The good and bad of Canadian REITs: A Raymond James Study

A comparative study of the Canadian and U.S. real estate markets finds that the goldilocks real estate environment north of the border will continue for the foreseeable future.

The 400-page study of 16 Canadian REITs and REOCs came out of a cross-country real estate tour by Raymond James’ Florida-based real estate analyst Ken Avalos. He got as far north as the oilsands boomtown of Fort McMurray, Alta., and checked out commercial properties in most major cities across Canada. He came away impressed with its potential.

“I came out with the conclusion that the sector, by that I mean the Canadian publicly traded REITs and REOCs, is let’s call it 10 or 12 years behind the U.S. with a nice long runway of growth and a nice long runway to improve the overall credibility of the sector,” said Avalos.

Canadian Differences Will Change Over Time

Avalos, who covers Canadian real estate for U.S. and overseas investors, sees four major differences between the two real estate markets which he expects to disappear over time.

Capital structure – Generally companies in Canada use more leverage and their balance sheets are not as flexible — they don`t hold a lot of unsecured debt or unencumbered pools of assets. “There is a financial cost to that, but from my perspective, it is worth it,” said the analyst. “In the United States we have lived three cycles in the last 15 years, in Canada you have been pretty blessed with 15 or 20 years with the capital markets in pretty good shape.”

Retail ownership – REITs and REOCs are about 70% owned in Canada by retail investors, whereas in the U.S., that number is reversed, with more than two-thirds of most companies owned by institutions.

That gives Canadian management more latitude typically than their U.S. counter parts. “Retail (investors) are not quite as demanding,” said the analyst. “The fact of the matter is they are just more concerned with the yield, safety and they are not as sensitive as institutional investors to such things as capital structure and flexibility.”

Avalos also believes Canada's REITs and REOCs need to get better prepared to weather some eventual tough economic times down the road. “The capital markets in real estate are still a cyclical business, so I would like to see companies that live on the leading edge preparing for eventual downturns.”

Governance – “This is also a function of retail ownership versus institutional ownership. You still have a lot of companies in Canada with externally managed structures with potential for conflicts of interest, related party transactions.” Those incestuous relationships “are going the way of the dinosaur” as companies expand internationally and attract more foreign investment.

Management scope and skill set – “RioCan is the only fully integrated real estate company in Canada. They are big and they can do everything” that a real estate company might need to do, explained the analyst. Another group, led by H&R REIT, First Capital and Primaris, are not far behind. “And the rest of them, are just smaller companies, they haven’t been through as many cycles, they haven’t acquired the personnel, the talent on the bench to really bring different growth avenues at different points of the real estate cycle.” At certain times, companies are better off acquiring, in other times in the cycle redeveloping and in others developing from scratch.
Portfolio quality – “Most of the type A, institutional-quality product across the major property types, in Canada they are held either by pension funds or private partnerships or families. In the States there has been a lot more churn and pension funds aren’t holding all the assets.” That will change, he predicts. “Over time, demographics will simply force pension funds to look for more yield.” The recent hostile bid for Primaris Retail REIT by KingSett Capital and RioCan, which is backed by the Ontario Pension Board, is part of that trend, he said. “They are looking for more growth, more yield, because they know the (pension fund) outflows start to hockey stick up and the inflows start to hockey flow down.”

His advice for his mostly foreign investors is to invest wisely in the sector and be prepared to pull out when the party inevitably stops. “I know these stocks are going to work in this environment, but what I tell investors is that every day they go up, the risk of a more violent correction increases because we are getting more and more detached from fundamentals.”

Ann launched RENX in 2001 as a part-time venture and has grown the publication to become a primary source of online news for the Canadian real estate industry. Prior to…

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Ann launched RENX in 2001 as a part-time venture and has grown the publication to become a primary source of online news for the Canadian real estate industry. Prior to…

Read more

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