Investing in REITs

[tonyla]

Starting to evaluate REITs as another method to invest in Real Estate. Mostly in tax sheltered vehicles (RRSP/TSFA). Focused mainly on REITs that invest in Western Canada and possibly the US.



Are there any REITs that members on this board own/like and why?



The Canadian names that I have just done some cursory research into are

Boardwalk (BEI.UN), Dundee (D.UN), RioCan (REI.UN) and Artis (AX.UN).



I don't have any US REITs on my radar yet. Would love to hear from others that are more seasoned/knowledgable in this area.

 

[housingrental]

I'd go REIT ETF route

Too hard / time consuming to do research in space if (as is often so) holdings in them are a very small portion of your portfolio

 

[TangoWhiskey]

I know a guy who decided to use US ETF's rather than buy buildings himself. According to him he generates 60K a year off of a 400K investment in a mortgage fund called Annaly - and he runs several million in funds for investors and has always been very ethical with everyone I've known. I believe him, I've known him my whole life. I don't understand how he generates such high returns but generally I think the 400 is used to borrow further funds at advantageous rates thus generating a highly geared return.

 

[bizaro86]

He's referring to Annaly Capital Management, a mortgage REIT traded on the New York Stock Exchange, symbol is NLY. It's trailing yield is 15.47%. Stated another way, the shares trade for $16.22 currently, and in the last year they've paid $2.51 in dividends.



However, there is some risk involved (as there must be to get a cash return of 15%+). The REIT borrows short term money and buys mortgage bonds with it. It makes money on the spread between it's borrow rate and it's lend rate, like a bank. However, if interest rates rise, it's borrowing costs will go up, and the value of the mortgage bonds in it's current portfolio will go down. (Bond prices move inversely to interest rates). So it will have a hard time generating enough cash flow to pay it's debt, and will have a hard time selling its assets for enough $ to pay its debt in that situation.



It's an excellent investment if you believe interest rates will be staying "lower for longer" as it pays out a high current yield. Someone who was really sure rates were going to stay low could compound the bet by borrowing the money on margin at <5% and investing it at >15%. But that compounds the risk as well.



Finally, I should mention that it's a US dividend, which means it's not eligible for the Canadian dividend tax treatment, and the US applies a withholding tax to the dividend income before it's received in your account. RRSP account are non-taxable and exempt from the US withholding tax, so if you're considering buying this security it's better in your RRSP than anywhere else. (Including your TFSA, which is not exempt from US withholding tax, and you won't get the foreign tax credit back.)



Michael



Edited to add: Also, it's a REIT not an ETF...

 

[Thomas Beyer]

REITS are excellent ways to participate in real estate as they must pay regular distributions. A portion of these distributions is usually tax free, as REITs flow out losses or gains or have cash-flow that is tax preferred through property depreciation.



There are 2 broad categories:

a) private REITS, not publicly traded, such as League's IGW REIT, Skyline or Centurion

b) publicly traded REITs which always run the risk of stock market volatility, like any stock.



The biggest benefit is regular cash-flow (unless they decide to stop like Lansborough did a few years ago and other might do if cash is tight). The biggest drawback is NAV accuracy / volatility. With respect to a) you have to rely on the issuers assurance that their net asset value (NAV) is accurate. The NAV is critical as the distribution from any REIT is not only from cash-flow or funds-from-operations (FFO) but also from asset sales or re-financing.



So if you give me $100,000 and I give you 10% a year, it does matter what is left in the bank (for you) i.e. your share 5 years hence: $35,000 ? $85,000 ? $115,000 ?



Thus, look at the FFO and the % of payout of it, the so called pay out ratio. Then ask if this payout is sustainable in light of the revenue, expenses, asset quality and NAV. That is the critical analysis which is complicated.



Many REITs over-distribute, because they assume the real estate asset value goes up, or because they pay mortgages down every month and thus, can re-finance every so often. If that is not the case, the price of the NAV continues to drops, such as in MOB.un, a GE sponsored Medical Office REIT, or Lansborough REIT (LRT.un) which dropped from around $5 to sub 50 cents (90%+ drop) a few years ago. Thus, despite cash-flow, the overall return is negative for a few years running. Private REITs tend to estimate their NAV based on real or imagined property values, sometimes disclosed, often not. Liquidity can be an issue.



Residential (aka apartment building based) publicly traded REITs in Canada are: Boardwalk (BEI.un), Transglobe (TGA.un), CAPReit (CAR.un), InterRent (IRR.un) and Northern Properties REIT (NPR.un). There are another 15 or so focused on various commercial, like industrial, storage, office or retail. The biggest one is indeed RioCan.



