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Passive income investors have many reasons to be bullish. However, most other investors turn bearish over rate increases and a possible swing into recession. Yields will rise as share prices fall. Assuming there’s no dividend or distribution cut, swollen yields can signal that a stock is an attractive long-term buying opportunity.
It is important to carefully analyze how cash flows will perform during periods of economic contraction. A reduction or cut in dividends is not something investors want to hear, especially during times of economic contraction.
Rate-driven slowdown is a major drag on the TSX
Many are still wondering if a 2023 recession could be possible after the Bank of Canada (BoC), shocking many with a 100-bps rate hike (a full point). A 100-bps rate hike is indeed the biggest in recent decades. While it may be a cause for concern, I’d argue that it’s far better to front-load the hikes to get rid of inflation.
The BoC can always reverse its decision if it hikes too high. What it can’t do is go back in time and increase the magnitude of its hikes. Inflation already had an insidious effect upon the purchasing power consumers.
Though the mix of higher interest rates and slower economic growth isn’t optimal for REITs (real estate investment trusts) or other high-yielding, capital-intensive firms, I do think that too much negativity is baked in.
Take a look at shares Canadian Apartment Properties REIT (TSX.CAR.UN). Killam Apartment REIT (TSX.KMP.UN), two real estate investments that have been sold off and are worth the investment for those who want to lock in higher yields.
Canadian Apartment Properties REIT
Canadian Apartment Properties REIT is a very high-quality REIT that’s one of the best known in Canada. The REIT lost more than 30% of its all-time high due to the market selloff. CAPREIT’s share price is now at $43 per share or less, a level not seen since 2020’s stock market crash. Are things worse than they were during the pandemic lockdowns that swept the country in 2005? Most likely not.
CAPREIT is a growth-oriented REIT and higher interest rates could make it fall from its stride. Although CAPREIT may miss a beat it is not foolish to do so (with a lower rate). F) to underestimate the resilience of the REIT’s cash flow stream, as we move through a difficult period.
The REIT still has a lot of growth potential, as it owns some of the most sought-after properties in Vancouver and Toronto. CAPREIT’s 3.32% yield combined with 5.7 times trailing earnings multiple makes it a top choice for passive income seekers who want to stash their RRSP or TFSA funds in the long-term.
Killam Apartment REIT
Killam is another growth-oriented REIT that’s quite similar to CAPREIT. One major difference is the concentration of Killam in the Atlantic coast region. Like shares of CAR.UN, Killam shares are down around 30% from their recent high, dragged close to 2020 lows by fears of higher interest rates — which could dampen growth prospects — and a coming economic contraction.
I believe that selling is excessive at this point. Killam may be a mid-cap name with a $1.93 billion market cap, but it’s incredibly well managed. The market seems to think that the days of big distribution growth are gone with Killam’s 4.2% yield and 5.8x trailing earnings multiple.
Despite the headwinds Killam could find a way to reduce the growth-dampening impact of higher rates.