Hunting for solid, income-paying stocks that have been beaten down to bargain levels? Look no further than Canadian REITs, which deserve a lot more respect than panicky investors are giving them right now.
Canada's top real estate investment trusts have a lot of things going for them, including conservative capital structures, rising cash flows and tax-efficient distributions that make them a favourite of retail investors.
But they also have one serious problem: They've got the words "real estate" in their name. As the U.S. housing market collapses, investors are steering clear of anything that involves land, mortgages and buildings.
That includes Canadian REITs, which, despite being in fabulous financial shape, have suffered a relentless pummelling over the past few months.
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Since peaking last February, the S&P/TSX capped REIT index has plunged 28 per cent. To put that drop in perspective, it's more than double the decline in the S&P/TSX capped financials index, underlining the fear that has gripped the Canadian REIT market in the wake of the U.S. housing bust.
But most of the concerns are unwarranted, analysts and investors say.
"The fundamentals are actually okay," said National Bank Financial analyst Michael Smith, who counts RioCan, Calloway, Boardwalk and Cominar among his favourite REITs. "If you're an income investor and you've got cash, it's a great time to be in the market picking up these names."
For one thing, yields are a lot higher than they were a few months ago. Calloway, the largest landlord for Wal-Mart Stores in Canada, now yields more than 7 per cent. Fellow shopping centre owner RioCan, Canada's biggest REIT, yields 6.9 per cent (disclosure: I own RioCan shares).
For high-quality REITs like these, the distributions are "absolutely safe," Mr. Smith said. If that's the case, what are investors so worried about?
One of their chief concerns is that REITs, which have to borrow money to buy properties, may have trouble accessing capital because of the credit crunch. But the evidence so far is that, because of the creditworthiness of many REITs, they're still obtaining loans at roughly the same terms as before the credit crisis, said Rossa O'Reilly, an analyst at CIBC World Markets.
"The most important thing is the fundamentals of the leasing market here couldn't be in better shape. There are record low vacancies for commercial spaces, rental rates are rising and the pipeline of new property construction is extremely small," he said. As rental revenues increase, that will lead to higher payouts for unitholders, he said.
Another plus for Canadian REITs is that they have been careful not to overextend themselves with debt, which will allow them to ride out any downturn in the economy. The fact that REITs typically sign tenants to long-term leases also insulates them from short-term economic swings.
"We believe the market reaction towards commercial real estate cannot be explained by underlying sector fundamentals, which remain healthy," Scotia Capital analyst Himalaya Jain said in a note to clients this week.
Many REITs are cheaper than they've been in years, he said. The companies he covers are trading at an average 8.5-per-cent discount to net asset value (the market value of the properties, minus debt), providing "attractive downside protection at current levels."
"While we cannot predict when the negative sentiment will pass, we believe investors can be comforted by relatively attractive yields in the near term," he wrote.
Much of the recent selling appears to have been driven by retail investors who couldn't stomach watching their unit prices plunge. The price drops were exacerbated because buyers were so scarce. Now, some institutions say REIT valuations are starting to look attractive.
Paul Gardner, partner and portfolio manager at Avenue Investment Management, said the firm may add to its existing positions in some REITs.
"The large-cap REITS are really cheap," he said.
Mr. Smith at National Bank agrees REITs are a good buy.
"Based on the fundamentals, the underlying real estate fundamentals, the downdraft is overdone," he said. "But in a bear market, fundamentals take a backseat to fear."
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S&P/TSX capped REIT sector
| Company name | Price $ | 52-week low $ | 52-week high $ | 1-year price change % | Yield % |
| InnVest | 9.49 | 9.47 | 14.90 | -30.5 | 11.5 |
| Calloway | 20.90 | 20.5 | 29.79 | - 25.1 | 7.1 |
| Chartwell Seniors Housing | 10.60 | 9.54 | 17.89 | - 25.0 | 10.2 |
| H&R Real Estate Invest. Trust | 18.15 | 17.72 | 26.99 | - 24.1 | 7.7 |
| RioCan Real Estate Investment | 19.04 | 18.70 | 27.34 | - 21.5 | 6.9 |
| Extendicare | 11.63 | 11.05 | 19.72 | - 21.2 | 9.6 |
| Cominar | 18.56 | 18.25 | 26.04 | - 18.0 | 7.3 |
| CAP | 14.87 | 14.44 | 21.89 | - 17.8 | 7.2 |
| Dundee | 32.70 | 32.01 | 47.39 | - 14.6 | 6.7 |
| Cdn. Real Estate Investment | 25.98 | 25.40 | 33.78 | - 12.5 | 4.9 |
| Primaris Retail | 16.85 | 16.20 | 22.23 | - 10.0 | 7.3 |
| Boardwalk | 41.15 | 38.01 | 50.95 | +8.3 | 4.3 |
SOURCE: GLOBE INVESTOR
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