Looking for income in the real estate places

Diversified REITs back on investors’ radar

When the first Real Estate Investment Trusts (REITs) listed in Canada almost 30 years ago, many used the diversified model, owning not merely one type of property, but several. The idea was that different sectors of the real estate market had different cycles and did not all move together. Therefore, owning a REIT that had exposure to retailing, industrial buildings, and offices gave the investor a one-stop shop to different sectors with different dynamics. Some of the first trusts to list, such Canadian REIT, H&R REIT, and Riocan REIT used some variant of this model.

In general, the underlying investment thesis proved to be correct, in that the diversified nature of these trusts’ holdings protected them to a certain extent from being too badly hit if one sector got into trouble. If city centre office buildings were suffering from a downturn in markets, strip shopping centres were very resilient. If industrial buildings were affected by a recession, converted warehouses on the fringes of the central business district would be doing well.

As time went by however, and investors became more knowledgeable about REITs and the different characteristics of the underlying sectors, they moved towards owning pure play REITs that just owned one type of property and were comfortable putting together a portfolio of different individual REITs rather than relying on the management of a diversified REIT to do the job for them.

Furthermore, precisely the less volatile and more stable nature of the diversified REITs portfolios meant they didn’t offer the same upside to sectors that were performing well. Combined with some missteps in asset allocation by some of the REITs, such as overexposure to the very volatile commodity-dependent Alberta market, diversified REITs underperformed the broader index and fell out of favour.

However, market conditions are changing, especially with investors now having a better understanding of the long-term effects of the Covid-19 pandemic on real estate markets. Single asset class REITs have become more difficult to invest in for many investors as the disparity in performance between REITs owning care homes, hotels, and traditional retailers on one hand, and owners of warehouses, apartments, and food retailers on the other has widened enormously given their very different experiences in the last 18 months.

A number of single-asset-class-focused REITs have also begun to diversify, particularly retailing REITs that have begun to develop their properties by adding apartments and in some case offices above their existing retail assets. Amongst those doing so are Choice Properties REIT, Riocan REIT, Canadian Tire-anchored CT REIT, Sobeys-anchored Crombie REIT, and Walmart-anchored Smart Centres. The defensive nature of their holdings as food anchored retailers place them among the most resilient sectors during the pandemic, remaining open as providers of household necessities.

Are there any bargains in the REIT sector? You’ll have to do some digging, but Artis REIT (TSX: AX.UN) might just be a candidate. New management, the Sandpiper Group, took control in 2020 after a proxy battle. It has half its assets in new industrial facilities in fast-growing U.S. sunbelt markets like Houston, Phoenix, and Denver. It sold its Toronto-area industrial properties in the third quarter last year for $750 million and is part of a consortium that bought Quebec focused Cominar REIT in October for $11.75 cash per unit. Plus it’s selling at a 45% discount to its net asset value as of Sept. 30, making it one of the cheapest – if not the cheapest – REIT in Canada. It has a 5% distribution yield.

Gavin Graham is a veteran financial analyst and money manager and a specialist in international investing, with over 35 years’ experience in global investment management. He is the host of the Indepth Investing Podcast.

Notes and Disclaimer

Content © 2022 by Gavin Graham. This article was originally broadcast as a podcast on Indepth Investing, hosted by Gavin Graham. Used with permission.

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