What are we looking for?
Financially healthy real estate investment trusts with growing dividends that are priced at a discount to their fair value.
The screen
Ever since the Bank of Canada started raising interest rates in early 2022, REITs have faced substantial headwinds. Higher borrowing costs, depreciation of asset values and uncertainty in property markets have prompted many investors to re-evaluate their strategies, and to gravitate toward fixed-income investments instead.
This has been reflected by the performance of the S&P/TSX Capped Real Estate index, which has declined by a substantial 18 per cent since rate hikes began in March, 2022. That slump stands in sharp contrast to the S&P/TSX Composite Index, which has dipped by just 6.4 per cent during the same period.
However, prevailing equity market conditions may present an opportune entry point for certain REITs. Some of them offer attractive and stable income. When rate hikes eventually subside, the prospect of improved economic conditions could propel these REITs to higher valuations.
Nevertheless, it is essential to be prudent and diligent when approaching this potential opportunity. Investors should assess critical factors when considering REITs, including the financial health of each one, current valuation relative to intrinsic value, dividend yield and the historical track record of dividend growth.
Today, I use Morningstar Advisor Workstation to screen for REITs with favourable attributes such as positive dividend growth, financial health and undervaluation.
Specifically, I screened for REITs traded on the Toronto Stock Exchange that met the following criteria:
- A positive five-year dividend growth rate;
- A minimum market capitalization of at least $1-billion, to weed out very small companies;
- A Morningstar rating for financial health of B or better. The rating is a proprietary measure that reflects a company’s financial well-being through an assessment of its leverage and cash position;
- A Morningstar Quantitative Rating for stocks of 4 or higher on a scale of 1 to 5, where 4 or 5 stars indicates that a stock is trading at a discount relative to its quantitative fair value.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Morningstar Advisor Workstation gives financial advisers tools for investment planning, portfolio analysis, securities research and sales presentations.
What we found
The REITs that met the above screening criteria are listed in the accompanying table, along with details on five-year dividend growth, dividend yield, financial health and quantitative Morningstar rating. The undervalued nature of these REITs is evident when looking at the last traded price compared to quantitative fair value.
It is important to note, though, that the possibilities of further rate hikes and continued economic uncertainty still loom, so REITs may experience further volatility. However, high-quality REITs can be a worthwhile consideration as a component of a well-balanced portfolio for long-term growth potential. As always, investors should conduct their own independent research before purchasing any investments listed here.
Michael Pe, CFA, is a senior product manager for Advisor Workstation at Morningstar Research Inc.