Real estate investment trusts (REITs) are some of the best options out there when it comes to creating passive income. That’s the income that comes in no matter what you do. To sleep? It’s pouring in. To eat? The same. Traveling? You better believe REIT is still paying out.
However, there are still some considerations that investors should take into account. So today, let’s take a look at what makes a solid REIT to invest in, and if Automotive Properties REIT (TSX:APR.UN) fits the bill.
Considerations
When looking for a good REIT to own, the first thing to consider is what type of real estate the REIT actually owns. Not all REITs are created equal and each property type responds differently to the economy. Before you buy, determine what type of real estate you think will remain relevant and profitable for the next decade, not just this year. From there you can research occupancy rates and rental terms. A good REIT thrives on predictable rental payments. That is why you want a high occupancy rate of ideally above 95% and long-term rental contracts with solid tenants. Short leases can mean faster rent increases in good times, but increase the risk when the economy weakens. Long leases provide more stable income, but slower growth.
A crucial factor is the strength of the balance sheet and debt management. REITs often use debt to acquire and maintain properties, but too much leverage can turn a steady income stream into a cash flow when interest rates rise. REITs with more fixed-rate debt are better protected against rising financing costs. Then focus on funds from operations (FFO). FFO provides a clearer picture of the cash available for dividends. A REIT with growing FFO per unit over time typically manages its properties well. The payout ratio, or dividends divided by FFO, also matters. A ratio below 80% is a sign that the dividend is sustainable. If a REIT pays out almost all of its money, there is no cushion for recessions or maintenance expenses.
Dividend stability and growth are what draws most investors to REITs, so pay attention to the distribution history. Has the REIT consistently increased or at least maintained payouts during tough markets? A REIT with a long track record of stable or increasing dividends is typically well managed and conservative in its cash planning. Be cautious of REITs with unusually high yields compared to peers, as these could signal stress or an impending cutback.
Where APR fits in
Automotive Properties REIT is a niche player in the Canadian REIT space focused on owning and acquiring income-producing properties that are leased to automotive dealers. This business model has a number of attractive features for investors. It means that the REIT owns physical real estate with long-term leases, with the REIT reporting an average lease term of approximately 8.5 years. Additionally, it has tenants with renowned brands, which can help with cash flow stability.
On the plus side, the REIT offers a relatively high dividend yield of around 7.4%, which may attract income-oriented investors. The return reflects both the niche real estate segment and perhaps the discount that the market gives to the risks it sees. Additionally, the company appears to be expanding its portfolio as the REIT continues to make acquisitions.
However, the REIT also comes with significant risks and there are some warning signs. A major concern is the leverage and profitability figures. For example, in one data set the debt/equity ratio is recorded at 82%, which is relatively high for a real estate company that is sensitive to interest costs. Furthermore, the payout ratio stands at 114%, which is also high, leaving little room for error.
In short
All in all, APR is a potentially interesting income play for investors who are willing to accept a higher level of risk in exchange for higher returns, and who believe in the long-term stability of car dealer real estate. But it’s not a low-risk, sleep tight REIT. If your priority above all else is the safety of dividends, you may prefer REITs with stronger balance sheets, more diversified property types, and better coverage. If you like high returns and like to keep an eye on the company and sector, APR.UN could be a more speculative income segment for your portfolio.
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