H&R REIT Looks Cheap
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Sure, you can invest in this 3-bedroom Vancouver old timer yielding a meager 3.5% to 4% CAP, but why torment yourself? Instead, you can indulge yourself with an 8.2% yield by owning these sexy office towers within H&R REIT’s portfolio:
As you may recall, the market has been punishing the Real Estate Income Trust (REIT) sector for much of 2007 and into early 2008, while the average yield is inching up each day. No one knows how long the spanking will persist, but as of this moment, the whole sector is roaming into bargain territory as many REITs are yielding well above 7%. That is far more attractive than the 3.74% offered by Canada 10-year bond, a popular yardstick to judge how attractive the REIT sector is relative to a guaranteed income investment.
I have taken an interest in H&R REIT - the largest Canadian office REIT and the overall second largest Canadian REIT behind RioCan. Today, HR.un is distributing an annualized $1.44 or 8.2% based on closing price of $17.49. That looks pretty cheap to me, and insiders agree. CEO Thomas Hofstedter and directors collectively scooped up $3 million worth of units in Nov & Dec at prices above $19. I picked up half a position at $18.05, but if we’re lucky enough, the trust will trade below $16 for a 9% yield. Otherwise, I’m happy to hold on to the half position for the long haul.
Back in 1999 when euphoric investors were dumping REITs while flocking to the ecstasy of dot-com land, HR.un traded briefly above a 12% yield at a time when 10-year Canada bond was yielding 6.25%. Outside of this anomaly, HR.un’s yield was around 10%, or a 4% premium above Canada bond. Today, the market is giving us a second chance to own this REIT at a 4.5% premium above Canada bond.
HR owns a portfolio of 35 office, 125 industrial, and 142 retail properties across Canada but principally in Ontario. Some of their well known creditworthy tenants include Bell Canada Inc., TransCanada Pipelines, Bell Mobility, Telus , Royal Bank, Public Works of Canada, Nestle, Canadian Tire, Finning International, Circuit City, Rona, Lowe’s, Shell Oil Products, Home Depot, Wal-Mart, Chapters, Famous Players, Walgreens, Sobey’s and Shoppers Drug Mart.
The trust has steadily bumped their distribution over the years, rising from $1.03 in 1998 to $1.44 today, or an annualized 3.8% growth. (They just increased distribution by 5.1% this month.) Together with the 8.2% yield, that’s a total return of 12%. Not too shabby for a hard asset class that’s traditionally weakly-correlated with the stock market. And if you’re into DRIP, HR offers a 3% bonus if you reinvest the monthly distribution to buy more units.
Real estate, by nature, is a highly leveraged asset class. HR’s average mortgage term is 10.4 years, but this is paired with an average tenant lease duration of 12.2 years with only 12.8% of leases expiring by the end of 2012. Nothing is bullet proof, but mortgage payments appear well covered. Nimble management was quick to snap up cheap buildings in a hot real estate market. New properties acquired during the first 3 quarters of 2007 cost the REIT a weighted average mortgage interest of only 5.67%, giving them an expected levered return on equity invested of 12.1%.
The only thing peculiar about HR is that their payout ratio actually exceeds 100%. The portfolio released $133.2 million of cash during the first 3 quarters of 2007, but distributed $133.7 to unitholders. This practice appears normal judging from other landlords in the REIT space. For example, bellwether REIT, RioCan has a shocking 116% payout according to a TD Waterhouse report. My only explanation is that REITs with a deeper pipeline can afford to over distribute in the short-term; RioCan has 10 properties in the pipeline versus HR’s 3.
** This is not a recommendation to buy. I’m not a REIT expert. If you have an opinion on HR or REITs in general, I’d love to hear about it.
For more info, please visit www.hr-reit.com.
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How does this work for the long term?
The EPS is steadily decreasing while the payouts are increasing. In ‘06 the EPS was 0.79 while the payout was 1.33. Doesn’t seem sustainable to me.