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Asset Allocation : The Hard Reit

Updated: Feb 4, 2022

As we approach 2021 and move further through the pandemic I wanted to provide this update on my current asset allocation.

The Hard Reit

85% Real Estate Investment Trust (REIT) 5% Bitcoin 5% Gold 5% Silver

This portfolio is designed to have a very high yield through a concentration in significantly discounted retail reits and is slightly diversified by smaller positions in gold, silver and bitcoin. These smaller positions provide additional inflation protection and a small reserve asset base.

Notably, this portfolio does not have any exposure to equities or fixed income. Current valuations of both of these asset classes are fairly high and I don't see a lot of upside in the bond markets at current interest rate levels. I view high quality REITS purchased at a significant discount to net asset value as a super bond that have income, capital appreciation and inflation protection. I plan on using the high yield of this portfolio to dollar cost average into non-REIT positions to slowly increase diversification over time.

The portfolio is heavily concentrated in two Canadian retail reits: RioCan (REI.UN) and Smartcenters (SRU.UN). These investments are trading at very low price/ffo levels with RioCan on track to generate approximately $1.60 in FFO per share in 2020 and is currently trading at $17 resulting in a 10.6 P/FFO and Smartcenters is on track for $2.18 in FFO per share in 2021 and is currently trading at $23 resulting in a 10.55 P/FFO. Typically the REIT average on the TSX has been approximately 14 P/FFO. This estimates that RioCan and Smartcenters are both discounted 25% based on 2020 FFO levels.

Despite the high concentration, I believe the portfolio is actually quite defensive. The diversified high quality tenant mix in both of these organizations are accompanied by long weighted average lease terms (RioCan: 7 Years, Smartcenters: 4.7 years). These longer lease terms should provide some revenue stability through the pandemic and recession.

Rent collection rates for both RioCan and Smartcenters have been high (>90%) despite lockdowns and the covid impact. Rent collections have been supported through government aid programs as well as strong leasing activities. The leasing activities demonstrate the resiliency of high quality real estate locations and their ability to fill vacant space quickly.

RioCan recently cut the dividend by 33% to reduce their payout ratio to a very healthy level (60%) and increase capital available for their development pipeline. After the cut, Riocan offers a 5.6% yield and is very safe with a low 60% payout ratio. This positions RioCan for both a high 5.6% yield and capital appreciation as the capital saved on the dividend cut can be deployed to the development pipeline. Investing in the development pipeline will increase net asset value and generate new recurring revenues. I view this change as a transition for RioCan from an investment that has been primarily focused on income to an investment that offers both growth and income.

Smartcenters offers an attractive 8% yield at an 88% payout ratio which is slightly higher than its average payout ratio of the last five years, 83.3%. Smartcenters has also been increasing their dividend each year by 5 cents from 2015 ($1.61) to 2019 ($1.81). It is doubtful that the dividend will be increased in 2020 due to the higher payout ratio, however it is likely that Smartcenters will return to raising dividends in the future. This allows you to purchase an 8% yield that should grow into the future.

Both organizations have a competitive advantage/moat in strategic land assets in Canada's best cities. This advantage provides them both very large development pipelines that will continue to generate value long into the future. These strategic properties are located along transportation infrastructure (subway stations/major highways/trains) and deliver low vacancy rates, high rental rates, and intensification/development opportunities. The supply of development land in these aaa locations is extremely limited creating the moats and making the investments very hard assets. They are both using their development pipelines to slowly diversify into the residential sector by building mixed use projects with both retail and residential components.

I am using 25% leverage with this portfolio and view this leverage as a short on fiat currency vs. a portfolio invested in hard assets. The high income from the portfolio far outweighs the cost of the leverage and can slowly pay down the balance or dollar cost average into investments.

The Hard Reit asset allocation generates a high monthly income so that I am paid to wait for the pandemic to end, retail REIT valuations to bounce back to 14XFFO Levels, and the reit development pipeline to generate value. The portfolio benefits from lower interest rates, inflation, immigration and fiat currency devaluation.

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