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REITs hold up well in market decline

Real Estate Investment Trusts (REITs) are looking pretty good in current markets. After lagging the S&P/TSX Composite Index for much of 2014, the S&P/TSX Capped REIT Index held up well in the recent market decline. Over the first few weeks of October, the Composite Index lost over three per cent of its value, while the REIT Index gained nearly three per cent. Consequently, on a year-to-date basis, REITs are now outperforming the main market index. REITs have gained just over seven per cent versus a gain of more than six per cent for the Composite.

When the year began, many observers felt that rising interest rates would cause REITs to underperform. But with the recent resurgence of deflation fears, it’s less certain the U.S. Federal Reserve or the Bank of Canada will move to raise rates in 2015.

This gives REITs a respite for now. Then too, fears of the impact of rising interest rates on these securities may have been exaggerated in the first place. After all, since rates aren’t expected to climb sharply in the coming years, REITs may well weather higher interest charges relatively well.

Keep in mind, too, that REITs that are able to raise their distributions over time should fare better in a rising-rate environment than those that are unable to do so. Here are two REITs that should be able to continue to increase their distributions in the years to come.

RioCan is Canada’s largest REIT

RioCan Real Estate Investment Trust (TSX–REI.UN) is Canada’s largest REIT, with a total enterprise value of about $14.9 billion at the end of its second quarter. The REIT owns and manages Canada’s largest portfolio of shopping centers, with ownership interests in a portfolio of 340 retail properties in Canada and the U.S. combined, with 16 under development, containing a total of 81.0 million square feet.

RioCan has performed roughly in line with analysts’ expectations this year. For the six months ended June 30, 2014, the REIT’s operating funds from operations, or FFO, were $254 million, or $0.83 a unit, compared with $245 million, or $0.81 a unit, in the same period of 2013. The increase was primarily due to higher rental income as a result of acquisitions, completion of development projects, same store growth of 2.7 per cent for Canada and 2.1 per cent for the U.S. portfolio, a favorable foreign currency gain from U.S. operations and a decrease in interest expense.

RioCan’s growth is expected to primarily come from organic growth from within the REIT’s portfolio, asset intensification and development in Canada.

The units recently traded at 16.1 times RioCan’s projected 2014 FFO of $1.64 a unit. At recent price levels the current annual distribution rate of $1.41 a unit yields about 5.3 per cent. Buy.

H&R buys into luxury development

H&R Real Estate Investment Trust (TSX–HR.UN) has purchased a 50 per cent interest to develop a landmark luxury residential rental development in Long Island City, NY. The parcel is zoned for 1.2 million square fee of mixed-used development, potentially accommodating up to about 1,600 residential units and approximately 30,000 square feet of retail space developed in three phases. The total “Long Island City Project” cost of all phases at the 100-per-cent level is expected to be about US$875 million.

H&R is a diversified real estate investment trust. It has ownership interests in a North American portfolio of high-quality office, retail and industrial properties comprising over 54 million square feet.

For the six months ended June 30, 2014, H&R’s funds from operations, or FFO, were $270.4 million, or $0.93 a unit, compared with $209.5 million, or $0.87 a unit, in the same period of 2013. Same-asset adjusted property operating income increased 5.6 per cent to $265.8 million, primarily due to the termination of the external property management contract and the strengthening of the U.S. dollar compared to the Canadian dollar.

H&R paid a distribution of $0.68 a unit for the first half, the same amount it paid in the prior period. The FFO payout ratio is a manageable 72.3 per cent. That should permit future increases in the distribution.

Given its sizable investment in the U.S., we expect H&R to benefit from the continuing U.S. recovery.

The units recently traded at just 11.7 times the $1.84 a share that H&R will likely earn in funds from operations in 2014. At recent prices the current annual distribution rate of $1.35 a unit yields 6.1 per cent. H&R is a buy for income and some growth.

 

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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