Rising interest rates in Canada and the United States could spoil this year's rebound in real estate investment trusts, according to Raymond James.
While the interest rate-sensitive REIT sector has had a stellar start to the year on both sides of the border, an improving U.S. economy would reintroduce upward pressure on interest rates.
"As such, we advise non-dedicated investors to trim their allocation to real estate and underweight the sector entering a period where 'growth equities' should outperform REITs in general," Raymond James analyst Ken Avalos said in a note today.
After a year in which Canadian REITs and real estate operating companies lagged the broader equities market by a large percentage, finishing 2013 down 5.5 per cent on a total return basis, the sector has returned 8 per cent year to date. Meanwhile, the MSCI US REIT Index has risen by 12 per cent.
"Real estate equities have benefitted from mixed economic data and a pullback in the 10-year (treasury)," Mr. Avalos said.
Benchmark yields on government bonds both in Canada and the U.S. have retreated this year as the economic backdrop has worsened.
"However, we believe this is a 'head fake,' similar to the past two years, and that the U.S. will show signs of a modestly strengthening recovery in the back half of the year," the analyst said.
As a result, Raymond James expects the REIT sector to trade flat to down over the remainder of the year.
Investors should reduce exposure to real estate accordingly, said Mr. Avalos, who expects rotation into higher quality, growth-oriented names. His top picks are Allied Properties REIT, Boardwalk REIT, Canadian Real Estate Investment Trust (CREIT) and RioCan REIT.