Or you could buy the ETF called XRE.un, a basked of about 12 or 15 REITs in Canada.



There are 200+ REITs in the US.



REITs were great buys about two, 2 1/2 years ago. Boardwalk, for example, went from $22 to over $50, but is now possibly trading over NAV with now a sub 4% yield.



You can usually do better in well run private syndications (such as ours or InvestPlus) or in JVs with REIN members if they know what they are doing (there are quite a few) if cash-flow is less of a goal. Always look at the total return of cash-flow plus equity creation through mortgage paydown or value upside. If cash-flow is the only or primary goal, then REITs are a good option, or real estate with low or no mortgages - however look at the sustainability of the distribution and the asset quality also.



REITs are great vehicles for monthly cash-flow for retirement where equity upside is less relevant perhaps.



Disclaimer: This is an opinion. This is not financial advice. I am not a financial analyst nor a financial advisor. Any investment has risk. Please invest at your own risk. We offer a private total-return oriented real estate based investment vehicle that is not a REIT but could be construed as competing with REITs.

 

[gwasser]

The answers posted here are excellent.



It is also true that REITs provide cashflow and that REITs have outperfomed the market. This is true for many high dividend paying investments. The stock markets are currently 'risk averse' and 'income hungry'. Unfortunately, 'income hungry' is rapidly becoming risky.



Most investors are complacent about interest rates and expect them to remain low for several years. Yet, interest rate risk is today the biggest risk. Just because most investors are doom and gloom right now does not mean they will be a year from now. I expect that if we get no recession in North America and when BRIC growth resumes the current fears will dissipate possibly turning into optimism or worse overconfidence. Moods do that in a heartbeat.



Today many investors are willing to invest in 1% interest bearing instruments while inflation is 3% but that can simply not last. Interest rates, even long term, are artificially low. Europe is slowly resolving and thinking that Italy will default on 7% interest rates is simply naive and irrational. Think back to Canada in 1982 with 10%plus inflation and Gov Bond rates in the teens. Did Canada go broke inspite of a high debt load? So why should Italy when interest rates peak temporarily for a few days above 7%?



The market will take off earlier than most expect. Economies will continue to grow probably in the the 1.5 to 3.5% real GDP in N. America; 8% plus in emerging markets and 1-1.5% in Europe. The result will be normalized interest rates. Then you will see the effects of those higher interest rates reflected in anything not inflation indexed and that is currently trading as high valuations such as REITs, preferred shares, medium to long term Gov bonds.



If you currently own REITs and inflation indexed preferreds I would call them 'holds'; certainly not 'buys'. Especially Canadian REITS with lots of holdings in Toronto, Ontario and Vancouver will become increasing risky with time. XREs are a good alternative because they are diversified and liquid. So when you buy them through a discount broker and you see the above described scenario take hold you can dump them on a moment's notice.



To be honest, if I had to choose between income paper securities and Alberta real estate, I would currently choose Alberta real estae in a heart beat and use the low interest rate window to my fullest advantage.

 

[orei]

I continue coming back to this forum for threads such as this one ... not threads where people are getting offended/not offended by silly jokes.



Keep up the great content Thomas, Michael and Godfried!

 

[Thomas Beyer]

Godfried raise a few great points, such as REITs may drop in value .. So while you get a 4% cash flow it may drop 10%, taking 2.5 years of cash flow with it. For example, whenever Alberta is in the news negatively, Boardwalk drops as it has about a third of its assets in Alberta .. Regardless of actual asset performance. Thus it behaves like a stock and moves on rumors or perception. It rose over 100% over the last 2 years. How much upside is there in the short term ?



This reminds me of a joke ....





Just kidding ...

 

[TangoWhiskey]

[quote user=gwasser]The answers posted here are excellent.



It is also true that REITs provide cashflow and that REITs have outperfomed the market. This is true for many high dividend paying investments. The stock markets are currently 'risk averse' and 'income hungry'. Unfortunately, 'income hungry' is rapidly becoming risky.



Most investors are complacent about interest rates and expect them to remain low for several years. Yet, interest rate risk is today the biggest risk. Just because most investors are doom and gloom right now does not mean they will be a year from now. I expect that if we get no recession in North America and when BRIC growth resumes the current fears will dissipate possibly turning into optimism or worse overconfidence. Moods do that in a heartbeat.



