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A Chartwell Seniors Housing REIT in Toronto. Investment in domestic real estate has exploded in recent years and the market capitalization of the iShares S&P/TSX Capped REIT ETF has increased tenfold since 2006.

Fred Lum/The Globe and Mail

Investors seeking income and growth from Canada's real estate sector should have something to cheer about this year, but they will have to look harder to unearth the gems.

Real estate investment trusts (REITs) no longer have the tailwind of falling interest rates, but their money managers suggest that total returns in the high single to low double digits are still possible this year. Investors should look for companies that can generate strong cash flow, have specific catalysts or benefit from a recovery in the United States.

"The outlook is relatively positive, barring a drop in economic growth or a sharp rise in interest rates," says Michael Missaghie, a portfolio manager with Sentry Investments.

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After surging ahead for four years following the global financial crisis, the S&P/TSX Capped REIT Index lost 5.5 per cent in 2013 on fears of rising interest rates, which would make refinancing debt more costly. But the index is up around 8 per cent so far this year as the U.S. 10-year bond has retreated slightly and stabilized below 3 per cent.

"The fundamentals, like occupancy and rent increases, generally are still outstanding" in most real estate areas except for the office sector, where supply is expected to increase, said Andy Nasr, a portfolio manager at Middlefield Capital Corp. He is generally avoiding office, except those in extraordinary circumstances; he sees more upside in senior's housing, apartment and industrial REITs.

If the 10-year bond stays at or below 3 per cent, "we think REITs will have a positive return, probably in the low double to high single digits," said Lee Goldman, a portfolio manager at First Asset Investment Management Inc.

He suggests investors also look for opportunities beyond traditional REITs to dividend-yielding real estate operating companies, or mortgage investment corporations.

Here are top picks from the managers of REIT-focused funds.

Andy Nasr, manager, Middlefield ActiveIndex REIT Fund

  • Brookfield Property Partners L.P. (BPY.UN-TSX)
  • Annual dividend: $1 (U.S.) a share
  • Yield: 5.1 per cent

This real estate company, which is acquiring Brookfield Office Properties Inc., is "still under the radar" but will benefit from more analysts' coverage, he said. It has minority interests in U.S. REITs and London's Canary Wharf, but it is expected to consolidate or divest them. The stock trades at a discount to his estimate of a net asset value (NAV) of $24 (Canadian) a share. He has a one-year target of $25 a share.

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  • Brookfield Canada Office Properties Inc. (BOX.UN-TSX)
  • Annual distribution: $1.17 a unit
  • Yield: 4.4 per cent

This REIT, which has the "highest-quality office portfolio in Canada," has the potential to be fully acquired by Brookfield Property Partners within the next 18 months, he said. The latter now controls 80 per cent of Brookfield Canada, which has a solid balance sheet and should see cash flow growth from rent increases, he noted. The REIT trades at a discount to its NAV, estimated at $31 a unit, "so it is relatively cheap."

  • Chartwell Retirement Residences (CSH.UN-TSX)
  • Annual distribution: 54 cents a unit
  • Yield: 5.2 per cent

Chartwell, which owns retirement and long-term care homes in North America, will benefit from a rise in demand from aging baby boomers. Demand growth is expected to outstrip supply starting this year, so the occupancy rate should rise and allow Chartwell to raise rents, he said. Chartwell trades at a discount to its U.S. peers and is a potential takeover candidate, he added. His target is $11.50 a unit.

Lee Goldman, manager of First Asset REIT Income Fund

  • Killam Properties Inc. (KMP-TSX)
  • Annual dividend: 60 cents a share
  • Yield: 5.8 per cent

This apartment operator, which focuses on Atlantic Canada, has faced headwinds from a harsh winter that has pushed fuel and snow removal expenses higher, Mr. Goldman said. But the Irving Shipbuilding contract in Halifax is expected to increase demand for apartments, and Killam is also a potential takeover candidate, he added. His target price is $12 a share, slightly above his estimate of NAV at $11.50 a share.

  • Tricon Capital Group Inc. (TCN-TSX)
  • Annual dividend: 24 cents a share
  • Yield: 3.2 per cent

Tricon was formerly known as an asset manager that ran real estate portfolios for pension funds, but it has also evolved into an "opportunistic real estate play" on a recovering U.S. housing market, Mr. Goldman said. Tricon rents out single-family homes bought at depressed prices and is now expanding into upscale mobile home parks in the U.S. sunbelt. His one-year target price is $9.50 to $10 a share.

  • Timbercreek Senior Mortgage Investment Corp. (MTG-TSX)
  • Annual dividend: 60 cents a share
  • Yield: 7 per cent

Timbercreek, which invests in first mortgage loans, is "a yield play," although there will be some capital appreciation, he said. The former closed-end fund became a mortgage investment corporation last year, and trades at a slight discount to its NAV. It has a low management fee, focuses on mortgages with low loan-to-value ratios, and will benefit from rising interest rates, he added. His target price is $9.50 to $10 a share.

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Michael Missaghie, manager of Sentry REIT Fund

  • Simon Property Group Inc. (SPG-NYSE)
  • Annual dividend: $5 (U.S.) a share
  • Yield: 2.9 per cent

Simon Property, the world's largest REIT and operator of upscale U.S. shopping malls, is making value-added acquisitions and delivers above-average free cash flow, Mr. Missaghie said. With a 63-per-cent payout ratio, it should continue to raise dividends. This REIT trades at a discount to a NAV that he estimates at $180 per share. Simon historically has traded at a 3- to 5-per-cent premium to NAV, he noted.

  • InterRent REIT (IIP.UN-TSX)
  • Annual distribution: 20 cents a unit
  • Yield: 3.6 per cent

The apartment REIT, which owns buildings in southwestern Ontario and in Ottawa, has a history of generating free cash-flow growth by buying properties and refurbishing them to charge higher rents. InterRent is attractive because it trades at a significant discount to its NAV, estimated at $6.55 to $6.60 a unit, Mr. Missaghie said. Its 60-per-cent payout ratio also means it can increase its distribution in the future, he added.

  • Chartwell Retirement Residences (CSH.UN-TSX)
  • Annual distribution: 54 cents a unit
  • Yield: 5.2 per cent

This operator of seniors' housing is really a turnaround story, Mr. Missaghie said. Chartwell has sold non-core assets, abandoned its mezzanine lending business for developing retirement homes and has lowered its payout ratio to a more manageable 82 per cent. Although Chartwell trades slightly above its NAV of about $10 a unit, the REIT is attractive because it will generate above-average free cash flow as occupancy rates and rents rise, he added. "Our target is closer to $11 on this name."

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