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(Deborah Baic/Deborah Baic/THE GLOBE AND MAIL)
(Deborah Baic/Deborah Baic/THE GLOBE AND MAIL)

Real estate

Why REITs may be a solid investment Add to ...

Canadian real estate investment trusts may have limited upside after this year's stunning rally, but healthy yields should ensure they make a solid investment through a tentative economic recovery.

Like many other sectors, Canadian REITs tumbled in value during the global financial crisis, though not nearly as hard as their U.S. counterparts.

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The drop was from concern that their funds from operations - a key measure that investors use to gauge a trust's ability to make its monthly distribution - were in peril from a slumping economy.

But REITs, focused on holding income-producing real estate assets, have also been winners as global stock markets rallied off the multiyear lows of March. Prices jumped as much-feared payout cuts failed to materialize. Experts said this will likely remain the case.

"There's no real reason for REITs to sell off," said Dennis Mitchell, portfolio manager of the Sentry Select REIT Fund, a nearly exclusive mix of Canadian REITs, with assets under management of $194-million as of the end of August.

"Investors who are looking to get into the REIT market right now should bank on getting their distribution. There doesn't seem to be a case for a lot of downside, so it's really a question of how much upside they'll realize."

As of Friday, the S&P/TSX REIT index was up about 62 per cent from the 2009 low it hit in March, That topped the broader TSX composite index's gain of about 50 per cent over the same time frame.

REITs offer investors a way to participate in real estate, including the potential rise in property values, with the added benefit of liquidity from the equity market and without the potential headaches of being a landlord.

Investors are usually attracted to these vehicles because of the regular distributions. REITs pay out most of their income to avoid taxation.

Analysts said even after the sector's rally, many issues still sport healthy yields, meaning there is little need for investors to move beyond higher quality issues when adding to their portfolio.

"At this point, there is very little value to be stretching out and taking some of the ones with higher risk. You're still getting 5 to 7 or 8 per cent yields in a lot of the better REITS in Canada, at a time when things are uncertain," said Charles Dillingham, a portfolio manager at Morguard Financial.

"There's enough opportunity and risk even in the best quality in this environment. Stay with the best stuff."

Among some of the names Dillingham and others favor are Canadian Real Estate Investment Trust , retail-focused RioCan Real Estate Investment , and apartment landlord Boardwalk REIT , because they are seen as high-quality, well-managed trusts.

Canadian and Boardwalk each yield about 5 per cent, while RioCan yields more that 7 per cent. By comparison, a 30-year Canadian government bond yields less than 4 per cent.

For yield-hungry investors, including a growing number of baby boomers approaching retirement, the REIT sector looks unlikely to face much competition from the bond market any time soon.

The Bank of Canada has conditionally pledged to keep interest rates near zero until the middle of next year. And the central bank predicts inflation, which could send bond yields higher, will not return to its 2 per cent target until 2011.

Longer term, REITS may find favour as the last game in the market offering this kind of income stream compared with other vehicles such as income trusts - which, due to government rules on tax issues, will likely see many convert back to corporations by 2011.

"There's no shortage of REITs. As income trusts in general disappear, REITs will remain," said Bob Gorman, chief portfolio strategist at TD Waterhouse.

"They may benefit from a bit of a scarcity premium in that you won't have these other sorts of securities that have the same kinds of yields. You may have them gaining additional interest from investors."

But, ultimately, the value of a REIT is reliant on its ability to keep generating income. Analysts say Canadian REITs may be a better bet than their U.S. counterparts in this regard. Canada's downturn has not been nearly as severe, in part due to the sound nature of its banking system.

"To the extent that investors are looking for some stable income as part of their portfolio, there seems to be good interest in Canada as a place to be," said Simon Nyilassy, chief executive of Calloway REIT, which holds 22 million square feet of retail space across Canada.

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