Looking at Canadian REITs (Part 1)

In this series, my goal is to identify Canadian REITs with potential of price appreciation and distribution growth. This is not an expert opinion and, in fact, is my first exposure to real estate. This post serves to organize my thoughts, build experience with Tableau and, hopefully, gets the ball rolling for deeper analysis. 

One of my favourite shows is The Sopranos. The Sopranos follows the New Jersey mafia through its tumultuous struggle for power in the early 2000s. I love it not only for the impeccable acting but also for the occasional wisdom it imparts.

In “Watching too much Television”, Tony Soprano, played by late James Gandolfini, defrauds HUD (United States Department of Housing and Urban Development) by purchasing crack houses and reappraising them at overvalue. Tony tries to use this opportunity as a bonding moment with his son – and to teach the value of real estate. “Buy land, AJ, ’cause God ain’t making any more of it,” Tony lectures. A.J couldn’t care less.

Tony enlists the help of his political ally, Assemblyman Ronald Zellman

Ignoring the corruption, Tony had the right idea. Everyone needs a roof over their head. Having low correlation with the stock market, Real estate also provides diversification to a portfolio. REITs (Real Estate Investment Trust) can provide that exposure at minimal cost.

Today, I will identify the best residential REITs based on the geographic distribution of its capital properties. My analysis will rely on historical vacancy rates and prices across 35 Canadian cities. Because these cities represent the most populous cities within a geographic region, the sample is representative of the general trend within its region.

Introduction to REIT

A REIT is a trust that passively holds interest in a portfolio of real properties (Pachai, 2016). Investors benefit from rent these properties generate. 

I do not have a legal background but I’ll take a shot are summarizing the major characteristics. Legally, an REIT is a trust. In Canada, at least 95% of a REIT’s income must derive from capital property and no more than 10% of its assets can be bonds, securities etc. (Pachai, 2016). Properties are treated as capital property – meaning they are intended to be held long term. Very rarely will properties be ‘flipped.’

There are two types of REITs: public and private. Public REITs are traded on the TSX/TSXV whereas private REITs are not traded on any exchanges (Pederson et al., 2012). The advantages of REITs are:

• Diversification
• More Liquidity than Underlying Asset
• High-Yield

Finding Communities With Potential for Growth

First, I identified communities with a decreasing vacancy rate. Luckily, Statistics Canada compiled vacancy rates of 35 cities across Canada from 2000-2017 (Statistics Canada, 2017). These cities are major economic hubs and assumed to be indicative of the overall real estate health in the area. Vacancy rate is the percentage of all available units in a rental property that are vacant or unoccupied at a particular time. Assuming all other factors equal, the lower the vacancy rate, the more likely it is for an apartment to be rented.

Fig. 1. Vacancy Rates across Canada (2010-2017)

Using Tableau, I made a visualization of all 35 communities. Slope is the slope of vacancy rate between 2010-2017.  Standard deviation for vacancy rate was calculated across 2010-2017 too. The closer the standard deviation is to zero, the more stable and reliable a trend is.

From Figure 1, I observe that:

• Vancouver city is showing a slight, but stable, decrease in vacancy. The effect ripples into Abbotsford
• Quebec and the Ottawa Region should be avoided.
• The Canadian Prairies should be avoided
• Toronto, with its surrounding communities, are showing strong, stable growth
• Thunder Bay is showing unusually strong, stable growth.
• With the exception of Halifax showing slight, but very stable, fall in vacancy rate – avoid Atlantic Canada.

In the end, eight communities had decreasing vacancy rate – then, we look at the pricing trend for those eight communities with a decreasing vacancy rate. The pricing confirms whether the value of an area is increasing and takes into account other factors as average, local economy and quality of life within the city.

I relied on Tateranet-National Bank House Price Index to get a sense of the direction of house prices. Unfortunately, historical data here cannot be downloaded but only visually examined (Teranet, 2018). Over the past 5 years, house prices in all eight communities have been increasing. I observe, however, that cities closer to the US/Canada border are appreciating at a much faster rate. For example, Greater Sudbury and Halifax have marginal growth compared to its counterparts closer to the border.

Table. 1. Growth in Home Prices in Eight Selected Cities

City	YTD	Approx. 5 Year Growth
Abbotsford-Mission	6.4%	83%
Oshawa	2.0%	76%
Vancouver	2.4%	74%
Toronto	0.3%	61%
Guelph	1.0%	48%
Thunder Bay	1.0%	29%
Greater Sudbury	2%	5%
Halifax	-0.6%	3%

REITs with Concentration of Properties in Growing Communities

Finally, I broke down the geographical distribution of suites owned by Canadian public REITs. Information for the distribution came from the 2018 Q1 Financial Statements, or if not available, the 2017 Annual Report. The reports can be found on the website of the REIT.

Fig. 2. Canada had 7 publicly traded residential REITs

I created Figure 2 with Tableau and Excel. I choose a stacked bar chart because it best displays a breakdown.

I want to target REITs with heavier allocation towards Ontario and British Columbia while avoiding Quebec and the Canadian Prairies. I am indifferent towards Atlantic Canada and the territories (Nunavut, Northwest Territories and Yukon) as long as they comprise a minor percent of the total portfolio. Some of these portfolios contain U.S and European assets too – I am indifferent to these too as long as they comprise a minor percent of assets.

Interrent Real Estate Investment Trust (TSE: IIP.UN), Canadian Apartment Properties REIT (TSE: CAR.UN) and Northview Apartment REIT (TSX: NVU-UN-T) stand out. The percent of assets in Ontario/BC are 84%, 60% and 44% respectively.

Conclusion

Today, I scratched the surface on Canadian Real Estate and I learned about the fundamentals of REITs. I identified the best residential REITs based on a province-wide breakdown of its portfolio. The best REITs are defined as the trust with most capital properties in a community with a stable decreasing vacancy rate plus increasing home prices. In the future, my goal is to build a net asset value (NAV) model to appropriately valuate REIT. I also want to further drill into the specific locations of  capital properties held by a REIT. A province level comparison is too unreliable to be a reason for investing. I also expanded my Tableau skills by putting my data on a map visualization. Overall, I am satisfied with my results and will continue using different techniques to explore Canadian real estate.

References

Pachai, S. (2016). Real Estate Investment Trusts In Canada. London: Western University.

Pederson, N. (2012, 1). PIMCO Solutions. Retrieved 5 20, 2018, from Modelling the Risk Characteristics of Real Estate Investments: http://media.pimco.com/Documents/QRandA_Pedersen_Tiwari_Hoffman_Jan2012.pdf

Statistics Canada. (2017). Canadian Mortgage and Housing Corporation . Retrieved 05 21, 2018, from Canada Mortgage and Housing Corporation, vacancy rates, apartment structures of six units and over, privately initiated in census metropolitan areas: http://www5.statcan.gc.ca/cansim/a26?lang=eng&id=270011

Teranet i. (2018, 05 21). Teranet–National Bank House Price Index. Retrieved 05 21, 2018, from House Price Index: https://housepriceindex.ca/

Appendix

https://public.tableau.com/views/PublicREIT/Dashboard1?:showVizHome=no&:embed=true

 

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