Growing economic shutdowns are putting increasing pressure on retail-oriented real estate investment trusts in Canada to reduce their payments, putting investors at risk of losing monthly income that was previously considered sacrosanct. .
Retail REITs have suffered since the outbreak of the COVID-19 pandemic, in large part because the area’s rent collections have been hit harder than office buildings or industrial warehouses. Some cut their distributions at the start of the pandemic, but most hoped to weather the storm.
In the fall, there appeared to have been an industry-wide rebound as retail sales rebounded, but in December RioCan REIT, one of the nation’s largest retail owners, cut its payment a third. There has been speculation since some rivals will soon be forced to follow suit, especially now that a new wave of closings is likely to hit rent collections.
“We believe there is a chance that some retail REITs may follow [RioCan’s] lead to preserving some liquidity, especially for those with high payout yields, payout ratios and leverage profiles, ”BMO Nesbitt Burns analysts wrote in a note to clients in December.
Not only will revenues likely fall again due to increasing closures, but many retail REITs have also committed to funding new condo and rental apartment development to diversify their range of properties as they grow. more and more stores are moving online. These projects require a lot of upfront expense, often worth hundreds of millions of dollars.
The potential for reducing the distribution of retail REITs “is the number one question we are asked,” Michelle Wearing, associate portfolio manager at Starlight Capital, said in an interview.
“All the councils are having this discussion right now, I guarantee that,” she added.
Last week, Brookfield Asset Management announced plans to buy out the 38 percent stake in its publicly traded real estate subsidiary, Brookfield Property Partners LP, which it does not currently own. Brookfield Property is one of the largest retail and office owners in the United States and was expected to pay out over 100% of its annual cash flow. The takeover of BAM is seen by some as a way to get around a cut in payments, as the company will be taken over by a parent company with a larger balance sheet.
First Capital REIT and SmartCentres REIT are often cited as two companies whose payments are at risk due to their extensive development pipelines. At the same time, First Capital has increased leverage levels after borrowing hundreds of millions of dollars to buy back some of its shares from a large shareholder, while SmartCentres is currently paying around 100% of its cash flow.
First Capital did not return a request for comment, but in an email, SmartCentres executive chairman Mitch Goldhar touted its REIT’s liquidity and relationship with Walmart Inc., which accounts for 25% of rental income. “Our cash flow from leases and earnings from development activities is strong and sufficient to prudently maintain our current distribution,” he said.
“Barring extraordinary and unexpected events, we do not plan to change our level of distribution of units,” he added.
REITs have touted their redevelopment potential over the past five years, with plans to increase the density of several properties, especially those located in suburbs with extensive parking lots. RioCan, for its part, has created a new division to build high-end rental apartments and SmartCentres has built condos, like its Transit City project in Vaughan, Ontario, just north of Toronto.
These projects are expected to help offset digital disruption in the retail industry, but their development requires a lot of money. And in some cases, even when new properties are up and running, the payback period can take decades, especially in the case of rental apartments where monthly rent checks are collected.
With so many REITs dabbling in development – including office owner Allied Properties REIT and industrial warehouse owner Granite REIT – the nature of the industry is changing. REITs became investment vehicles in the late 1990s after numerous promoter bankruptcies, and their goal was to create stable, income-producing real estate businesses that paid reliable monthly distributions to investors.
Yet many risk profiles of REITs have changed. To limit the impact, REITs have promised measures such as capping development projects to a small percentage of their total assets. But the pandemic has exposed some flaws despite this caution, suggesting that investors may need to rethink their view of the sector.
“Canada and Australia are the two markets in which people buy REITs for income,” said Corrado Russo, head of global real estate securities at Hazelview Investments. “This must change.”
In many other countries, payments often hover around 55% of adjusted funds from operations, an industry measure for cash flow, he said. Before RioCan reduced its distribution, retail REIT payments in Canada averaged about 92% of AFFO.
Despite the risks, development projects do not always radically change the profile of a REIT. Choice Properties REIT, for its part, intends to increase the density of its properties, but the REIT also derives 57% of its annual rent from the Loblaw grocer – and the grocers have performed well during the pandemic. Office lessor Allied Properties REIT also added development projects and increased its payout in December.
But for REITs testing the limits of their balance sheets, Ms. Wearing of Starlight suggested using RioCan’s move as a kind of airline cover to address investor concerns. “You have the option of having a kitchen sink area,” she says. “Throw out as many as you can.”
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