Your local Loblaws grocery store is far from the Strait of Hormuz, but you wouldn’t know it from the downturn in Choice Properties Real Estate Investment Trust CHP-UN-T over the past couple of months.
The REIT, which counts Canadian supermarkets among the key tenants of its properties, has slumped about 10 per cent since July in terms of its unit price.
But with a distribution yield back above 5 per cent, a splashy takeover of a rival REIT in the works, and a business model lauded by analysts as economically defensive, Choice Properties deserves a closer look.
“Grocery-anchored retail has become one of the most sought-after property types as rapid growth in retailer store counts and a shortage of space have pushed occupancy rates to near-full levels, rent growth firmly into the double digits and investor demand sharply higher,” Lorne Kalmar, an analyst at Desjardins Securities, said in a note this week.
The problem? There’s a lot of uncertainty weighing on investor sentiment right now, even if not directly related to real estate.
As the U.S. conflict with Iran drags on, the Strait of Hormuz – the conduit for Middle East oil exports – remains closed. The price of oil, which was falling at the beginning of the summer amid hopes for a peace deal, touched US$106 a barrel earlier this week. That’s up nearly 50 per cent in just two months.
The runup is creating inflationary pressures on top of simmering concerns about government debt loads, a disconcerting combo that has sent bond yields soaring to multiyear highs.
The yield on the 10-year U.S. Treasury bond rose above the key threshold of 5 per cent this week, up from about 4 per cent in late February, before the United States attacked Iran. Yields move in the opposite direction to bond prices, which means bond prices are falling.
The Federal Reserve acknowledged on Wednesday that inflation is a concern when it raised its key interest rate for the first time in three years, and signalled at least one more rate hike later this year.
Many dividend-producing investments have been struggling in this environment – no doubt causing some queasiness among investors watching their portfolios shrink.
But some buying opportunities are emerging, and Choice Properties stands out.
The REIT’s yield, which was below 4.7 per cent in July as the unit price climbed to a record-high, was nearing 5.3 per cent after the Fed’s rate hike on Wednesday.
For sure, the economic backdrop could get worse: Inflation could persist, pushing the Fed to raise rates more than currently expected.
That might weigh on REITs and other stable income-producing investments that take their valuation cues from the bond market.
Consider that three years ago, when central banks were raising their key interest rates aggressively in a battle against inflation, Choice Properties traded as low as $11.90 per unit in October, 2023. The yield rose as high as 6.3 per cent.
The other knock against Choice Properties is that it has been raising its monthly distribution at a snail’s pace, as funds from operations – a key financial metric that reflects operating cash flow – grows slowly.
That makes the REIT sensitive to what’s going on in the bond market, since investors can’t count on rising distributions to offset rising bond yields.
Over the past five years, the REIT has raised its distribution by a combined total of just 4 cents per unit, or 5.4 per cent.
Compare that pace to the biggest banks. Royal Bank of Canada – just one example among the Big Six – raised its quarterly distribution by nearly 47 per cent over a similar five-year period.
But Choice Properties has a few things going for it.
A rising rate environment increases the risks of a recession, as borrowing costs rise. Yet, a REIT with large, stable grocery tenants is relatively secure from an economic downturn.
Second, the valuation is reasonable. Before the current downturn, the units traded at a premium to net asset value – the total market value of the REIT’s properties after subtracting debt. Now, the units trade at a slight discount.
Lastly, Choice Properties expects to close a deal to buy First Capital REIT later this year, with KingSett Capital. The deal will add $5-billion of shopping-centre assets in major Canadian cities, underpinning the REIT’s heft.
Granted, rising bond yields aren’t working in the REIT’s favour right now. But since they are making the units cheaper to buy, perhaps that’s a good thing.