Real estate investment trusts are taking a hit as investors fret about higher interest rates, prompting analysts to weigh in with a variety of investment strategies.
The Canadian REIT structure is about to turn 20 years old, and for much of that time interest rates have provided a tailwind, RBC analyst Neil Downey points out in a research note. "We believe that higher interest rates, when they occur, will be a headwind for the entire listed property sector," he writes.
That could mark a reversal of fortunes for an industry that has been on a tear, and one of the havens for investors seeking yield. The S&P/TSX Capped REIT Index posted a total return of 17 per cent last year and 22 per cent in 2011, compared to the S&P/TSX Composite Index's returns of seven per cent and nine per cent, respectively, according to CIBC.
Ultra-low government of Canada bond yields have been one of the key factors supporting the sector, and interest rates rose 37 basis points in Canada in May. So, as Mr. Downey notes, "May was a tough month for the S&P/TSX Capped REIT Index, which suffered a price decline of slightly more than six per cent. Year-to-date we note that the REIT Index level is now in negative territory, to the tune of 1.5 per cent."
While the level of interest rate increases is important, so is the speed at which they're changing, Mr. Downey adds. "A slow and gradual grind higher in 10-year Government of Canada bond yields can be 'absorbed,' at least to some degree, by the passage of time and earnings growth," he writes. "Sharp upward moves in yield cannot."
Based on a list of criteria that includes financial leverage and asset quality, Mr. Downey says his picks for the companies that offer the most resiliency in the face of higher interest rates are Canadian Real Estate Investment Trust, Brookfield Canada Office Properties, Allied Properties REIT, Morguard Corporation, Boardwalk REIT, Northern Property REIT, CAP REIT, First Capital Realty and Hungtingdon Capital Corp. The ones that he thinks are the most exposed are Partners REIT, Retrocom REIT, NorthWest Healthcare REIT, Pure Industrial REIT, Leisureworld Senior Care Corp., Artis REIT, Extendicare Inc., Regal Lifestyle Communities Inc. and Plazacorp Retail Properties Ltd.
The REIT sector sold off 3.4 per cent in Canada and 5.2 per cent in the U.S. just last week, points out Macquarie analyst Michael Smith, who has cut his forecast for the sector's returns.
"In our 2013 outlook report we suggested that the Canadian REIT sector would see a total return of 10 per cent to 12 per cent for the calendar year but we now think our forecast was too aggressive and have revised our forecast to 7-9 per cent," he writes in a research note.
But he says that's mostly because the better-than-expected outlook for the U.S. economy is making U.S. REITs look better than Canadian REITs. "Real estate operating fundamentals in Canada remain constructive and we recommend investors use the current choppy markets to pick up size in some names that historically have been difficult to acquire without significantly moving the trading price," he writes. "In particular we highlight Boardwalk REIT, Allied Properties REIT and First Capital Realty."
(Tara Perkins is a Globe and Mail real estate reporter.)
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