Today many investors are willing to invest in 1% interest bearing instruments while inflation is 3% but that can simply not last. Interest rates, even long term, are artificially low. Europe is slowly resolving and thinking that Italy will default on 7% interest rates is simply naive and irrational. Think back to Canada in 1982 with 10%plus inflation and Gov Bond rates in the teens. Did Canada go broke inspite of a high debt load? So why should Italy when interest rates peak temporarily for a few days above 7%?



The market will take off earlier than most expect. Economies will continue to grow probably in the the 1.5 to 3.5% real GDP in N. America; 8% plus in emerging markets and 1-1.5% in Europe. The result will be normalized interest rates. Then you will see the effects of those higher interest rates reflected in anything not inflation indexed and that is currently trading as high valuations such as REITs, preferred shares, medium to long term Gov bonds.



If you currently own REITs and inflation indexed preferreds I would call them 'holds'; certainly not 'buys'. Especially Canadian REITS with lots of holdings in Toronto, Ontario and Vancouver will become increasing risky with time. XREs are a good alternative because they are diversified and liquid. So when you buy them through a discount broker and you see the above described scenario take hold you can dump them on a moment's notice.



To be honest, if I had to choose between income paper securities and Alberta real estate, I would currently choose Alberta real estae in a heart beat and use the low interest rate window to my fullest advantage.






Although markets may take off earlier than most expect I don't think it is likely to last. With 50 million baby boomers starting to retire and starting to convert paper assets into real cash I don't see how the future of the stock market is that positive in the medium term to 2025 or so for a buy and hold investor. At the end of the day the stock market is hardly on sale right now and over the long-term it seems like more wealth is going to be pulled out of the market than go back into it. Our investing experience of the last 20 years has arguably been that lots of people poured money into the market in the 90's and then made nothing for ten years (or lost a lot due to market timing and emotional reactions) due to high valuations going in. There's a huge amount of academic research showing returns are highly correlated to intial value. Sooner or later much of that money is going to leave the market in increasing amounts as the saving part of the population becomes smaller than the ones spending.



Developed country gov'ts are entering a huge deleveraging cycle to reduce the inflated debt to GDP ratios that are the result of all the promises politicians made to everyone and unions etc for decades. That doesn't suggest great things for employment rates or GDP. Even worse, they're figuring out how to reduce those ratios in politically opaque ways - look at Italy, now run by an appointed PM and cabinet because politicians can't afford to own any of the responsibility. Manipulated and hidden real inflation rates, real interest rates below the cost of inflation - I feel sorry for the fixed income pensioners I rent to.



I agree with your expectation of inflation and that will hurt all the people buying for yield today. It all makes me wonder if we aren't entering the start of a supercycle for multi-family - a great investment for inflationary times and one to weather deflationary periods. The low interest rates today are truly a window of opportunity - so long as you buy right.

 

[bizaro86]

[quote user=ThomasBeyer]Many REITs over-distribute, because they assume the real estate asset value goes up, or because they pay mortgages down every month and thus, can re-finance every so often. If that is not the case, the price of the NAV continues to drops, such as in MOB.un, a GE sponsored Medical Office REIT, or Lanesborough REIT (LRT.un) which dropped from around $5 to sub 50 cents (90%+ drop) a few years ago. Thus, despite cash-flow, the overall return is negative for a few years running. Private REITs tend to estimate their NAV based on real or imagined property values, sometimes disclosed, often not. Liquidity can be an issue.





Interesting that Thomas mentions this REIT. I've recently purchased a few shares, between 30 and 40 cents. It's declined precipitiously, due the fact that it's cancelled it's distribution, and it has very high debt. Low oil prices for awhile didn't help the market in Fort McMurray, where the vast majority of it's assets are located. That's the bad news.



The good news is that it has ~530 million dollars of real estate at book value, and ~470 million dollars of debt. So, if the real estate is worth what they paid for (admittedly a big if) the asset value remaining for the equity is ~60 million dollars. At it's current share price of $0.36, the market cap of the company (price you'd pay to buy all the shares for $0.36) is ~6.5 million. Thus, if the equity in the company were to equal the equity in the real estate, the share price would be >$3.00.



Now, I grant that this is a speculative investment. There are binomial outcomes here, since it's entirely possible that this company will go bankrupt. They are current on their mortgage payments (and earned enough money in rents last quarter to make their payments) but their mortgages are in technical default because they aren't meeting the debt service coverage ratios required. That means the bank could call the mortgages at any time and take back the properties. Which would cause bankruptcy, and the stock will go to zero.



