Real Estate Investment Trusts (REITs) are popular with income seeking investors because of the dividends generated by their underlying assets.
REITs have become even more attractive against a backdrop of global trade tensions, falling interest rates and an economic cycle in the late stages. Canadians tend to think of REITs as office buildings and strip malls, but in the new economy, where technology is a dominant theme, they have evolved to meet new demands. These include data storage facilities, labs that enable medical research and the warehousing of goods for online shopping.
But the underlying philosophy remains the same: The underlying assets of a REIT offer a defensive, diversified holding. They add portfolio stability since REIT prices move in different ways than stocks and their lease-based revenue stream is typically less volatile and also offers inflation protection.
“There’s lots of noise out there, tweets and geopolitical tensions,” says Mike Dragosits, Portfolio Manager at Harvest Portfolios Group. “So, defense and a focus on quality makes sense. REITs own hard assets; they add a layer of diversification and have predictable income streams.”
What are REITs?
REITs were launched as an investment vehicle in the U.S. in 1960. They became popular in Australia in the 1970s and 1980s and came to Canada in 1993. There are currently 38 REITs traded on the Toronto Stock Exchange.
REITs invest in real estate in its many forms. While investors tend to think in terms of shopping centres, office buildings and strip malls, REITs have evolved. They include such things as temperature-controlled, secure data centres for cloud computing storage. Another area is facilities that serve the healthcare sector storing temperature-sensitive medicines or enable biotechnology research. A third is related to the growth in online shopping. REITs own the warehouses and logistics facilities that store goods to be shipped to a global marketplace. The Canada Pension Plan Investment Board (CPPIB), which invests on behalf of the CPP, is one of the largest owners of warehouses facilities in China.
In all cases, the business model is the same. REITs collect rent and after covering costs, most of what remains is paid out in the form of dividends. REITs offer small investors a way to own real estate in an easier, more liquid and more diversified way than directly purchasing an income property. To cash out, you sell your shares.
Low interest rates and the REIT advantage
REITs become more attractive relative to stocks in an environment of falling interest rates since their dividends are seen as a proxy for bonds. For example, a Government of Canada 10-year bond is yielding 1.1 per cent.[1] Half of the sovereign bonds in the Euro Zone have a negative yield – in other words, investors get less back on maturity than they paid with no interest in the meantime. A Danish bank has launched the world’s first negative interest rate mortgage, effectively paying homeowners to borrow money. The loans charge -0.5% a year.[2]
By comparison, the yield on the Chartwell Retirement Residence REIT, a component of Harvest Global REIT Leaders Income Fund (TSX: HGR) is 3.97%. [3]
REITs with high quality holdings and prime tenants can capture higher rents. They can also adjust to inflationary pressure by passing along higher costs, because leases, unlike bonds, include inflation adjustment clauses. Inflation also helps REITs retain their real value as inflation tends to increase the price of property.
The different kinds of REITs
REITs come in a variety of categories.
- Retail: Shopping centres, strip malls and regional malls with anchor tenants;
- Lodging: Hotels, motels and resorts, catering to business and leisure travel;
- Residential: Apartments and student housing;
- Retirement & healthcare: Assisted living, nursing homes and medical office buildings;
- Specialty: Data centres, biotech research, warehouses, telecom infrastructure;
- Office: Catering to professionals, services and companies seeking to rent space.
Going global with REITs
The case for going global with REITs is based on the fact that Canada’s REITs make up about 3% of the global total. “So, there’s lots of opportunity outside Canada,” says Mike Dragosits, a Harvest portfolio manager. He notes that Canadian REITS tend to be concentrated in strip malls, office and industrial, but with very little in many of the other categories and with none in the specialty categories.
“So, a global approach offers breadth,” he says.
Mr. Dragosits adds that since there is a low correlation between real estate markets in Canada and those in the U.S., or Europe, a global REIT offers a buffer against economic conditions in any one area, while offering unique opportunities not available in Canada.
The Harvest Global REIT Leaders Income ETF
Harvest launched the Harvest Global REIT Leaders Income ETF (TSX: HGR) in 2017 to capture this opportunity.
The ETF invests in an actively managed portfolio of between and 20 and 30 developed market real estate issuers. To Aug. 31, 2019, the average market cap of the portfolio was CAD $28 billion. More than half of the holdings were in the U.S. (57%), 11% were in France, 10% in Germany and 7% in the UK. The holdings are broadly diversified with 27% of the companies involved in industrial or residential REITs, 16% in the healthcare sector, 11% in office, 10% in real estate and 7% in retail.
The average dividend yield as of Aug 31, 2019 was 2.92%. To enhance income and reduce volatility, the Harvest Global REIT Leaders Income ETF selectively writes covered call options on up to 33% of the option eligible securities.
The ETF is TSFA, RRSP, RRIF and RESP eligible and pays a monthly distribution. The ETF is reconstituted quarterly and is actively managed. The Harvest selection process uses a proprietary set of quality, valuation and momentum metrics and then filters the companies for financial stability, relative value, market capitalization and price momentum.
Harvest Global REIT diversity
Here are some examples of the holdings:
Orpea S.A. is based in Paris and is one of Europe’s largest operators of retirement and nursing homes, rehabilitation clinics and psychiatric care facilities. It owns 950 properties with 96,557 beds in 13 European countries and Brazil.
As of Aug.30, 2019, Orpea had a market capitalization of €7.4 billion (C$10.8 billion.) In its 2018-year revenues were up 9% to €3.4 billion. (C$5.2 billion)
Digital Realty Trust Inc., based in San Francisco, provides temperature-controlled facilities, with secure internet connections and high levels of data security for business interested in cloud computing and storage. Businesses rent space for their servers and computing hardware.
Digital Realty’s portfolio includes 210+ properties in 14 countries, including two in the Toronto area. About 70% of its properties are in the U.S. Clients range from financial services, cloud and information technology services, to manufacturing, energy, gaming and consumer products. Digital Realty had a market capitalization of US $26.9 billion as of Aug 30, 2019.
Alexandria Real Estate Equities Inc. is also based in California and its holdings are all in the United States. Most of Alexandria’s properties are offices and laboratories. These are rented to pharmaceutical, biotechnology, medical device and life science agencies, as well as technology companies. Tenants include Pfizer, Google and Eli Lilly.
Alexandria tries to locate its properties around universities. As of mid-2019, 36% of rental revenue was in the Boston area, 25% in San Francisco and 16% in San Diego. It had a market capitalization of $17 billion as of Aug 30, 2019.
The Harvest Advantage
The Harvest Global REIT Income Fund ETF stands out for several reasons, says Mr. MacDonald.
“We can’t control the markets, but we can control the quality of the companies we buy,” he says.
This gives investors:
- A source of REIT investments outside of Canada;
- Attractive monthly income with the opportunity for capital appreciation;
- A covered call strategy to generate additional income;
- Exposure to growth sectors: Technology, Healthcare & Ecommerce;
For more on Harvest Portfolio Group ETFs click here.
[1] As of Aug 27, 2019
[2]Almost half euro government bonds yield less than zero pct, Reuters, May 31, 2019; Danish-bank-launches-worlds-first-negative-interest-rate-mortgage, Aug. 13, 2019 Guardian
[3] Aug. 26, 2019
The views and/or opinions expressed in the blog are of a general nature and are for informational purposes only. Blog contents should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Investors should consult their investment advisor before making any investment decision.
