What are we looking for?
Real estate investment trusts poised to benefit from falling interest rates.
The screen
CIBC recently predicted aggressive cuts to interest rates of 50 basis points in both December and January. They expect rates to bottom out at 2.25 per cent in June, 2025, a significant drop from the current Bank of Canada interest rate of 4.75 per cent. As savings rates fall in lockstep with interest rates, investors may be on the lookout for other sources of yield.
REITs stand out in this environment for their ability to offer both high dividend yields and potential capital gains. They typically rely on extensive debt to fund property acquisitions and developments, making them particularly sensitive to changes in interest rates. Lower rates translate to reduced borrowing costs and increased profitability.
To identify REITs that will benefit from falling rates, I used FactSet’s screening tool and applied the following parameters:
- Traded on the S&P/TSX Composite
- Market capitalization greater than $1-billion
- FactSet Sector – “Real Estate Investment Trusts”
- Dividend yield greater than 3 per cent
- Variable debt as a percentage of total debt greater than 10 per cent, highlighting companies that will benefit the most from lower interest rates
The eight remaining companies were ordered by a multifactor ranking of dividend yield, price-to-funds from operations (a key real estate valuation metric of profitability), price-to-book, and variable debt as a percentage of total debt.
What we found
Allied Properties Real Estate Investment Trust AP-UN-T, an urban office space developer, topped our screen with an impressive 9.5-per-cent dividend yield. With 39.2 per cent of its debt classified as variable, it stands to greatly benefit from rate cuts. However, its interest coverage ratio of 1.6, a measure of how easily a company can cover interest expenses with earnings, is below the screen’s average of 2.6. This additional risk may explain why Allied Properties is trading at the lowest price-to-book and price-to-funds from operations ratios. Despite these risks, the REIT is well positioned for a strong recovery as interest rate reductions ease its debt burden.
RioCan Real Estate Investment Trust REI-UN-T, a retail-focused real estate manager, ranked No. 2 on our screen with a 5.4-per-cent dividend yield. Notably, 48.6 per cent of RioCan’s debt is variable, indicating substantial upside from rate cuts. RioCan’s tenant base includes resilient consumer staple companies such as Loblaws and Shoppers Drug Mart, providing some downside protection should rate cuts be less aggressive than anticipated.
The information in this article is not investment advice. The author assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained above.
Arjun Deiva, CFA, is an MBA Candidate at the University of California, Berkeley, Haas School of Business
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.