A dramatic rebound in the valuations of Canadian real estate investment trusts is breathing new life into the sector, after it suffered horribly last year from volatile bond markets.
After a wild multi-year run that saw REIT prices soar, the sector took it on the chin in 2013 amid fears about the Federal Reserve unwinding its massive bond buying program and its expected effect on interest rates. Last year the S&P/TSX Composite Index popped 13 per cent, after accounting for dividends, while the REITs lost 5 per cent on an equivalent basis.
The ugly performance scared many people away from the sector, but those who stuck to their guns and kept their investments have been rewarded. This year the total return for the S&P/TSX Composite Index is 10.6 per cent, while the REITs have outperformed with a 12.1 per cent total return.
It all boils down to interest rates and bond yields. The central banks in Canada and the U.S. have sent strong messages that they are worried about an uneven global recovery and what that could mean for their domestic economies, killing any fears of a surprise rate hike.
In turn, bond yields have plummeted – reversing their stunning run during the summer of 2013. The Government of Canada's 10-year bond yield now sits at 2.06 per cent after soaring to 2.82 per cent in September.
The newfound confidence in Canadian REITs has allowed them to tap the equity markets for fresh funds. On Tuesday, Canadian REIT raised $125-million, following bought deals from companies such as Killam Properties, NorthWest International Healthcare Properties REIT and Milestone Apartments REIT.
In this new world where resources are suffering, REITs look all the more attractive to retail investors. At the end of October, every single REIT property type had put up positive returns in 2014, according to CIBC World Markets analyst Alex Avery. Retirement and long-term care REITs were the best performers, up 22 per cent.
The current market environment not only makes juicy REIT yields attractive to retail investors, but low bond yields also make it easier for the companies themselves to refinance their mortgages.
Canadians have to be careful not to invest blindly, however. "Canadian office property markets stand out as being the property type most likely to see some degree of oversupply, with recent accelerations in development activity," Mr. Avery wrote in a recent note to clients. "Should potential future developments be announced, as is quite possible, we expect office property fundamentals could soften across a number of markets over the next few years, notably Toronto and Calgary."
And interest rates are expected to finally – fingers crossed – rise next year, which will push bond yields higher.
But the sector's rebound this year illustrates just how volatile this market can be. And people who believed in the underlying fundamentals must feel good about themselves.