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Jun 26, 2014

Bargain REITs

by Richard Morrison

Richard Morrison

If you own a house or a condominium, you already have a big stake in your local residential real estate market.

You probably don’t own a collection of shopping plazas, malls, office buildings or factories, however, and the fortunes of these parts of the real estate segment often move in a different direction than local house prices. That’s why income-seeking investors should always have some real estate investment trusts (REITs) as part of a well-diversified portfolio.

REITs can also provide capital gains. “In addition to providing a stable yield, a good REIT creates value,” said Michael Emory, president and CEO of Allied Properties REIT (AP.UN/TSX) in the company’s 2013 letter to shareholders. “Indeed, a good REIT is a growth engine.”

Not that REITs don’t fall in value. Like the prices of bonds and utility shares, the unit prices of REITs drop at the slightest hint of rising interest rates. For example, all Canadian REITs fell last summer after the U.S. Federal Reserve Board said it would begin tapering back on its “quantitative easing” policy. The only large Canadian REIT to have recovered from last year’s sell-off is Allied, and even then it is only a couple of percentage points ahead.

At the other end of the spectrum, Dream Office REIT, which changed its name from Dundee REIT (D.UN/TSX) on May 12, is down more than 20% over the past year, while Cominar REIT (CUF.UN) is down about 18%. The rest are off by a few percentage points.

We looked at some of the most well-known Canadian REIT names and found that based on price to funds from operations (FFO) Dream Office and Cominar look to have fallen into bargain territory. In the REIT sector, FFO is a better measure of performance than earnings, since the latter includes non-cash items like depreciation.

Allied Properties Real Estate Investment Trust (AP.UN) is best known for its Class I heritage office properties that cater to tenants who favour brick, wood and wrought iron over concrete, steel and plastic. Allied owns and manages properties in downtown Quebec, Montreal, Ottawa, Toronto, Kitchener, Winnipeg, Calgary, Edmonton, Vancouver and Victoria.

Last year, Allied’s FFO grew by 8%, which meant its distributions represented just 70% of FFO, while its adjusted FFO climbed 16%, putting distributions at 82% of AFFO. That allowed the company to raise its annual distribution by 4%. Allied made $182-million in acquisitions and took other steps to prepare its FFO for growth, its annual report says. At a recent close of $25.27, Allied trades at a lofty 18.18 times FFO per unit. Allied’s distribution of $1.41 per unit works out to a yield of 5.6%.

Artis Real Estate Investment Trust (AX.UN) has about half of its properties in the office sector, with the remaining 50% split roughly evenly between industrial and retail. Artis has about 23.4 million square feet of leasable area in 220 properties. (Leasable area by asset class is approximately 18.3% retail, 32.1% office and 49.6% industrial.)The portfolio is located 7.9% in British Columbia, 25.7% in Alberta, 5.1% in Saskatchewan, 15.4% in Manitoba, 16.0% in Ontario and 29.9% in the United States. Artis improved its balance sheet last year, and qualified for an investment grade rating from DBRS (only BBB low, admittedly). The company’s FFO climbed by 12.3% to $1.46 per unit, while adjusted FFO rose 9.6% to $1.26 per unit. At $16.25, Artis’ unit price is a reasonable 11.13 times FFO, while the distribution yields a generous 6.8%.

Calloway Real Estate Investment Trust (CWT.UN) focuses almost entirely on the retail segment, particularly on Wal-Mart stores. Wal-Mart anchors 96 of Calloway’s 123 shopping centres and its presence helps consumer traffic, which in turns attracts more tenants—to the point where Calloway’s shopping centres boast a 99% occupancy rate. Calloway has a partnership with SmartCentres, identified by the penguin family signs and statues you may have seen in mall parking lots. Last year, Calloway increased its FFO to $1.82 per unit. At a unit price of $26.89, that works out to 14.77 times FFO, a little on the expensive side. The presence of Wal-Mart as a major tenant, however, reduces risk. The annual distribution of $1.55 yields 5.76%.

Canadian Real Estate Investment Trust (REF.UN) is well suited to those seeking geographic and sector diversification as it has about 24 million square feet of retail, industrial and office properties spread out across Canada and in Chicago, Ill. Most of its properties are in Alberta and Ontario. The company’s retail outlets were 97.1% occupied last year; industrial space was 95.1% occupied and office space was 92.0% occupied, for an average occupancy rate of 95.5%. Canadian REIT generated $2.84 in FFO per share or $2.44 in adjusted FFO in 2013. At a recent close of $45.87, that works out to a price to FFO multiple of 16.15 times. The $1.59 annual distribution yields 3.84%.

