Dundee Reit - Entrust Tower in Ottawa.
The second Canadian real estate investment trust takeover in just two days proves the country's burning hot property market isn't confined to residential homes.
Dundee REIT announced Tuesday it is buying Whiterock REIT for $582-million, in a move that solidifies Dundee's office-property presence in the Greater Toronto Area, particularly the downtown core. The acquisition follows Quebec-based Cominar REIT's friendly deal to acquire Canmarc REIT, boosting its portfolio by almost 50 per cent.
The deals aren't likely to stop, as investors pour into the hot real estate sector. The S&P/TSX Capped REIT index was up 22 per cent in 2011, beating the S&P/TSX composite index and its 11-per-cent annual loss by a long shot, and cheap mortgage financing makes it easier for the companies to bulk up by tacking on new properties.
REITs are also catching the eyes of more buyers. Pension funds and big private equity firms are attracted to the long-term nature of real estate assets, which match well with long-term pension liabilities.
"There are more and more people who want to own real estate versus traditional assets," said Michael Cooper, chief executive officer of Dundee REIT, who noted on a conference call Tuesday that he was shocked by the extent to which his firm was outbid in recent property auctions.
"Everybody's accepting that we're in a low interest environment and that [rates are]going to remain there," Mr. Cooper said. The sector is so hot, he noted, that REITs no longer drive demand and pricing for property acquisitions, like they did from 2009 until last summer. Now they are following the private buyers' leads.
As everybody piles into real estate, capitalization rates, or the income generated from a property divided by its value, are plummeting. (If a $1-million property generates $100,000 in income, its cap rate is 10 per cent. If that building's value jumps to $2-million, the rate falls to 5 per cent.) Mr. Cooper cited recent transactions for specific properties completed at rates of 4.8 and 5.2 per cent as proof, so he felt fortunate to buy Whiterock at 6.5 per cent. The 20-year average is around 7.5 to 8 per cent; however, current rates are skewed by the rock bottom yield on government bonds.
Some market watchers predict even lower rates in the future. "For Dundee, I would say this is a stroke of genius just ahead of another wave of cap rate compression," said Alex Avery, a real estate analyst at CIBC World Markets.
Mr. Avery is bullish on the property market. While he acknowledges that it is already extremely hot, he points out that vacancy rates continue to fall, market rents are higher than the rents the REITS have locked in, new construction is very limited, and just like homeowners, REITs get to refinance their mortgages at lower rates as they come due.
Because he expects real estate to stay strong, Mr. Avery anticipates more acquisitions. He likes the possibility of more REIT-on-REIT deals because bulking up helps these firms to diversify their assets. That gives investors confidence, and if liquidity improves because more buy in, their valuations typically rise.
If the market stays firm, Mr. Avery also said a large fund could even consider acquiring a large, quality REIT such as RioCan or Primaris.
But that 'if' is a big question mark. Though the Canadian fundamentals are strong, a European economic implosion could very quickly wreak havoc. "I do worry that there are a lot of problems in other economies," Mr. Cooper said.
And there is reason to worry that valuations will soar too high, even with fundamental support. "It's certainly something to keep an eye on," Mr. Avery said. But he isn't very worried just yet. "We're a long way from bubble territory."
Tim Kiladze