With rents soaring and vacancy rates shrinking, finding an affordable apartment has become a challenge for a growing number of Canadians.
As my colleague Matt Lundy recently reported, demand for rental units is overwhelming the supply, and the problem isn’t going away any time soon.
In my capacity as an investing columnist – and a parent who wonders how his kids will ever be able to afford a place of their own – I’d like to offer a suggestion from the “if you can’t beat ‘em, join ‘em” school of investing:
Consider owning apartment real estate investment trusts.
The same factors that are making life difficult for renters are generating higher revenues for apartment REITs and sending their unit prices up sharply.
Since I launched my model Yield Hog Dividend Growth Portfolio on Oct. 1, 2017, the best-performing security, by a wide margin, has been Canadian Apartment Properties REIT (CAR.UN). Through Aug. 19, units of CAP REIT – one of Canada’s largest residential landlords – have surged about 57 per cent, excluding dividends. (Full disclosure: I also own CAP REIT’s units personally.)
Other apartment REITs are also enjoying the view from a higher floor. InterRent REIT (IIP.UN) has roughly doubled over the past two years, Killam Apartment REIT (KMP.UN) has jumped about 59 per cent over the same period and newcomer Minto Apartment REIT (MI.UN) has gained about 54 per cent since its initial public offering less than 14 months ago.
Will such scorching gains continue? Well, yields and valuations are not as attractive as they once were, so investors should probably temper their expectations. However, I believe apartment REITs will continue to benefit from the tight rental market, rising rents and the tailwinds of immigration, population growth and urbanization.
Let’s take a closer look at the four REITs mentioned here. Remember to do your own due diligence before investing in any security, and always maintain a diversified portfolio.
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Canadian Apartment Properties REIT (CAR.UN)
Price: $53.44
Yield: 2.6 per cent
CAP REIT’s latest results demonstrated how landlords are benefiting from the rental squeeze. In the second quarter, rent increases on lease renewals averaged a modest 2.1 per cent, reflecting the impact of rent controls. But for suite turnovers – when landlords can set the rent at whatever the market will bear – rent increases in CAP REIT’s Canadian portfolio averaged 14.2 per cent. That trend will likely continue for years, analysts say. “We believe market rents may be 15 to 20 per cent above the portfolio’s in-place rents and it may take CAR.UN another four to five years to fully capture today’s gap,” RBC Dominion Securities analyst Neil Downey said in a note. In addition to enjoying higher rents on its portfolio of more than 57,000 residential units across Canada and the Netherlands, CAP REIT is growing via acquisitions of manufactured home communities – commonly known as mobile home parks – and new rental buildings. It also sees the potential to add more than 5,000 rental units through its own property developments.
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InterRent REIT (IIP.UN)
Price: $15.52
Yield: 1.9 per cent
Focused on Ottawa, Montreal and the Greater Toronto Area, InterRent follows a simple formula: It buys dated or under-managed properties and invests in suite improvements, energy-efficiency upgrades and other enhancements that allow it to charge incoming tenants higher rents (or apply for increases above rent-control guidelines for existing tenants). The strategy has been a big success: "IIP continues to knock it out of the park from an operating perspective,” Desjardins Securities analyst Michael Markidis said, noting that net operating income (a real estate measure of profitability) jumped 12.3 per cent in the first six months of 2019 on a same-property basis. After a $201-million equity issue in July to fund several acquisitions in Montreal, InterRent “has plenty of flexibility to pursue additional acquisitions while continuing to fund its value-add [capital expenditure] program and early-stage development initiatives,” Mr. Markidis said. In other words, more growth ahead.
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Killam Apartment REIT (KMP.UN)
Price: $20.55
Yield: 3.2 per cent
Killam is a major apartment landlord in Atlantic Canada and also owns properties in Ontario and Alberta. About 90 per cent of its net operating income is from apartments, with the remainder split between commercial properties and leased-land manufactured home communities. Thanks to steady rent increases and a strong development pipeline that includes ownership interests in projects under construction in Charlottetown, Ottawa and Mississauga, Killam has “above-average growth prospects,” Industrial Alliance Securities analyst Brad Sturges said in a note. Killam’s distribution yield is also above-average for a growth-oriented apartment REIT and, like the other REITs mentioned here, it has been raising its distribution annually in recent years, with more increases likely, analysts say.
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Minto Apartment REIT (MI.UN)
Price: $22.72
Yield: 1.9 per cent
Minto is relatively small – it owns and operates 27 apartment properties in Toronto, Ottawa, Montreal, Calgary and Edmonton – but analysts like the REIT’s high-quality portfolio, its tight focus on major urban centres and its strategic relationship with real estate developer and manager Minto Group, the REIT’s largest unitholder. Having gone public in July, 2018, Minto’s results have exceeded forecasts, including second-quarter results released this month that beat analysts’ expectations and included a 7.4-per-cent distribution hike – likely the first of many for the REIT.
Closing thoughts
After such strong recent gains, all four REITs are already at or near the average 12-month target prices of analysts. That alone isn’t a reason to avoid them – some of these REITs have a history of blowing past targets – but a prudent approach might be to wait for a pullback in the unit prices before investing.
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John Heinzl