It can be lucrative to invest in real estate. You can get price appreciation over the long term and earn a stable monthly income.
However, an investment property requires a large investment up front. Most people have to pay a lump sum for the down payment, get a huge mortgage, and pay it off (on top of the interest) over time. Maintenance is also another expense.
From an investment perspective, it’s simpler to invest in real estate investment trusts (REITs).
American Hotel Income Properties REIT LP (TSX:HOT.UN) and H&R Real Estate Investment Trust (TSX:HR.UN) are stable REITs with great yields and the potential for capital gains.
American Hotel
American Hotel gives exposure to branded hotel properties and railroad lodging in the United States.
The REIT’s portfolio includes 43 Oak Tree Inn hotels across 21 states that provide lodging accommodations for railroad employees from U.S. railroad operators, including Union Pacific, BNSF, and CSX.
The REIT has long-term relationships of at least 25 years with these railroad operators. These railroad operators give the hotel portfolio stable occupancy and a recurring revenue stream. In the first half of 2015 the rail portfolio contributed 46% (or US$29.5 million) of revenue.
The rest of its revenue comes from its branded portfolio of 35 hotels across nine states. The REIT has five franchise partners. Its top three partners are Marriott, Intercontinental, and Hilton.
American Hotel is selling at a discount to its peers and to its net asset value (NAV). American Hotel’s NAV per unit is US$9.22. This equates to C$12.80 using a foreign exchange rate of US$1 to C$1.39.
At $10.40 per unit, its discount to NAV is almost 18%. Its yield of 8.6% is safe because its adjusted funds from operations (FFO) payout ratio is 68%. The lower the payout ratio, the safer the yield.
H&R REIT
H&R REIT owns a portfolio of retail, office, industrial, and residential properties. It has interests in 512 properties across 46.6 million square feet of gross lease area (GLA), and 12 of its top 15 tenants have investment-grade credit ratings and make up 42% of gross revenue.
On the positive side, H&R REIT earns 28% of its operating income from the United States, so the REIT benefits from the strong U.S. dollar. H&R also earns 34% of its operating income from Ontario, which is a stable province.
H&R has maintained an occupancy rate of above 96% since 1997. Its average commercial lease term is 10 years. Its FFO payout ratio was 67% in the third quarter. These factors help keep its income stream stable and its yield safe.
On the downside, H&R earns 28% of operating income from Alberta. Of that, the 62% that comes from office assets is a concern. However, those are trophy properties with mostly high-quality tenants (who have a BBB credit rating or higher) that are committed to long-term leases of 16 years or longer.
The REIT is well diversified across its assets. It has 42% of GLA in retail assets, 29% in office assets, 26% in industrial assets, and 3.5% in residential assets. About 53% of H&R’s operating income comes from office assets, 39% comes from retail assets, and 8% comes from industrial assets.
At $20 per unit, H&R is selling at a discount of roughly 13% to its normal multiple. If it trades back at the $23 level, investors buying today will experience a 15% gain. On top of that, you’ll earn an above-average yield of 6.7%.
Summary
REITs are great additions to diversified portfolios. American Hotel and H&R can boost your income with safe 7-9% yields, and they have the potential for nice capital gains because they’re priced at a discount.
It would be even better if interested investors can buy them on any further dips; for example, it would be better to buy American Hotel below $10 and H&R below $20.
REITs pay out distributions that are unlike dividends. Interested investors should consult their tax advisors to find out the most appropriate account to invest in.