On the other hand, the banks are getting paid, so they don't have a big incentive to foreclose right now. And since vacancy has decreased dramatically, the cash flow coverage is improving. Vacancy has decreased dramatically, which is the biggest upside story here, in my opinion. Vacancy in their most recent quarter was 6% in their Ft McMurray properties, compared to 33% in the same quarter a year ago. That is money flowing to the bottom line, which should allow them to dig out of the hole they're in.



In summary, this security is extremely risky, but has a high potential for gain as well. It's certainly not suitable for money you can't afford to lose, or for a big portion of your portfolio. I'm only mentioning what I've done, and so this shouldn't be construed as advice to anyone, do your own research and get professional advice if you require it.



Regards,



Michael

 

[Thomas Beyer]

Book value is what the firm paid minus annual depreciation. LRT.un paid very high prices 3-4 years ago, and one could argue that they now have negative equity as prices might not be 250-300/door for a rental unit in Ft. McMurray.



LRT.un also has very high management fees to a firm related to the founder/president. I am surprised no one has turfed him yet after the 90%+ stock price drop. Thus, LRT.un is indeed a very speculative purchase, only technically a REIT, more like a penny stock.



Boardwalk, Interrent, Northern Property, Transglobe or CAP REIT are all solid apartment building owners/operators with solid yields .. but the risk of declining unit prices lingers !



Neil Downey of RBC does a REIT by REIT analysis, based on FFO and multiples that you may wish to get on any REIT you intend to follow.



Note my disclaimer in my original post, please !

 

[tonyla]

Some great information from you and other posters in this thread.



Interesting comment about stated book value. How do you usually calculate NAV for a REIT? Most REITs will post their numbers of what their opinion of NAV is. How reliable is this?



Also how would you get those reports that you mention authored by Neil Downey?

 

[bizaro86]

[quote user=ThomasBeyer]Book value is what the firm paid minus annual depreciation. LRT.un paid very high prices 3-4 years ago, and one could argue that they now have negative equity as prices might not be 250-300/door for a rental unit in Ft. McMurray.



LRT.un also has very high management fees to a firm related to the founder/president. I am surprised no one has turfed him yet after the 90%+ stock price drop. Thus, LRT.un is indeed a very speculative purchase, only technically a REIT, more like a penny stock.



Boardwalk, Interrent, Northern Property, Transglobe or CAP REIT are all solid apartment building owners/operators with solid yields .. but the risk of declining unit prices lingers !



Neil Downey of RBC does a REIT by REIT analysis, based on FFO and multiples that you may wish to get on any REIT you intend to follow.



Note my disclaimer in my original post, please !




Book value used to be price paid minus depreciation, when public company records were kept under GAAP. If the company in question has switched to IFRS (which I believe most have, LRT.UN has) then book value is required to be based on recent appraisals. How recent depends on how large the property is as a percentage of their assets. They had slightly more than 50% of their portfolio appraised last year.



The trustees won't turf the management (which takes a property management fee of 4% plus an asset management fee, which is significant iirc) because some of the debt owed by LRT.UN is owed to the parent company. If they turf them, they'll have to pay it back. Also, I think that arrangement is written into the trust documents, so there would probably be a penalty involved to pay it out.



You're absolutely right, that LRT.UN is more like a penny stock than a traditional reit, as it will either be worth more or nothing, and doesn't pay a distribution.



There are some extremely good reits out there for gradual income as well. My favourites are the CAP reit (CAR.UN) and Riocan, for apartments and retail respectively.



Regards,



Michael

 

[bizaro86]

Further research indicates that IFRS is required for Canadian public companies as of Jan 1, 2011. So all REITs should be now getting their properties appraised on a regular basis and using that for their book values. I would check the notes to the financial statements for any company you're considering buying to see whether the appraisals are being done at a frequency you're happy with and by an appraiser you're happy with.



More on IFRS here: http://www.cica.ca/IFRS/

 

[YoungRealty]

Great Forum discussion, a lot of interesting sides, both positive and negative. For beginners, this may seem confusing, I would recommend you invest in what you are comfortable with. Find something you enjoy and learn everything there is to learn about that investment before actually investing. The difficulty with REITs and the stock market in general is that you have no control over your own money. You can find many deals that you control the outcome and you will see the same returns if not better. Good luck investing and let me know if anyone wants to invest in JV deals in downtown Toronto, I have some great properties with higher returns than the REITs, and you get to personally own and manage the properties if you want to.

