Interest rate hikes are back on the table, with the Bank of Canada (BoC) raising rates by 25 bps, the first raise in more than three years. Undoubtedly, it’s easy to hit the panic button when it comes to some of the more capital-intensive industries out there.
Either way, though, the latest rate hike (and more that could be to come) might already be taken into account in today’s prices. When it comes to the Canadian REITs (Real Estate Investment Trusts), there has already been quite a bit of damage done in recent months, with the reaction in the bond market causing pressure on share prices.
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Rising REIT pressure and higher rates
The good news for income investors is that there’s more yield to be had at lower prices. Just how much of the latest correction across the REIT scene is an actual discount, though, remains the big question. Whenever borrowing costs take a sharp rise and property values look to take a hit, the fundamental story stands to take a step or two back. Either way, REIT investors shouldn’t look to time the REIT market, especially since the recent rate hike was seen coming from miles away.
While the summertime plunge in the REITs might not be as big a deal as rate-hike expectations continue to climb from here, I do think that there are real yields to be had at prices that aren’t all that bad, even when you consider the headwind of higher rates.
As the BoC considers its next move, as it looks to finally stomp out what remains of higher inflation, there could be a very difficult next few quarters for the yield-heavy, capital-intensive REITs. But at the same time, one has to imagine the scenario where inflation finally does come down and investors start looking for the BoC to pivot again. Perhaps a cutting cycle that follows the current hikes isn’t all too far off, especially given the seemingly fragile state of employment.
SmartCentres REIT’s near-7% yield
For investors looking for something to pick up after the rate-hike fear-driven sell-off in the REIT scene, a name like SmartCentres REIT (TSX: SRU.UN) really does stand out now that the yield is hovering around the 7% mark again. The distribution is heightened, yet it’s quite well-covered by cash flows. Of course, the retail REIT is going to feel the full weight of every rate hike. Either way, the REIT is starting to trade at quite a notable discount to net asset value.
In my view, there’s now quite a bit of wiggle room as the impact of rate hikes finally comes into effect. As the REIT slowly but steadily diversifies away from shopping centres and into residential real estate (SmartCentre’s mixed-use future does look quite promising), I wouldn’t bet against the name over the long run. The cash generation remains incredibly robust, and the high occupancy rate probably won’t flinch even as a few more rate hikes come in.
While the adjusted funds from operations (AFFO) picture could get tighter in a rising-rate world given its debt load, I do think that the REIT has what it takes. The Bank of Canada’s first rate hike in over three years is pressuring REITs, but much of the fear may already be priced in, leaving higher yields for investors who can ride out more volatility and make it through a tightening cycle and what ultimately could be the BoC’s last battle against lingering inflation.
