Canada's REITs stand out as global bargain

Canadian real estate investment trusts are bargains compared to other property vehicles around the world, according to a new study by CB Richard Ellis.

In its first-quarter market perspectives and outlook report, the firm suggests being overweight on the REIT sector in Canada.

"One of the cheapest markets across the globe," said CB Richard Ellis in its nine-page report. "[The Canadian market has] high-yielding stocks with reasonable growth expectations and recent legislation and index inclusions announcements [should] influence capital flows."

Most of the publicly traded real estate "stocks" in Canada trade are REITs. The study points out the average yield of the sector is about 8%.

The index to which CB Richard Ellis refers in the report is the overall TSX/S&P composite. S&P has opted to include income trusts in index.

Trusts are expected to be added to the index at some point this year and a number of REITs are likely to make the cut.

The inclusions comes after government legislation made unitholders exempt from the liability of the trusts they own, thereby making REITs equivalent to corporations -- the structure used by most TSX companies.

The high praise for Canadian REITs comes after a stellar May. The CIBC World Markets total return index was up 4.9% last month. The total return for the first five months of the year was 8.2%.

Overall, global real estate securities were down 4% in the first quarter of 2005. The U.S. REIT market is the main culprit behind the decline.

"Global property stocks have outperformed global equities and bonds over the past decade," says CB Richard Ellis. "We suspect that the most recent correction is a healthy short-term event rather than the onset of a sustained long-term trend."

The firm adds that the proliferation of REIT legislation globally is leading to more initial public offerings and the emergence of REITs as an asset class.
Back home, CB Richard Ellis calls for an office market recovery and expects Canadian markets to improve faster than their counterparts in the United States.
"In Canada, vacancy rates are expected to drop more meaningfully than in the U.S. but rent growth is expected to be flat."

In terms of REITs, the key seems to be that they are trading at a high relative spread to current bond yields, a major competitor to income products.

"The market offers good value in Canada," according to the report, noting the spread between average REIT yields and bond yields is 300 basis points.

Shant Poladian, an analyst with Canaccord Capital Corp., believes Canadian REITs do have upside. "The conclusion is almost always that Canadian REITS should trade at a discount to U.S. REITs, due to smaller size, lower liquidity, higher payout ratios and higher cap rates in the Canadian market."