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As the double whammy of a slowdown and high inflation hits investor portfolios, people are looking at options that generate steady income. As a result, many people have been looking for an income stream to help them achieve their goals. Real estate Investment trusts, aka REITs, are an excellent option to fulfill this goal.
They provide easy and affordable access to real estate, and nowadays, their popularity is growing, especially in surging markets like British Columbia or Ontario. This article guides investors who want to know more about REITs and how to use them to make money. By the end of this article, you will also find out the 3 Best TSX REITs for Canadian investors.
What are REITs?
REITs Explained And The 3 Best TSX REITs For Canadian Investors
REITs are real estate companies that are primarily engaged in the process of buying and managing real estate assets. They take money from investors to invest in properties and distribute their income from those properties amongst the shareholders. The properties they invest in may be residential or commercial, like apartments, cell towers, data centers, hotels, medical facilities, office buildings, retail centers, and warehouses. They operate like equity mutual funds. Instead of investing in shares of companies, they invest in real estate.
REITs are known for generating a steady stream of income for their investors. Each share is called a unit (just like mutual funds). The unitholders benefit from the fact that they can earn dividend incomes from real estate investments without having to buy, manage, or finance those properties themselves. Investors also benefit from capital appreciation though the capital appreciation provided by REITs is much lower.
Now, when several REIT companies are listed on the Toronto Stock Exchange, investors can similarly buy them as they do in the case of stocks.
How do REITs make money?
REITs, like any other publicly-traded company in the stock market, can raise funds from the public through Initial Public Offerings. They use these outside funds to acquire, develop, and manage real estate assets to profit. To make money, these companies usually give rent or lease or sell off the properties they have purchased.
The unitholders of the REITs have the responsibility to choose a board of directors who, in turn, are given the responsibility of selecting the investments and hiring a group of suitable working professionals to manage those properties regularly.
Moreover, as per regulations, REITs must regularly distribute 90% of the total income they generate amongst the unit holders. Their profits are called Fund from Operations (FFO), the net income they generate from renting or selling properties after deducting the cost of administration and financing. Investors who want to check the accurate calculation of their FFOs must look at the company’s quarterly report or other supplemental information.
Important Valuation Metrics for REITs
There are several matrices for the valuation of REITs. Some of the most important ones are described below:
1. Price to FFO
In general, net income and earnings per share translate poorly in the case of REITs. Investors must check the Funds from operations (FFO) to get a clear picture. To determine FFOs, some adjustments are made to the REIT’s net income. Most of the reports shared by REITs mention their FFO per share alongside their headline numbers. So, to judge if a REIT is cheap or expensive compared to the broader market, investors can use this metric.
2. Adjusted, Normalized, or Core FFO
Besides the normal FFO, some REITs also mention company-specific FFO metrics in their reports. Those adjustments are made considering the one-time items and non-standard incomes to give the best picture of how profitable it is. This metric will be the best determinant for judgment if mentioned in the REITs report.
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This is the perfect measure if anyone wants to compare the leverage between different REITs. You can find this ratio in many REIT reports directly, but investors can calculate it quickly if it is not provided. Generally, there is no specific debt-to-EBITDA ratio to look out for. However, if the ratio of one is significantly on the higher level compared to its peers, then its situation might not be favorable.
4. Payout Ratio
This is the amount paid out as dividends by REITs, expressed as a percentage. Using this metric, investors can determine the sustainability of a REIT’s dividends. Most REITs have higher-than-average payout ratios ranging from 70% to 80%. However, a dividend cut may be forthcoming if it is 100% or higher.
3 Good TSX REITs
1. Canadian Apartment
It is the largest publicly traded apartment landlord in Canada. Canadian Apartment owns real estate assets across Canada and some in Europe, making it a perfect long-term investment for those who demand diversification in their portfolios. This diversification factor also reduces the risk factor associated with this REIT’s stock and lends greater liquidity to its operations.
Further, Canadian Apartment is increasing its distribution yearly while demonstrating growth in its portfolio size and cash flow. For the quarter ending June 30, 2022, its NFFO per unit is 0.585 with an NFFO payout ratio of 61.9%, which is much better than the previous year’s NFFO per unit of 0.579 and NFFO payout ratio of 59.8%. As this REIT is trading at a meager price these days, it is one of the best investment options today in the market. It was even mentioned in our top 3 picks for Canadian REITs in August.
2. Allied Properties
Allied Properties is one of the leading owners, managers, and developers of urban workspace across major Canadian cities. Its network-dense urban data centers in Toronto have contributed considerably to developing a hub for global connectivity in the country. It has over 200 properties in multiple Canadian markets for which its investors access different asset classes.
Allied Properties had seen massive growth four years before the 2020 crash. However, it trades at a discount of almost 54% from the pre-pandemic levels. The dividend yield provided, moreover, is as high as 6.43%, and the market believes it might start growing at its pre-pandemic pace once again.
3. Automotive Properties
Automotive Properties’ primary focus is on owning and acquiring income-producing automotive dealership properties throughout the Canadian region. It manages approximately 73 income-producing automotive dealership properties and has some solid fundamentals. It reported a total cash NOI of $17.1 million in the second quarter of this year, which is 6.7% higher than last year. Furthermore, its rental revenue increased 6.5% yearly to $20.83 million during the same period.
The company is in a perfect position to go for future acquisitions as it has a low debt-to-GBV (gross book value) ratio and a strong liquidity position. Further, its huge yield of 6.23% also makes it an attractive bait for investors.
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