It was pretty much a year ago that the Great REIT rout of 2013 began. We still haven't fully recovered, but there's still hope.
That's the message on real estate investment trusts contained in a recent note from Harry Levant, an independent analyst who runs IncomeResearch.ca. "Should our forecast for stable to lower interest rates prove accurate, there is still further room for price appreciation in the REIT sector," he wrote.
The S&P/TSX Capped REIT Index equalled its all-time high on May 31, 2013 and then bumped its way to a loss of 18 per cent by year's end. The trigger was a sharp run-up in bond yields that investors widely interpreted as the beginning of a bear market for bonds. That turned out not to be the case, and REIT prices have this year been gaining ground steadily. As of mid-May, the year-to-date gain was 14 per cent.
Levant said he doesn't expect previous all-time REIT highs to be reached. But upside is possible for REITs with yields that exceed their historical average spread over 10-year Government of Canada bonds. Among them are CAP REIT, RioCan, Morguard, H&R, Northern Properties, Granite, Crombie, Pure Industrial REIT and Cominar.
His general rule for valuing a REIT: For low and medium risk REITs, spreads over the 10-year Canada bond run from 1.5 per cent to 5 per cent. The higher the spread, the more risk there is. REITs with spreads on the lower side have the potential to rise in price only when adjusted funds from operations moves higher, he says.
Levant's REIT thesis is based in large part on his expectation that rates won't rise any time soon. "REITs still offer one of the few sources of regular income in a market where reliable above average yields are hard to come by," he wrote. "A year from now we expect little will have changed."
In mid-May, the 10-year Canada bond yield was in the range of 2.4 per cent. The S&P/TSX Capped REIT Index yield was about 4.9 per cent. There's your case for REITs right there.