Why are Canadian REITs falling?
There's a real lack of new supply, especially as higher interest rates pushed back development projects. At the same time, Canada has increased immigration rates significantly and shows no signs of meaningfully slowing down. Rents are being driven higher and apartment REITs are the beneficiaries.
As of March 2024, the PE ratio of REITs in Canada stood at -18.6, with the earnings of the market forecast to grow 62.3 percent annually. The PE ratio is a valuation metric which is calculated as the ratio of the total market cap to the total earnings.
Here's an explanation for how we make money . More than a year of interest rate hikes by the Federal Reserve pushed down returns on real estate investment trusts, or REITs. While higher rates negatively impacted nearly every sector of the economy in 2022 and most of 2023, real estate was hit especially hard.
The overall business performance of the S-REIT sector has been lacklustre and some segments of the industry have not been able to recover to pre-COVID levels, either due to a change in business dynamics or due to an inflationary environment. Office REITs have faced challenges due to the new work-from-home (WFH) trends.
Canadian REITs are a popular choice for income investors seeking reliable cash flow. With their high dividend yields, tax advantages, and diverse property portfolios, they can be a valuable addition to your investment strategy.
The good news is that Canadian REIT returns with dividends included have been reasonably good. REITs usually pay high dividends, and Canadian REITs offer particularly high yields when compared to U.S. ones.
Some 492,083 residential properties are forecast to trade hands via Canadian MLS® Systems in 2024, a 10.5% increase from 2023. This is mostly unchanged from CREA's previous forecast. The national average home price is forecast to climb 4.9% on an annual basis to $710,468 in 2024.
Right now, REITs (VNQ) are at an inflection point and time is running out for investors. But now as we head into 2024, we expect the polar opposite and this should lead to an epic recovery across the REIT sector. The Fed expects at least 3 interest rate cuts in 2024 and the market is predicting even more.
The REIT (VNQ) market has been in a bear market for over two years now with the broader market averages dropping by over 25%. But despite that, most REITs have kept growing their dividend. Most of them hiked in 2022, 2023, and will hike again in 2024.
But since REITs are invested in property, there's more protection against the horror show of having shares crash to $0. By law, 75% of a REITs asset must be invested in real estate. The market value of the property owned by the REIT offers a bit of protection, as long as the value of the property doesn't go to zero.
Why are REITs getting crushed?
In addition, higher interest rates make the relatively high dividend yields generated by REITs less attractive when compared with lower-risk, fixed income securities, which reduces their appeal to income-seeking investors.
REITs historically perform well during and after recessions | Pensions & Investments.
In fact, REIT total returns bounced back with impressive performance in the last quarter of 2023. Based on historical experience, the convergence of the wide valuation gap between public and private real estate will likely ensure continued REIT outperformance into 2024.
There's no question that some of the most popular REITs to buy are residential REITS. And while there are several high-quality residential REITs to consider in Canada, two of the best are Canadian Apartment Properties REIT (TSX:CAR. UN) and Morguargd North American Residential REIT (TSX:MRG. UN).
Canadian Apartment Properties was the real estate investment trust (REIT) with the largest market cap in Canada as of April 11, 2024. The market cap, or the aggregate value of the total outstanding shares of the company, was 5.4 billion U.S. dollars during that period.
Canadian Apartment Properties REIT
The Canadian Apartment REIT holds the position as both the country's largest REIT and the country's largest Residential REIT.
Real estate investment trusts reduce the barrier to entry for investors in the real estate market and provide liquidity, regular income and other perks. However, you'll be exposed to risks that aren't inherent in the stock market and dividends are subject to ordinary income tax.
The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.
Canadian REITs are significantly cheaper than U.S. REITs, with lower cashflow multiples and greater discounts to net asset value. However, higher leverage and smaller market caps make them riskier as well.
More housing tidbits:
Q1 2024 has already seen solid price appreciation and increased sales activity, well before anticipated interest rate drops. According to a recent CIBC poll, 56% of non-homeowners said they still hope to own a home one day.
Why are houses so expensive in Canada?
The main drivers behind why is housing so expensive in Canada is too much demand (population growth) and not enough supply (new buildings), with rising and falling mortgage rates acting as a type of lever, either reducing or increasing the supply of new homes as they rise and fall.
Prices and home sales are expected to climb further in 2025, according to the CREA. The increases will be bigger in the East Coast provinces and Alberta, but prices will remain relatively flat in Ontario and B.C.
REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures. Thereafter, REIT managers became far more conservative in their investment and financing practices.
Property Market Factors Influencing VNQ
Inflation-indexed bonds may continue to decline due to energy market issues, possibly creating a 20-30% downside for VNQ. 20% based on its compressed yield spread and an additional 10% due to "energy-inflation" risk factors.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
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