The S&P/TSX REIT Index is down 18.1 per cent year to date and that’s including dividends. As I wrote in an April column, the dividend and distribution yield on REITs no longer look as attractive relative to rapidly climbing risk free government bond yields.
CIBC REIT analyst Dean Wilkinson presented a bullish counterpoint to recent sector performance in Tuesday’s Ask Not For Whom The Debt Rolls: Are Rising Interest Rates A Harbinger Of Doom?
For Mr. Wilkinson, the rising rate environment is just business as usual for the real estate sector, “REITs have long been in the business of managing debt, and a changing interest rate environment (even rapidly) is nothing more than part of the natural ebb and flow of their business cycle”.
CIBC estimates that even if financing costs double from here, the effects on general REIT profitability would be “immaterial.”
The issue of competitive risk free yields remains, but REITs are now trading at attractive valuation levels that could be fully compensating investors for inflation risk with potential price upside.
Mr. Wilkinson writes that REITs are currently trading at a roughly 24-per-cent discount to net asset value compared with the usual 5-per-cent discount. In his words, a return to normal implies “healthy double digit upside” for the sector.
The analyst sees REIT prices already reflecting a future inflationary environment of rising bond yields. With these risks largely priced in, the depressed valuations combine with reasonably attractive yields to make the beleaguered sector an interesting option for investors.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: What are your thoughts on holding exchange-traded funds in registered accounts given what appears to be a higher volume of reinvested or “phantom” distributions recently? In the past year I have received phantom distributions in my non-registered and registered accounts, but while I get the benefit of increasing my adjusted cost base in my non-registered account, I get no benefit at all in my registered accounts.
Answer: Increasing the adjusted cost base of an ETF in a non-registered account is only a “benefit” to the extent that it prevents you from paying more capital gains tax than necessary when you eventually sell your units. However, there are no capital gains taxes in registered accounts, so raising the ACB of the ETF would not provide any benefit. For that reason, you should feel comfortable holding ETFs in a registered retirement savings plan or tax-free savings account, for example. In addition to receiving all investment income and capital gains tax-free, holding your ETFs in an RRSP or TFSA will simplify your bookkeeping. (In the case of RRSPs, income tax only comes into play when money is withdrawn.)
Also keep in mind that 2021 was an especially busy year for phantom distributions, because surging stock markets created a lot of capital gains that ETFs distributed (on paper) to unitholders for tax purposes at the end of the year. Given the rough start for markets in 2022, however, I suspect we won’t see nearly the same volume of phantom distributions this year. For more on phantom distributions, read my recent column here.
-- John Heinzl
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Compiled by Globe Investor Staff