Skip to main content
yield hog

Yield Hog is part of Globe Unlimited's Strategy Lab series. Subscribers can read more at tgam.ca/strategy-lab.

Back in June, 2015, I wrote a favourable column about Canadian Real Estate Investment Trust. Canada's oldest – and, some would say, best managed – REIT had tumbled in price because of weakness in Calgary's office market, and I suggested it was a good time to buy.

Well, that turned out to be the right call. In the 20 months since, CREIT's units have rebounded by about 16 per cent. Including dividends, the total return was more than 21 per cent, topping the S&P/TSX composite index's total return – also including dividends – of about 11 per cent over the same period.

So is it time to sell CREIT and lock in the profits? Heck no. I own the units personally and consider them a core long-term holding. Here's why I believe CREIT has a bright future.

It's conservatively managed

As a risk-averse fellow, I appreciate CREIT's prudent operational and financial approach. Its 2016 payout ratio – calculated as distributions divided by adjusted funds from operations (AFFO) – is among the lowest in the industry at 71.9 per cent, providing it with ample flexibility to maintain and raise its distribution. (AFFO is a real estate industry measure of cash flow). What's more, CREIT maintains a conservative level of borrowing, with an indebtedness ratio (debt divided by the total value of its assets) of 38.6 per cent – well under the 60-per-cent limit set out in CREIT's declaration of trust. If the economy were to experience a recession, CREIT would be in a strong position to weather the downturn.

The distribution is growing

CREIT's yield of about 3.7 per cent is modest for a REIT, but avoiding the units on that basis alone would be a mistake. Fuelled by its expanding property portfolio and growing cash flow, CREIT has paid higher distributions for 15 consecutive years and, in a testament to its financial strength, it even hiked its payment during the financial crisis of 2008 and 2009. And there are almost certainly more increases to come. Despite pockets of weakness including Calgary's soft office market, "we view CREIT as a defensive holding, appealing to investors who value its solid balance sheet, consistent internally generated and retained cash flow, and low payout ratio," CIBC World Markets analyst Alex Avery said in a note.

It's diversified

CREIT's $5.7-billion property portfolio is well diversified, with retail accounting for about 55 per cent of operating income and the remainder split between office and industrial real estate. Its 203 properties (including developments) are also diversified geographically, with most of its operating income generated in Alberta (38 per cent), Ontario (26 per cent), the Atlantic provinces (13 per cent), Quebec (11 per cent) and British Columbia (9 per cent). Another source of growth and diversification is CREIT's recent foray into residential real estate, which includes a 198-unit apartment building under construction in north Toronto and a 50-per-cent stake in a new 95-unit rental building in Edmonton, where CREIT also has several other residential developments planned. Diversification promotes stability of CREIT's cash flow and adds another layer of safety to its distribution.

Occupancy is solid

CREIT's occupancy levels have been consistently strong, ranging from about 94 to 97 per cent since 2000 (at the end of 2016 occupancy was 94.8 per cent). The low level of vacancies reflects CREIT's stable tenants – which include the likes of Canadian Tire, Loblaw, Sobeys and Leon's Furniture – and its prudent diversification strategy; with its top 10 tenants accounting for just 22 per cent of rental revenue, CREIT limits its risk should one of its tenants run into financial trouble. CREIT is also making significant progress on leases that expire in 2017, having already obtained firm or highly probable commitments on 59 per cent of the 2.5 million square feet of space.

Units are fairly – not cheaply – valued

CREIT's units aren't cheap. They trade at a multiple of more than 18 times estimated 2017 AFFO, compared with an average of about 14 to 15 times for other diversified REITs. The unit price is also roughly a 6-per-cent premium to the estimated net asset value of CREIT's properties. But given CREIT's strong financial position, high-quality portfolio and solid growth prospects, analysts say a premium valuation is warranted. "For individual investors seeking only one REIT in their portfolio over the long term, we often recommend CREIT," RBC Dominion Securities analyst Neil Downey said in a recent note in which he reiterated an "outperform" rating and $53 price target on the units. (They closed Tuesday at $49.80). Of the nine analysts who follow CREIT, four have a "buy" or equivalent rating, five have a "hold" and there are no "sells," according to Bloomberg.

Closing thoughts

If you're looking for a stock that has the potential to double or triple in the next year or two, CREIT is probably not for you. Rather, it's suitable for an investor seeking stable income, slow-but-steady distribution growth and modest capital appreciation over the long run. Remember that there are risks with investing in real estate, including the possibility of higher interest rates and the potential for tenant bankruptcies in the event of a recession. Keeping those risks in mind, CREIT is a conservative pick for investors who want diversified exposure to Canadian real estate.