 

[Thomas Beyer]

[quote user=YoungRealty]The difficulty with REITs and the stock market in general is that you have no control over your own money. You can find many deals that you control the outcome and you will see the same returns if not better.
Well said .. but someone, namely you or a JV partner has to do this, which takes skill and time, and as such deserves compensation for it:

• 
  Investigate location/area of North America to invest in
• 
  Investigate location once city or metroplex is selected
• 
  Screen/filter potential investment properties using realistic rents and/or expenses.
• 
  Write offer on selected property (this may involve multiple offers and
  multiple iterations since typically not all offers will be accepted).
• 
  Negotiate terms and conditions of offer.
• 
  Finalize offer.
• 
  Set up the legal structure/corporation, and co-investor structure usually via a joint venture or limited partnership agreement.
• 
  Select property manager, onsite manager and other professionals (such as
  tax advisors, inspectors, appraisers, bankers, engineers, roof experts,
  boiler mechanics) that may be required to inspect the property
  initially and operate the property on a day-today basis.
• 
  Will market, rent, fix up, repair, paint, landscape and/ or enhance said
  property to standards that expert sees fit to achieve appropriate rent
  and/or resale value.
• 
  Will keep a record of such fixtures, repair material and/or landscaping
  material expenditures and/or of all other expenses, such as property
  management fees, subcontractors , onsite managers, taxes, insurance,
  realtor, legal, advertising and/or related expenses to market, upgrade,
  rent and later sell said property.
• 
  Set up WCB (Worker's Compensation Board), contractor, Rona, Home Depot or supplier accounts.
• 
  Negotiate and set up preferred vendor, supplier and contractor list.
• 
  Negotiate with financial institution to obtain, initially and/or later,
  re-finance using 1st, 2nd and/or CMHC or FannieMae insured mortgages.
• 
  Manage all relationships with banks, realtors and/or 3rd parties.
  
  Set up reporting and e-payment mechanism to investor.
  
  Act as the primary interface to property manager, or may manage properties inhouse.
  
  Adjust rents frequently with market realities.
  
  Invest frequently (but not always) personally into the venture.
  
  Sign all necessary legal documents.
  
  File annual or quarterly statements/documents that may be required by various jurisdictions.
  
  Sign required personal guarantees for required mortgage(s).
  Suggest exit timing
  Suggest exit options
  Prep asset for exit
  liase with realtor & lawyer on exit
  prepare document for exit
  manage exit procedure
  do more reporting & filing on exit

I call this "blue dollars", as opposed to "green dollars". You need a return on (green) $s and a return on blue $s (time, effort, skills, education, know-how, ..)

 

[housingrental]

I'm disappointed to read this post.

You might find jokes about certain nationalities are not as silly when it's your own community being targeted.





[quote user=orei]I continue coming back to this forum for threads such as this one ... not threads where people are getting offended/not offended by silly jokes.



Keep up the great content Thomas, Michael and Godfried!

 

[housingrental]

A question to all:



There's seems to be some group think and/or seeing what you want to see - ie that you invest in real estate and want to invest more therefore all scenario's point to being a benefit for investing in real estate - amoung the posters in this thread / REIN space in general.



If long term debt rates increase in the future how do you view this as desirable for rental properties?

This does imply a market that will demand a higher cap rate = lower potential values for property / higher debt servicing costs.Not good for rental properties. Not good for timing to purchase rental properties. Good time for sale. After market adjustment good time for purpose.



I'd love to hear your detailed thoughts on the above.

 

[Thomas Beyer]

Given the debt situation, the low spending of echo boomers until well into their 30's and retiring baby boomers assume for now that interest rates will very VERY LOW, ie I around the current level for a LONG time.. Say a decade or so !give me one reason why they will go up more than one percent perhaps .. Just one reason, please !

 

[TangoWhiskey]

Although I agree that interest rates are very likely to remain low for a long time to come say 3-4 5 years I don't think it is possible to be sure of this thesis beyond two years. No one knows what the future holds but sooner or later a reversion to the mean for interest rates is in the cards. Conservative leverage and cashflow will allow owners to survive the lag phase as interest rate increases eventually show up as reduced home ownership and rent growth.



I can give you one reason why rates might rise. Eventually gov'ts will have to pay back all that debt, including the US and Japan (whose population is now shrinking in the face of the worlds biggest debt per capita.). They will employ all kinds of measures to do this in ways hidden from the electorate, but one way will be higher inflation. Higher inflation means higher rates. The real question is how successful will govt's be at keeping real interest rates below inflation. It took til the 1970's, but that's how the debt for WWII was paid back - the last time the developed world had similar debt to GDP ratios.