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yield hog

As stock markets were plunging this week, Michael Zakuta wasn’t panicking.

He was calmly buying shares of his own real estate company.

“I bought today and I bought yesterday,” he said in an interview on Wednesday. “I’m confident we’ll look back and say, wow, what a great buying opportunity this was.”

Mr. Zakuta is in a better position to judge the current crisis than most. As president and chief executive officer of Plaza Retail Real Estate Investment Trust (PLZ.UN), which operates primarily open-air retail centres in eight provinces, he has an insider’s view of how novel coronavirus fears and social distancing measures are affecting business at Plaza and other REITs.

Customer traffic has definitely slowed, he said, and some mom-and-pop retailers may need rent deferrals to get through the crisis. But for the big chain stores that make up the vast majority of Plaza’s tenants – such as Shoppers Drug Mart, No Frills, Dollarama, Canadian Tire and Sobeys – business is carrying on and Plaza sees no interruption to rental income.

Yet Plaza’s units have plummeted about 33 per cent from their high, and other REITs have suffered even steeper losses, indicating that the market is pricing in nothing short of disaster for the REIT sector. But Mr. Zakuta said the reality on the ground is not nearly as dire as the stock market would have people believe.

“I just don’t get it,” he said of the huge drop in Plaza’s unit price. “We think we have a really solid business.”

Plaza’s distribution, which now yields more than 9 per cent, is also well-secured, he said, thanks to a conservative payout ratio of about 70 per cent of funds from operations, a common real estate cash flow measure. What’s more, Plaza and other REITs stand to benefit from a recent drop in borrowing costs, which will allow them to refinance mortgages and credit lines at lower rates, helping to offset any rent softness.

Shares of SmartCentres REIT, which operates several reatil centres, have plunged.The Globe and Mail

Some REITs have been hit even harder than Plaza. Units of SmartCentres REIT (SRU.UN), which also operates open-air retail centres and has an extensive mixed-use property pipeline, had plummeted nearly 50 per cent from their recent high.

The market’s valuation of SmartCentres “makes no sense,” Mitchell Goldhar, executive chairman of the REIT, said in an e-mail. The market is treating SmartCentres units as if “50 per cent of our retail space in existence will be closed not just for two weeks, not just for one month or for three months, but forever, never to open or be leased again, ever, to anyone, as if the buildings will disappear off the face of the Earth, along with the land under them, never again to generate revenue,” he said.

But that is categorically incorrect, Mr. Goldhar said. SmartCentres’ tenant base consists primarily of large, stable retailers such as Loblaw, Sobeys, Metro, Shoppers Drug Mart, Canadian Tire, Lowe’s, Dollarama, Home Depot, McDonald’s and the major banks and wireless companies. The REIT’s biggest tenant by far is Walmart, which accounts for more than 25 per cent of SmartCentres’ rental revenue. Walmart and many other stores have remained open and are seeing a steady flow of customers stocking up on food and other supplies to ride out the crisis.

“Our centres have always been about selling at low prices. That is what people need, especially now or in slower economic times. Therefore some of our tenants are very busy like Walmart and Loblaws. Others are not as busy or temporarily closing. I spoke this week with one small independent retailer whose business is very affected by the virus, and I assured her that we have every intention to stand by her and help her through this, even if it includes some form of rent deferral,” Mr. Goldhar said.

“But, as a percentage, very few tenants have requested rent deferrals, and of those, all are small businesses, which in SmartCentres’ case make up only 3.5 per cent of our space.”

Given SmartCentres’ deeply depressed unit price, Mr. Goldhar, already SmartCentres’ largest shareholder, has been buying more units. “This is one of those moments people will look back on and regret not taking advantage of this significant discount to real value,” he said.

As for SmartCentres’ distribution, which now yields about 11 per cent, “based on current coronavirus predictions, we have the capacity to maintain our distributions. As always, we will decide on that monthly,” he said.​

Analysts agree that the selling has been overdone.

In a note this week, RBC Dominion Securities analyst Pammi Bir said many REITs are now trading at “unprecedented valuations," with an average discount of 29 per cent to the net asset value (NAV) of their properties (based on estimates prior to the coronavirus crisis). That is an even steeper NAV discount than the previous record low of 27 per cent during the financial crisis of 2008, he said.

“Importantly, the sector has historically rebounded from double-digit NAV discounts. As well, lower bond yields have reduced borrowing costs, while liquidity seems readily available,” Mr. Bir said. “Market volatility may very well persist, but on balance, we believe the appetite for real assets will continue to support the sector.”

The take-home message: As cheap as REIT unit prices are now, they could get even cheaper if coronavirus fears continue to roil markets. But, ultimately, life will get back to normal and REIT unit prices will recover – possibly in dramatic fashion – from their current depressed levels.

“This is going to be a shock to the system, that’s quite clear,” Mr. Zakuta said. But after the dust settles, “we’ll be looking back and saying, ‘What just happened? Why didn’t we buy more?’”

(Disclosure: the author owns units of PLZ.UN and SRU.UN)

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