2 Cheap REITs: The Value Investors Dream or the Value Trap?

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Since practically everyone has stopped going to work, stopped shopping, stopped going out for entertainment, REITs have suffered. Rents have been suspended in an attempt to stabilize the economy. Unit prices of formerly popular names such as H&R REIT (TSX: HR.UN) and RioCan REIT (TSX: REI.UN) are trading around or below their book value.

Are they a dream of a value investor?

If you like to smell transactions, Canadian REITs are probably one area that will catch your eye. H&R and RioCan seem pretty tempting at these levels. They were absolutely slaughtered and did not recover as quickly as the other stocks.

H&R is currently trading at around $ 10, far from its previously stable price of just over $ 20 per share. RioCan is not doing much better, currently trading at around $ 16 per share after dropping from its relatively stable price of around $ 25 per share.

I am going to skip the multiple courses / profits for now, as it is fairly certain that the profits will fall into the toilet. Rather, I will focus on book value, which is a much more relevant figure at the moment given that much of the value of these businesses comes from the intrinsic value of their land.

Currently, the two companies are trading at huge discounts from their declared book values. RioCan is traded at approximately 0.62 times its reported book value. H&R has an even more drastic discount, trading at around 0.42, or less than half, of its reported book value. These stocks are cheap according to this metric; there is no doubt.

Where’s the risk?

Much of the risk, in my opinion, comes from the book value itself. The loss of income and the effect of a recession in Canada have already been largely taken into account. It is therefore the value of the company’s assets that is at stake.

Fortunately, the good news is that many of the properties owned by businesses are located in large urban centers like Toronto. It is highly likely that these properties have a better chance of retaining their value over time. They also benefit from the fact that interest rates are expected to remain low, which lowers the cost of financing and could generally support real estate as an asset.

The problem is, what if real estate falls sharply in the months and years to come? What if global debt, regardless of incredibly low interest rates, becomes unsustainable? The resulting cascade of defaults could depress asset prices, including property values. The book value of these companies could collapse with profits, causing their prices to fall even further.

Distribution yield

One of the main reasons why people buy REITs is the regular income these companies generally provide. These companies are no exception, with current returns of 13.4% for H&R and 8.69% for RioCan. The yields are generous, but they are also more at risk of being cut than they have ever been before.

The pandemic is about the worst thing that could have happened to these REITs. Even in times of financial crisis, people can still buy things from a store. Right now the doors are closed and the offices are closed. There is literally no way to go out and buy a lot of anything, and the choice to go to work has been forcibly removed.

Plus, after the crisis ends, who knows how much of a homework mentality will remain. Perhaps he will never return to pre-pandemic levels, leaving some offices closed for good.

The foolish Takeaway

In this article, I do not recommend buying or staying away from these stocks. This is a bipolar choice, depending on your vision of real estate and the growing economy. If you think real estate will hold its value over the next few years and possibly increase, these are glaring purchases today. If you think real estate is going to go down and there will be a permanent change in the working environment in the future, stay away.

Do not buy them as income securities at this point. Dividends could remain in place or be reduced. If you buy, think of yield as a bonus to a potential capital gain while you wait for a recovery.

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