For real estate investment trusts, the signs are encouraging: Interest rates appear to be set in concrete, we've emerged from our mini-recession unscathed and REIT valuations are attractively low.
So is it time for investors to revisit REITs? Most definitely, says Rob Sutherland, a Toronto-based analyst who covers the real estate industry for the investment firm Euro Pacific Canada Inc.
For Mr. Sutherland, a key measure for the sector is the difference between the yield of the Canada 10-year bond and the yield produced by REITs. That spread is about 5.4 per cent. "Outside of a couple months in 2009-2010, it is the highest it has been in decades."
That yawning gap gives REITs an operating cushion to help them withstand potential negatives such as a rise in interest rates, says Mr. Sutherland, "but also kind of shows that things are really, really cheap."
On top of that, persistent price weakness has REITs trading at a 10-per-cent discount to their net asset value, or the value of their bricks-and-mortar real estate. "So you are buying them at 90 cents on the dollar," he says, and you are not having to pay for any of the extras beyond the physical value, including the management team and the ability for future growth.
REITs have been cooling their heels for the better part of two years now. After a run of 17 REIT initial public offerings in the 20 months that ended with CT REIT in October of 2013, there has been just one successful REIT initial offering.
The current environment is making life difficult for some of the newer, smaller REITs, notes Mr. Sutherland, who likes larger, established trusts such as Dream Office REIT, which has a $2.4-billion market cap and pays a 10-per-cent dividend. "It has fantastic management, a portfolio that would rival a lot of pension funds or private equity funds around the world, you are getting a 10-per-cent yield on it and it is trading well below the intrinsic value of its real estate."
That's a no-lose investment proposition in his estimation. "Either something has to give [with respect to Dream's unit price] or you just clip that coupon forevermore and make your 10 per cent. There are a lot of good REITs paying 8 per cent, 9 per cent."
REITs have performed relatively well even while not being front-and-centre with investors, says Carolyn Blair, RBC Dominion Securities Inc.'s managing director of real estate. In a Toronto presentation last month, she showed that over the 12 months ended in August, REITs declined 4.3 per cent compared with 8.7 per cent for the TSX composite index over the comparable period. That does not count the steady, machine-like delivery of dividends from most REITs.
Bonds have outperformed REITs over the past year, Ms. Blair noted last month, but REITs have outperformed government bonds and the TSX when it comes to their five-year compound annual growth rates, and the figure is even better as the years stretch out. From 2001, the Canadian REIT index has increased by 502 per cent, or at 13-year compound annual growth rates of 11.6 per cent, compared with 5.6 per cent for the TSX and 5.8 per cent for bonds.
Not all REIT subsectors are created equal, however, says Paul Gardner, a partner and portfolio manager with Avenue Investment Management of Toronto. Retail tenants are increasingly shifting their business to the online world and need less real-world space to sell goods. And trusts that serve Canada's aging population – seniors and assisted-living-facility operators – have trends working in their favour.
The biggest head-scratcher for Mr. Gardner is the performance of the apartment sector, which should benefit from rising home prices that make rentals more attractive. Two companies that his firm owns, Western Canada-focused Mainstreet Equity Corp. and Boardwalk REIT, have been beaten up on the markets because of the oil-led slump.
Considering that real estate is in "the seventh or eighth inning of a 20-year cycle," investors should search out "stock specific opportunities" when looking for bargains and sectors poised for further growth. He prefers REITs that specialize in one asset class and have executive teams with a significant ownership stake, both attributes of Boardwalk and Mainstreet.
One other REIT he is partial to is Quebec-based B2B REIT, which owns a mix of retail, office and industrial properties. He likes the economic prospects for the province, B2B's 9-per-cent yield and improving financials.
Although the investment fundamentals appear positive for REITs, not everyone is a fan of trusts for investors.
"I wouldn't call REITs a forgotten asset class, I would call them an asset class that is being prudently being left off the docket lest investors expose themselves to concentration risk," said John DeGoey, a vice-president and portfolio manager with Burgeonvest Bick Securities Ltd. in Toronto.
Many investors have more than half of their wealth tied up in real estate, namely their personal residences, and that figure can rise if they own vacation properties, too.
"So for them to go around and put some of their discretionary personal investment money into real estate investment trusts, even though it is securitized, even though it has geographic diversification and whatever else it might have, is probably too much exposure to real estate," Mr. DeGoey says.
Even for investors who may rent their homes or have portfolios sizable enough to outweigh any real estate concentration, Mr. DeGoey recommends that they consider international REITs to lessen exposure to Canada's real estate market.