September 28, 2009 / 11:34 AM / 8 years ago

RPT-BAY STREET-Yields seen supporting Canada REITs after rally

(Repeats Sept. 27 column)

* REITS outperform broader TSX index

* High payouts expected to cement gains

* Best risk/reward seen in high-quality plays

By Ka Yan Ng

TORONTO, Sept 28 (Reuters) - Canadian real estate investment trusts may have limited upside after this year’s stunning rally, but healthy yields should ensure they make a solid investment through a tentative economic recovery.

Like many other sectors, Canadian REITs tumbled in value during the global financial crisis, though not nearly as hard as their U.S. counterparts.

The drop was from concern that their funds from operations -- a key measure that investors use to gauge a trust’s ability to make its monthly distribution -- were in peril from a slumping economy.

But REITs, focused on holding income-producing real estate assets, have also been winners as global stock markets rallied off the multiyear lows of March. Prices jumped as much-feared payout cuts failed to materialize. Experts said this will likely remain the case.

“There’s no real reason for REITs to sell off,” said Dennis Mitchell, portfolio manager of the Sentry Select REIT Fund, a nearly exclusive mix of Canadian REITs, with assets under management of C$194 million as of the end of August.

“Investors who are looking to get into the REIT market right now should bank on getting their distribution. There doesn’t seem to be a case for a lot of downside, so it’s really a question of how much upside they’ll realize.”

HEFTY YIELDS APPEAL

As of Friday, the S&P/TSX REIT index <0#.GSPRTRE> was up about 62 percent from the 2009 low it hit in March, That topped the broader TSX composite index’s gain of about 50 percent over the same time frame.

REITs 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 potential headaches of being a landlord yourself.

Investors are usually attracted to these vehicles because of the regular distributions. REITs pay out most of their income to avoid taxation.

Analysts said even after the sector’s rally, many issues still sport healthy yields, meaning there is little need for investors to move beyond higher quality issues when adding to their portfolio.

“At this point, there is very little value to be stretching out and taking some of the ones with higher risk. You’re still getting 5 to 7 or 8 percent yields in a lot of the better REITS in Canada, at a time when things are uncertain,” said Charles Dillingham, a portfolio manager at Morguard Financial.

“There’s enough opportunity and risk even in the best quality in this environment. Stay with the best stuff.”

Among some of the names Dillingham and others favor are Canadian Real Estate Investment Trust REF_u.TO, retail-focused RioCan REI_u.TO, and apartment landlord Boardwalk BEI_u.TO, because they are seen as high-quality, well-managed trusts.

Canadian and Boardwalk each yield about 5 percent, while RioCan yields more that 7 percent. By comparison, a 30-year Canadian government bond CA30YT=RR yields less than 4 percent.

HUNGRY FOR YIELD

For yield-hungry investors, including a growing number of baby boomers approaching retirement, the REIT sector looks unlikely to face much competition from the bond market any time soon.

The Bank of Canada has conditionally pledged to keep interest rates near zero until the middle of next year. And the central bank predicts inflation, which could send bond yields higher, will not return to its 2 percent target until 2011.

Longer term, REITS may find favor as the last game in the market offering this kind of income stream compared with other vehicles such as income trusts -- which, due to government rules on tax issues, will likely see many convert back to corporations by 2011.

“There’s no shortage of REITs. As income trusts in general disappear, REITs will remain,” said Bob Gorman, chief portfolio strategist at TD Waterhouse.

“They may benefit from a bit of a scarcity premium in that you won’t have these other sorts of securities that have the same kinds of yields. You may have them gaining additional interest from investors.”

But, ultimately, the value of a REIT is reliant on its ability to keep generating income. Analysts say Canadian REITs may be a better bet than their U.S. counterparts in this regard. Canada’s downturn has not been nearly as severe, in part due to the sound nature of its banking system.

“To the extent that investors are looking for some stable income as part of their portfolio, there seems to be good interest in Canada as a place to be,” said Simon Nyilassy, chief executive of Calloway REIT CWT_u.TO, which holds 22 million square feet of retail space across Canada.

$1=$1.09 Canadian Reporting by Ka Yan Ng; Editing by Jeffrey Hodgson and Rob Wilson

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