Cominar Real Estate Investment Trust (CUF.UN) has about 384 office, retail, industrial and mixed-use properties, most in Quebec, with 17 in Ontario, 57 in the Atlantic provinces and 12 in western Canada. The portfolio consists of approximately 10.2 million square feet of office space, 7.8 million square feet of retail space, 12.7 million square feet of industrial and mixed-use space and 485 units located in multi-residential buildings for a total leasable area of about 30.7 million square feet.  Last year, Cominar reported $1.77 in FFO per share and $1.54 in adjusted FFO per unit. The unit price has fallen over the past year and now trades at just $19.37, which works out to 10.94 times FFO per share. The relatively low unit price means the annual distribution of $1.44 yields a generous 7.5%, second only to Dundee.

Crombie Real Estate Investment Trust (CRR.UN) has about 170 office and retail properties throughout Atlantic Canada, Quebec, Ontario, Saskatchewan and Alberta, most anchored by grocery and drug stores. Last year, Crombie acquired several retail properties, many anchored by Shoppers Drug Mart. The acquisition of 70 Safeway properties in Alberta, B.C., Manitoba and Saskatchewan added 3.1 million square feet of leasable area.

Crombie’s funds from operations worked out to $1.10 per share, while adjusted FFO came in at $0.94 per share.  At a recent close of $14.44, that works out to 12.34 times FFO per unit. The annual dividend of $0.89 per share yields 6.6%.

Dream Office Real Estate Investment Trust (formerly Dundee) (D.UN) has about 185 properties totaling approximately 28.0 million square feet, of whichmits interest is approximately 24.5 million square feet. Its office buildings are located in Toronto, Calgary, Edmonton, Montreal, Kitchener-Waterloo, Ottawa, Vancouver, Regina, Saskatoon, Quebec City, Yellowknife and Halifax.  Major tenants are the governments of Canada, Ontario, Quebec and Saskatchewan, the Bank of Nova Scotia, Bell Canada, Enbridge and Telus. Last year, Dundee increased its funds from operations and reduced its debt, but its occupancy rate slipped to 94.3% from just over 95%.  Dream Office/Dundee’s units have fallen more than 20% over the past year, more than any other Canadian REIT. As a result, Dream Office/Dundee’s depressed unit price of $29.22 works out to just 10.15 times FFO per unit. The REIT also comes in as least expensive based on earnings, book value and sales per share, with a P/E ratio of just 7.17, a price of just 80% of book value and price/sales per share of just 4.36 times. The low price also means the annual distribution of $2.23 produces a high yield of 7.76%.

H&R REIT (HR.UN) has a mix of office, retail and industrial properties with a fair market value of about $13-billion. At the end of last year, H&R had 42 office buildings, 112 industrial facilities and 167 retail properties.  Of its 204 Canadian properties, 110 are in Ontario, 44 in Alberta, 19 in Quebec and 31 in other provinces.  

H&R also owns about a third of ECHO Realty LP which owns 173 properties totalling 7.3 million square feet. Last year H&R bought Primaris, which owns 26 properties valued at $3.2-billion.  

H&R’s three largest tenants are EnCana Corp. (10.6% of rentals), Bell Canada (7.5%) and Hess Corp. (3.7%).  Other major customers include TransCanada Pipelines, Telus Corp., Canadian Tire Corp., Rona Inc., the Bank of Nova Scotia and the Royal Bank. In 2013, H&R’s funds from operations rose to $472.8 million from $329.0 million the year before. H&R increased its distribution by 14% last year to an annual rate of $1.35 per unit, which works out to a yield of 5.8%.

RioCan REIT (REI.UN) is the largest Canadian REIT with a market capitalization of $7.9 billion. RioCan owns and manages 340 retail properties across Canada, the northeast United States and Texas, with rental revenue collected from a broad selection of major retailers (no one customer accounts for more than 3.7% of revenue).  About 72% of RioCan’s annualized rental revenue comes from properties in six markets: Toronto, Montreal, Ottawa, Calgary, Edmonton and Vancouver. RioCan’s operating FFO increased to $492 million for the year ended Dec. 31, 2013, up 12% from the $440 million it logged in 2012. Operating FFO per unit climbed to $1.63, up 7% from the $1.52 per share reported in 2012.  Over the past year, the Canadian real estate sector is up by about 3% while RioCan’s units are down by about 4%. RioCan itself recognized the dip as a buying opportunity, and bought back 917,700 of its units last year at an average price of about $24. RioCan’s annual payout of $1.41 yields 5.18%.

For those who don’t want to buy individual REITs, three exchange-traded funds give investors instant exposure to a portfolio of REITs. BMO Equal Weight REITS Index ETF (ZRE/TSX) yields 4.51% but has a management expense ratio (MER) of 0.62%; the iShares S&P/ TSX Capped REIT Index (XRE/TSX) yields 4.36% with an MER of 0.55%; and the Vanguard Canadian Capped REIT index (VRE/TSX) yields just 2.14% with an MER of 0.4%.

If you were to buy equal weights of each of the nine REITs mentioned here, however, you would have an average yield of 5.87%, less your one-time commission charges.

Richard Morrison, CIM, is a former editor and investment

columnist at the Financial Post