Landlords get mortgage renewals too. Their buildings may contain hundreds of households, but the lender still expects interest, and it doesn’t accept “people always need somewhere to live” as payment.
That’s why an apartment real estate investment trust (REIT) can struggle even while collecting rent. If financing costs rise faster than rental income, less money reaches each unit holder.
With the Bank of Canada weighing inflation risks before its October 28 decision, investors need to look beyond the reassuring idea of owning housing.
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Two bills moving differently
Apartment rents generally change through renewals, tenant turnover, and local regulations. Debt costs follow a different calendar, depending on mortgage maturities and whether borrowing is fixed or floating.
A rate increase therefore doesn’t hit every building loan immediately. It can still raise the cost of future refinancing and reduce what buyers are prepared to pay for properties.
For a simple illustration, refinancing $100 million of debt at a rate one percentage point higher adds $1 million in annual interest. That extra bill has to be covered before it can support distributions.
The question for a REIT is whether rent growth, asset sales or other savings can absorb that cost. Full buildings help, but don’t make the subtraction disappear.
A familiar landlord
Canadian Apartment Properties REIT (TSX: CAR.UN), known as CAPREIT, owns rental housing and earns its income from tenants. Its portfolio gives investors access to apartments without personally answering a Sunday call about a leaking dishwasher.
The latest results show both the appeal and the pressure. Canadian same-property occupancy was 97.5% at June 30, down from 98.4% a year earlier. Most suites remained occupied, but the direction deserves attention.
Quarterly diluted Funds From Operations (FFO) per unit fell 1.1%. FFO adjusts accounting earnings to provide a better view of recurring property performance, though it isn’t cash left after every building expense.
A discount with conditions
There are considerations. At a recent share price of $31.25, CAPREIT traded about 42.5% below its June 30 net asset value of $54.38 per share.
That’s a substantial valuation gap. Net asset value (NAV) estimates property values after liabilities, so it depends on assumptions about rents and the returns property buyers require. If interest rates rise, those appraised values can fall. Buying below today’s NAV doesn’t guarantee the market will eventually pay that NAV.
Still, the discount provides room for a patient investor if apartment income stabilizes and financing remains manageable. For someone buying stocks in Canada, that is a more useful argument than simply declaring housing essential.
Watch the renewal calendar
CAPREIT has been arranging mortgage financing over multiple years, which spreads the impact of changing rates. The risk is that refinancing costs and softer occupancy combine before rent growth can offset them.
A property sale can release capital, but it also removes the income that property previously generated. The result needs to improve what remains for each unit. I’d therefore consider a small, gradual purchase at this discount for a long horizon. I would keep expectations for rapid distribution growth modest until recurring earnings regain momentum.
An eligible Tax-Free Savings Account (TFSA) can shelter investment income and gains when room is available. Property exposure still needs diversification and patience.
Bottom line
CAPREIT’s discount gives buyers something to work with, while its financing and occupancy explain why the discount exists. Improving earnings per shre could eventually make these apartments more valuable to shareholders, without requiring every interest-rate headline to cooperate.
