TORONTO (Reuters) - Soaring demand for Canadian real estate investment trusts has driven sales of new equity to pre-crisis levels, boosting bankers’ paychecks but stirring fears the popular products may be vulnerable to a downturn.
A combination of ultra-low interest rates and yield-hungry baby boomers seeking a haven for retirement savings has fueled the surge, with REITs raising more than C$2 billion ($2 billion) year-to-date in secondary offerings.
“What’s driving them?” said Karine MacIndoe, a real estate analyst with Bank of Montreal. “An unbelievable hunger for yield ... what they can get on comparable Canada bonds, corporate bonds, other yield options, has made REITs look pretty attractive.”
Bonds yields tumbled after the financial crisis as the central bank slashed rates to a record low in a bid to revive the economy. The Bank of Canada has since nudged its key rate up to 1 percent, but is expected to keep it there well into 2011. <CA/POLL>
As result, Canada’s benchmark 10-year bond now yields just 2.85 percent. By comparison Calloway Real Estate Investment Trust CWT_u.TO, which specializes in renting out retail and mall space, yields 6.3 percent.
REITs are taking advantage of investor appetite to raise capital for acquisitions that can be easily financed in a low interest rate environment, another factor in the near perfect storm for trusts.
In October alone six secondary offerings by REITs, ranging in size from C$23 million to C$130 million, raised some C$500 million.
REITs have also raised more than C$800 million in initial public offerings this year, and still more in debentures, according to Bank of Montreal.
“Investor appetite for REIT secondary offerings has been very robust,” said Roman Dubczak, head of equity capital markets at CIBC World Markets. The unit of Canadian Imperial Bank of Commerce (CM.TO) was the third most active bookrunner in Canadian secondary offerings to September 30.
He said investor appetite for REITs should remain strong as long as low interest rates prevail.
Recent issuers include Chartwell Seniors Housing Real Estate Investment Trust CSH_u.TO, one of the largest participants in the North American seniors housing business, which said it raised C$130 million in an offering on October 29.
Earlier in the month Calloway closed a C$115 million financing in which underwriters fully took up a 15 percent over-allotment option.
Proceeds from the offerings go mostly to fund further property acquisitions and to repay indebtedness.
“With interest rates this low and credit spreads that have tightened, the cost of debt is so low that it’s pretty accretive to acquire property,” said Mark Rothschild, who covers real estate at Canaccord Genuity in Toronto.
“If you can grow your cashflow per unit you can grow your distributions and that’s really what they’re trying to do, grow distributions.”
But Rothschild said with interest rates as low as they are, demand for REITs is probably at a peak.
REITs are popular because they offer investors a way to participate in real estate, including the potential rise in property values, with the added benefit of liquidity from the equity market and without the headaches of being a landlord yourself.
The resurgence this year has also been fueled by the Canadian government’s decision to gradually remove the favored tax-status of competing business trusts.
Analysts dare not say the word “bubble,” but they will whisper it as they compare the REIT market today with 2007, the last year of robust secondary offerings. That year trusts raised C$1.9 billion. Secondary offerings were C$480 million in 2008.
In particular, market observers worry the trusts would be highly susceptible to a fresh economic downturn that would hurt revenue from the rental properties they own.
Some worry that less savvy investors may think that owning REITs means they own the real estate.
“They may not realize that the banks own them first, through the mortgages, then unsecured debenture holders hold them, and then convertible debenture holders own them,” said Tim Logan, a portfolio manager with Cockfield Porretti Cunningham in Toronto.
Editing by Jeffrey Hodgson and Rob Wilson