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Cooling real estate market bad news for REITs Add to ...

There has been much talk about the impact that a slowing real estate market could have on Canada’s banks. But less attention has been paid to the impact that it might have on the REITs.

That’s a mistake, BMO analyst Tom MacKinnon suggests in a note to clients.

For one thing, while he agrees that a slowdown is a worry for banks, given their massive mortgage portfolios, in the longer term he thinks it might not be such a bad thing. "A slowdown in the domestic real estate market is good for long-term growth of Canadian banks as it should help Canadians reduce debt," he argues.

And in the aftermath of a slowdown consumer spending and economic activity will suffer, likely having a dampening impact on the REITs, he says.

That’s part of the reason why he believes that current bank valuations represent a more attractive investment gamble than those of the REITs. To compare the numbers, he looks at the spread differential between the yields on REITs and banks.

That differential has averaged 262 basis points since 2006, and is currently at 88 basis points. The spread recently troughed at 78 basis points - having peaked at 706 bps during the financial crisis.

"The payout ratio on bank earnings is currently 45 per cent and the payout ratio for the REITs is 92 per cent," Mr. MacKinnon adds. "We believe that the banks should grow dividends by 3 to 5 per cent over the next few years."

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