In their continued search for yield, many investors have turned to Real Estate Investment Trusts (“REITs”). These companies pay out a significant percentage of their earnings as dividends; accordingly, they have historically provided a high level of income. However, a high dividend payout ratio leaves little in the way of earnings that can be reinvested in the business, such that the REIT must sell more shares in order to acquire additional income?producing properties.
Lately, in order to support continued dividend increases—which are required to support continued share issuance—many REITs have also resorted to reducing their capital expenditures below the levels that will ultimately be required to properly maintain their properties. We have previously touched on these and other risks associated with investing in American REITs and, for the most part, prefer to implement any real estate exposure through owner?operated real estate development and management companies rather than through REITs.
Real estate developers frequently have dormant assets, in that undeveloped land generates no cash flow, which makes such developers more difficult to value using standard metrics such as capitalization rates, price to earnings ratios and adjusted funds from operations multiples. Furthermore, their value?creating projects are generally very long?term in nature, which reduces their utility to investors focused on near?term results.
Broadly speaking, Canadian?listed companies trade at a discount to their United States?listed peers, providing an opportunity to invest in high quality North American companies at attractive valuations.
Canadian REITs
The Canadian REITs yield considerably more than the American REITs despite having lower dividend payout ratios and much more conservative balance sheets. Typically, they pay out 80 percent of earnings. Yet, there is no US?listed exchange?traded fund (“ETF”) for Canadian REITs, even though there are over three dozen publicly?traded REITs in Canada. The market capitalizations of the Canadian REITs are too small to make such a fund a first?order profit opportunity.
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