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Fears of a U.S.-style implosion in the housing market have some investors leery of alternative mortgage lenders such as Capital Homes Group.The Globe and Mail

As the fate of mortgage lender Home Capital Group Inc. hangs in the balance, investors are finding another way to play Canada's potential housing slump: bet against real estate investment trusts.

The iShares S&P/TSX Capped REIT Index ETF has fallen 3.1 per cent since April 19 -- steeper than the benchmark gauge's 1.7-per-cent decline -- when regulators accused Home Capital of misleading investors, triggering a run on deposits and raising questions about its survival. Short interest on the ETF rose to a record 4 million on April 13 and was at 3.8 million or 4.6 per cent of shares outstanding at the end of last month, according to the latest exchange data.

Problems at Canada's REITs go beyond Home Capital's woes. A slump in oil prices has hurt demand for property in Alberta, the country's big cities are seeing rents fall far behind price gains, which dents revenue, and online shopping has shrunk traffic at malls. Finally, in times of broad market stress, REITS behave more like stocks rather than safer bonds, according to Pavilion Global Markets Ltd.

"We find the risk-reward in Canadian REITs to be quite poor in the current environment," Alex Bellefleur, an analyst at Montreal-based Pavilion, wrote in a strategy note Wednesday. "In the context of Canada's property bubble, we would stay away from this asset class."

The REIT model of growth by acquisition also doesn't make sense when rates start to rise, said John Zechner, president of Toronto-based wealth management company J. Zechner Associates, who is short the iShares REIT ETF. That's because REITs pay out most of their operating cash flow to holders, leaving little to reinvest in the business.

"If you can't reinvest in your business, you don't have very much internal growth," said Mr. Zechner, whose firm manages $2-billion. "That works well in great markets, but what happens when you don't have those great markets anymore?"

The concern became more relevant on Wednesday: The Dow Jones Industrial Average tumbled more than 370 points, Treasuries rallied the most since Brexit and volatility spiked higher as the turmoil surrounding U.S. President Donald Trump's administration roiled financial markets around the globe.

Be Cautious

Alex Avery -- who covers REITS for CIBC World Markets -- disagrees that the sector is overvalued, especially when compared with 10-year bonds. Investors should instead cautiously look for companies with compelling growth strategies and strong management, he said.

Mr. Avery said pension funds are increasingly hungry for alternative assets like real estate and REITs are trading at discounts to net asset value. He said REITs that are mostly likely to be takeover targets include RioCan REIT, Chartwell Retirement Residences, Killam Apartment REIT and Canadian Apartment Properties REIT. Among the large-cap REITs he favors are Allied Properties REIT, Crombie REIT, H&R REIT and Smart REIT.

"I think there's a good reason to believe there will be more privatization in the next few years," Avery said. "It's not a good story but the REITs are not expensive."

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