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Veteran real estate fund manager bets on Alberta

Charles Dillingham of Morguard Financial Corp. Fernando Morales/The Globe and Mail

Canada's real estate investment trusts are no longer bargains, but those with exposure to the Albertan economy are better positioned than others for gains, says a veteran real estate fund manager.

"Alberta is making a very significant recovery," said Charles Dillingham, who oversees about $225-million in retail and institutional portfolios at Toronto-based Morguard Financial Corp. "And the office market, particularly, is rebounding in a fashion that was not expected."

A surge in the price of crude and increased drilling in the oil patch have lifted the province's economy, said Mr. Dillingham, who runs CIBC Canadian Real Estate fund and the TSX-listed Morguard Sunstone Real Estate Income Fund.

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His funds hold securities that get a big chunk of revenue from Alberta, such as Dundee Real Estate Investment Trust and Artis REIT , both of which lease office space, as well as Boardwalk REIT , which rents apartments.

But REITS "are no longer cheap" after rallying from the stock-market bottom in 2009, he said. "Most trade at bit of premium to their net asset value."

Investors have driven up REIT prices as they scramble for steady payouts in a low-interest rate environment.

"Without a lot of growth in the economy to help increase corporate profits, it is very hard for the stock market prices to move up much more," he said.

REITS, which rely upon debt for acquisitions, are vulnerable to rising interest rates, Mr. Dillingham warned. But he doesn't expect a big rate hikes, at least over the next six months, given the softness in the North American economy.


Canadian REITS are in better shape now than they were a few years ago because they have refinanced their debt at lower rates and for longer terms "so the immediate risk to their cash flow [from higher rates]is much less," and they have also reduced their payout ratios significantly, he said. The payout ratio is the percentage of a REIT's earnings that it pays out in distributions.

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"The average payout ratio is in the area of 80 per cent," Mr. Dillingham said. "Back in 2008, a very significant percentage were paying more than 120 or 130 per cent of what they were earning on the basis that the capital markets would always let them come and borrow again."

Despite the 2008 market collapse, his CIBC Canadian Real Estate Fund has managed to generate an annualized return of 10 per cent over the decade ending April 30 versus 7.9 per cent for the S&P/TSX Capped Real Estate Index.

Mr. Dillingham works for a company whose parent, Morguard Corp. , has about $10-billion invested directly in real estate in North America. Being "plugged into the industry" undoubtedly has helped in managing the CIBC fund, said Dan Hallett of HighView Financial Group.


The performance of that mutual fund is "impressive" given its high fees of nearly 3 per cent, and the extreme volatility of the last bear market, Mr. Hallett added. "Bear in mind, the fund lost 50 per cent of its value [compared with a loss of nearly 60 per cent for the index]from June 30, 2007, to the end of February, 2009 … and we really didn't have a serious real estate crisis in Canada."

Given the market's volatility, Mr. Dillingham has shifted to more defensive securities. He now owns names such as Canadian nursing home operator Leisureworld Senior Care Corp. that can prosper no matter what the economy does. He has also increased U.S. holdings to about 20 per cent of his CIBC fund's portfolio, based on his belief that the hard-hit U.S. real-estate market has more room to bounce back.

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The manager likes the North American industrial sector, which got hurt badly during the downturn. He owns Pure Industrial Real Estate Trust , the only industrial REIT in Canada, as well as U.S. warehouse operators AMB Property Corp. and ProLogis, which have agreed to a merger.

He is cautious on shopping centres because retail sales remain soft, but does own shares in companies such as First Capital Realty Inc. in Canada and U.S.-based mall owner Simon Property Group Inc.

Some investors expect the acquisition of Zellers stores by Target Corp. to boost the profits of shopping centre REITS, but the U.S.-based retail giant won't be a big cash cow at first, warned Mr. Dillingham, who owns four REITS with Zellers exposure.

"[Target is]coming in and demanding expensive renovations from the landlords so there is going to be a cost [to REITs] It won't bring them money right away."

Dillingham's picks

First Capital Realty Inc.

This Canadian real estate company develops and operates malls in metropolitan areas. These malls are anchored by "essential" retailers such as drug stores, liquor outlets, banks and grocers, Mr. Dillingham said. The company has a payout ratio of around 87 per cent and a 4.8-per-cent dividend yield. His one-year target is $18 a share.

Leisureworld Senior Care Corp.

This Ontario nursing-home operator has a veteran management team, a payout ratio of about 82 per cent and an 8-per-cent dividend yield. It will not grow much but is a "very good source of what I expect will be high sustainable [payout]" Mr. Dillingham said. His one-year target is $12 a share.

Canadian Real Estate Investment Trust

This REIT, which owns retail, office and industrial real estate, is "very conservative and well managed," Mr. Dillingham said. Investors have worried that CREIT's growth is slowing, but last week it bought two Toronto area shopping centres for $171-million. The REIT, which has a yield of 4.4 per cent, has a payout ratio of about 70 per cent.

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