real estate stocks
The sunrise segment in real estate is retail REITs, especially those in necessity-based retail centres. SmartCentres REIT (TSX:SRU.UN) and Choice Properties REIT saw a strong recovery because of the high exposure to tenants like Walmart and Loblaw.
As the largest retail REIT in Canada, SmartCentres has one of the longest dividend-paying histories of 23 years among REITs. It has sustained its distribution by renting retail stores to grocers and other necessity retailers. The REIT also develops mixed-use properties to enhance the value of its stores. Its property portfolio puts its NAV at $34.64 but the REIT is trading at a 27% discount of $25.42 as the real estate sector has only begun a recovery rally. SmartCenters REIT is an attractive investment opportunity to lock in a 7.3% yield.
Residential REITs
The Canadian government introduced various measures to improve housing affordability for first-time home buyers and discourage underused housing. Moreover, the Bank of Canada has accelerated interest rate cuts to make mortgages affordable. This could see an uptick in the sale of affordable houses and increase house prices moderately after a steep decline.
However, rental activity could be tepid as the government’s reduction in immigration targets could reduce the demand for rental properties in metros. Hence, it is better to steer clear of the residential REITs.
Investor takeaway
Canadian real estate stocks are set to ride the recovery rally after almost three years of correction. However, the recovery speed might differ across provinces and property types. It is better to invest only in REITs that have lower leverage and a distribution payout ratio below 100%.
