Written by Puja Tayal at The Motley Fool Canada
The real estate market can be tricky in the short term and rewarding in the long term. The sector is cyclical and dependent on economic growth. The Canadian real estate market saw a crackdown after the pandemic as house prices inflated significantly, making housing unaffordable. The Bank of Canada had to intervene and cut interest rates, which led to a sharp fall in house prices. Several REITs’ unit prices fell significantly in April 2022 when the interest rate hike began.
Meanwhile, commercial real estate collapsed during the pandemic as several offices shifted to a hybrid model and reduced their leasing space. Hospital real estate made a remarkable gain but later slowed its growth. One retail segment that stood strong and continued to grow steadily was the retail sector. Even in retail, a few segments outperformed, such as grocers, pharmacists, and other essential services like banks. Discretionary retailers saw a V-shaped recovery pre- and post-pandemic.
The main attraction of real estate is its rent. It is a quiet growth engine as rent increases every year through renewals and new leases. And if the REIT makes enhancements to the property, it can demand a higher rent.
However, the biggest challenge is finding a long-term tenant with a good credit score, which can assure the REIT of occupancy and timely rent. Another challenge is expensive land acquisitions and developments with no assurance of full occupancy.
CT REIT (TSX:CRT.UN) overcomes both challenges because of its unique business structure. Its single largest tenant is Canadian Tire (TSX:CTC.A), which is also its parent company. Canadian Tire has gas stations and department stores where it sells automotive goods, sports and outdoor equipment, home products, and more, bringing in sales all year round.
Canadian Tire spun off its real estate business into CT REIT. The REIT gets more than 90% occupancy from the parent itself, and Canadian Tire can convert a portion of its rent expense into dividend income.
When Canadian Tire wants to open a new store, CT REIT has the first choice to reject it. CT REIT is assured that any new store it builds or an existing Canadian Tire store it acquires from a third party will have strong occupancy. This special benefit gives CT REIT an edge over others. It does not need to spend on brokerage and marketing to find a tenant. Neither does it have to worry about the timely payment of rent.
CT REIT passes on the benefit it gets from this arrangement with Canadian Tire to unitholders in the form of growing distributions. Most REITs don’t grow their distributions annually as they face volatility in occupancy, which they overcome by charging higher rent on renewals and new leases. The higher rent helps them cover the cost of marketing and the real estate agent’s commission. Canadian Tire has a weighted average lease term of 7.5 years. CT REIT grows rent by 1.5% annually for its parent.