The S&P/TSX REIT index is down 18.1% year to date and that includes dividends. As I wrote in an April column, REIT dividend and distribution yields no longer look as attractive relative to rapidly rising risk-free government bond yields.
CIBC REIT analyst Dean Wilkinson provided a bullish counterpoint to the sector’s recent performance on Tuesday. Don’t ask for whom the debt circulates: Are rising interest rates a harbinger of doom?
For Mr. Wilkinson, the rising interest rate environment is simply business as usual for real estate: “REITs have been in the debt management business for a long time, and a changing interest rate environment (even quickly) is just part of the natural environment. ebb and flow of its business cycle.
CIBC estimates that even if funding costs double from here, the effects on the REIT’s overall profitability would be “immaterial.”
The issue of competitive risk-free returns remains, but REITs are now trading at attractive valuation levels that could fully compensate investors for the risk of inflation with potential price increases.
Mr. Wilkinson writes that REITs are currently trading at a discount of approximately 24 percent to net asset value compared to the usual 5 percent discount. In his words, the return to normality implies a “healthy double-digit rise” for the sector.
The analyst sees that REIT prices already reflect a future inflationary environment of rising bond yields. With these risks largely discounted, depressed valuations combine with reasonably attractive returns to make the beleaguered sector an attractive option for investors.
— Scott Barlow, Globe and Mail Market Strategist
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Others (for subscribers)
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Ask Globe Investor
Ask: What do you think about holding ETFs in registered accounts given what appears to be a higher volume of reinvested or “phantom” distributions recently? Last year I received phantom distributions on my registered and unregistered accounts, but while I get the benefit of increasing my adjusted cost basis on my non-registered account, I don’t get any benefit on my registered accounts.
Answer: Increasing the adjusted cost basis of an ETF in an unregistered account is only a “benefit” insofar as it prevents you from paying more capital gains tax than necessary when you eventually sell your units. However, there are no capital gains taxes on registered accounts, so increasing the ETF’s ACB would provide no benefit. For that reason, you should feel comfortable holding ETFs in a registered retirement savings plan or tax-free savings account, for example. In addition to receiving all investment income and capital gains tax-free, holding your ETFs in an RRSP or TFSA will simplify your accounting. (In the case of RRSPs, income tax only comes into play when the money is withdrawn.)
Also note that 2021 was an especially busy year for phantom distributions, as rising stock markets created many capital gains that ETFs distributed (on paper) to unitholders for tax purposes at the end of the year. However, given the markets rough start in 2022, I suspect we won’t see nearly the same volume of ghost distributions this year. To learn more about ghost distributions, read my recent column here.
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