The average Canadian REIT yield remains at a level that implies low returns despite recent Bank of Canada rate cuts that make the sector’s income streams more attractive to investors.
I looked at the yield and returns for the S&P/TSX REIT index from May, 2006, the maximum available. I found a high correlation between two-year returns for the index and the extent to which the index yield exceeded two-year government bond yields.
The accompanying chart clearly depicts the trend. The horizontal X axis shows the yield spread – the yield of the REIT index minus the yield on the two-year bond for every month since mid-2006. The vertical Y axis shows the two-year cumulative return for the index from that point.
As an example, the data point farthest to the right (it’s from February, 2009, but dates are not used on scatter charts) shows a month end when the yield spread was 10.8 percentage points and the index return for the next two years was 94 per cent.
The upward-sloping trend line is indicative of a consistent trend – the more the REIT yield exceeds the bond yield, the better the returns for the next 24 months will be.
Currently, the yield on the REIT index is 5.4 per cent and the two-year bond yield is 3.1 per cent. This makes the spread 2.3 percentage points. If we find roughly 2.3 on the X axis, we see performance data points ranging from -40 per cent on the low side and 0.0 per cent on the upper end.
The conclusion here is that investors in the broader REIT index can expect low simple returns in the next two years based on the available performance data.
Time for some caveats. There’s the usual “past performance patterns may not hold in the future,” for one. We’re also only working with about 200 data points here, and I’d prefer a lot more. Furthermore, there’s a worldwide financial crisis and a pandemic in this data set, and it’s reasonable to expect a bit less volatility in the next 20 years.
It is also important to note that the REIT index returns are an average of very different companies dealing with varying business conditions. The conclusion from the chart might, for instance, apply more for currently beleaguered office REITs than apartment REITs benefiting from scarce supply.
The overall pattern, however, should remain the same. The more a REIT’s yield exceeds two-year bond yields, the better performance investors can expect in the ensuing years.