Canadian real estate investment trusts (REITs) and Guaranteed Investment Certificates (GICs) have different risk/reward profiles. Both investments generate income for their investors. The yields of Canadian REITs have risen from rising interest rates that have weighed on their stock valuations.
Riskless GICs guarantee that you get your original principal back and earn interest income. In more recent years, a new form of GIC has become available. It provides growth potential from stock markets — likely a percentage of the growth. But again, it provides principal guarantees. Currently, the best interest rate offered by traditional five-year GICs is about 5%.
There are Canadian REITs that offer similar or higher income than GICs. Typically, it’s the slow- to no-growth REITs that are offering higher yields than GICs. Because of changing stock prices, REITs also have the potential to deliver price appreciation, such as when interest rates decline again.
Here are a couple of slow-growth REITs that offer higher income than traditional GICs and could deliver decent price appreciation over the next five years, particularly if interest rates revert lower.
H&R REIT
H&R REIT (TSX:HR.UN) stock has declined about 14% year to date. In the first quarter, its same-property net operating income rose 10.5%, driven by gains across its portfolios and particularly driven by strong rent growth and higher occupancy for its residential and industrial assets. A stronger U.S. dollar against the Canadian currency also helped contribute to the growth. Ultimately, its adjusted funds from operations per unit grew 2.0% year over year.
The diversified REIT trades at about 8.7 times funds from operations at $10.37 per unit at writing. The stock currently offers a monthly cash distribution that equates to a cash distribution yield of almost 5.8%. Its payout ratio is estimated to be sustainable at about 50% of its funds from operations this year.
On a reversion to the mean, the stock could trade at about $13.80. Sure enough, the 12-month analyst consensus price target is $13.92, which represents a discount of about 26% and a fabulous near-term upside potential of about 34% on top of the nearly 5.8% annual income.
Northwest Healthcare Properties REIT
Northwest Healthcare Properties REIT (TSX:NWH.UN) is even more sensitive to interest rate changes. The stock has declined about 31% year to date. At $6.56 per unit at writing, the REIT trades at a discount of about 9.2 times funds from operations. Indeed, the 12-month analyst consensus price target is $9.21, which represents a discount of about 29% and a fabulous near-term upside potential of about 40%.
The stock currently offers a cash distribution yield of close to 12.2%. Naturally, investors should question the viability of this massive yield. The trailing 12-month cash-distribution payments were supported by the free cash flow generated with a payout ratio of about 78%. However, its first-quarter funds from operations payout ratio was 99.5%, which leaves very little margin of safety. Therefore, it’d be better for investors to consider it for total returns.
Its portfolio maintains a high occupancy of about 97% across more than 2,000 tenants and has a weighted average lease expiry of about 14 years. So, in the event of a cash distribution cut, a cut of about 30% may be reasonable to make the payout ratio more sustainable at about 80% of funds from operations.
Summary
Canadian REITs can provide monthly income to their investors. Price appreciation is also in the cards. However, as we saw the year-to-date decline of the two examples, investors could experience losses as well. Traditional GICs provide risk-free income and the guarantee to pay your principal back. Consequently, if you have a high-risk tolerance and long-term investment horizon, you can consider Canadian REITs for income. Otherwise, GICs that now pay out higher interest income from a year ago are the safest places to park your money.
