The year 2020 has been a very trying time for many Canadian real estate investment trusts (REITs) due to the devastating COVID-19 pandemic. Poor rent perception and a feared drop in occupancy rates, especially on commercial properties during lockdowns, scared investors into exits. Several battered REITs are available for sale on the TSX today, but the asset class may soon heat up as news of potential vaccines floods in November.
Investors’ hopes for a coronavirus vaccine rise in November with reports that Pfizer and Modern candidate vaccines are over 90% effective in protecting humans against the troublesome pathogen.
Why buy high yield REITs in a TFSA?
One of the best ways to earn passive income in a TFSA is to invest in high yielding, dividend paying stocks. The best returns are currently in the real estate sector. But they could disappear as soon as the vaccine trade takes hold.
Canadian REITs were created to provide investors with the ability to pool their capital resources and use leverage to invest in real estate assets to generate stable rental income. Trusts are exempt from income tax as long as they pay the majority (90%) of their annual income to investors (unitholders).
REITs are renowned for their high income distribution returns. Yields have generally skyrocketed on most Canadian REITs shot down during the pandemic. This is true, even on some trusts that were forced to cut their distributions during the turmoil.
Storing REITs in a tax-sheltered TFSA account means that the distributed income will forever escape CRA taxes. An annual return of 10% comes out on a Morguard trust management today.
A closer look at defeated Morguard REIT
Morguard Real Estate Investment Trust (TSX: MRT.UN) The shares traded more than 6% earlier Monday after the announcement of Moderna’s vaccine success. The REIT shot is a great value opportunity for TFSA investors today.
Morguard REIT owns a $ 2.6 billion portfolio of 47 commercial, office and industrial properties in Canada with a leasable area of 8.3 million square feet.
MRT units are down over 60% year-to-date for good reason. The trust is heavily exposed to closed shopping malls, a real estate segment hardest hit by the pandemic. Closed shopping malls remain deserted as shoppers fear contracting the coronavirus in confined spaces. Investors expected the worst to happen to its cash flow and balance sheet. This is understandable given that the trust derives around 41% of its income from tenants in closed shopping malls,
Third quarter revenues were down 8.7% from last year. It wasn’t too bad given the current circumstances. Net operating income decreased 21.7% year over year and funds from operations (FFO) decreased 33.8% to $ 14.4 million in the last quarter. Adjusted funds from operations (AFFO) decreased 27.5% to $ 11.5 million in the most recent quarter. The Trustees decided to reduce the monthly distribution by 50% on April 30 to preserve liquidity in the face of extreme uncertainty.
Encouragingly, however, portfolio occupancy rates remained resilient at 93% as of September 30 of this year. Rent collection fell from 76% for the second quarter to an average of 86% for the third quarter. The October collections were much better at 87% on October 27.
Lock in a juicy yield and enjoy capital gains
More importantly, the current monthly distribution was well covered in the last quarter. AFFO’s payout rate was only 66.7% for the third quarter. This was a significant improvement over a 100% payout rate in the previous quarter. I wouldn’t expect a further reduction in distribution over the next year.
Analysts expect the distribution to hold steady for some time as confidence recovers from a perfect storm. This means that you can guarantee a 10% return on Morguard REIT and expect capital growth in the form of a bonus during the coming rally.
Units are currently trading at a discount of 40% to their net asset value. It’s reasonable to expect a quick recovery once a COVID-19 vaccine becomes available in 2021 and the masses feel free to visit their favorite malls again. A closer peer should even double.
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Fool contributor Brian Paradza has no position in any of the stocks mentioned.