A Different Kind of REIT
Think REITs are boring? Here’s one that’s a little different
Investors seem to be ignoring real estate investment trusts (REITs) these days. The sector was only ahead 4% year to date at the time of writing, less than half the gain recorded by the S&P/TSX Composite Index.
Part of the problem may be concern about the likelihood of interest rates rising in 2015 and the consequent downward pressure that could exert on the price of REIT shares. But I suspect another factor is that REITs are rather boring. Apartment buildings, shopping malls, office towers – ho-hum. What else is new?
Well, here’s something new: a REIT that trades on the Toronto Stock Exchange that is based in Texas and owns a portfolio that consists entirely of U.S. properties. It’s called Milestone Apartments REIT and it trades on the TSX under the symbol MTS.UN. Here are the details.
Milestone Apartments REIT
Type: Real estate investment trust
Trading symbols: MST.UN, MSTUF
Exchanges: TSX, Pink Sheets
Price (Sept. 26): C$11.50, US$10.29
Entry level: Current price
Annual payout: $0.65
Financial highlights: Second-quarter results were encouraging. Adjusted funds from operations (AFFO) came in at $11.1 million ($0.20 per unit), up from $9.9 million (also $0.20 per unit) in the same period of 2013. Note that the REIT reports in U.S. dollars.
For the first half, AFFO was just over $22 million ($0.42 per unit) compared to $13 million ($0.26 per unit) in 2013. The first half payout ratio was 71%, down from 78% a year ago.
During the quarter, Milestone made acquisitions in Orlando, Florida and Atlanta, Georgia for a total cost of $78.7 million.
Risks: Interest rate risk must always be considered when making a decision about buying REITs. At the moment, it appears there is unlikely to be any significant upward move in rates for the next year or so. The recent announcement by the U.S. Federal Reserve Board that rates would stay at current levels for a “considerable time” was interpreted as signalling no move before mid-2015. The Bank of Canada has also indicted it is in no rush to raise rates. That said, rate hikes will come at some point and Milestone’s share price could be negatively impacted when that happens.
Since all the REIT’s properties are in the U.S., currency risk must also be taken into account. A rise in the value of the loonie would erode the value of any U.S. dollar denominated assets, as we saw during the period from 2002-2012 when our currency moved sharply higher.
As well, there are the normal business risks that are part of any operation. Overall, I rate this security as moderate risk.
Distribution policy: The REIT pays monthly distributions of C$0.05417 per unit (C$0.65 per year) to yield 5.65% at the current price.
Tax implications: For tax purposes, distributions to Canadians will be considered as income, return of capital (ROC) or a combination of both. In 2013, the entire amount paid out was treated as return of capital. This means no tax is payable immediately but the cost base of the shares is reduced by the amount deemed as return of capital. The net effect is to increase the capital gains tax liability when the shares are eventually sold. There is no guarantee that all future distributions will receive ROC treatment; the amount will vary from year to year.