Canadian REITs: No Longer a Bargain

January 18, 2010


As I noted in an earlier post (See Asset Class Returns for 2009), Canadian REITs were red-hot last year, posting a total return of 55.3%. While REITs are still roughly 25% off their all-time highs, several valuation metrics suggest that they may not be big bargains any more.

Take the distribution yield, for instance. The cash yield on the iShares CDN REIT Sector ETF (TSX: XRE) is approximately 5.45%, a spread of less than 2% over the 10-year Government of Canada bond, which is currently yielding 3.55%. Historically, the REITs have yielded as low as 0.73% over bonds and as high as 10%, suggesting that current yields are at the low end of the range.

Many REITs are also trading at a premium to analyst estimate of net asset value (NAV). RioCan (TSX: REI.UN), the largest REIT in Canada, for instance, is trading at $19.90 but TD Securities analysts estimate the NAV per unit to be just $16.30. RioCan’s current 22% premium to NAV is also in the higher end of its historical range suggesting that Canadian REITs may not be screaming bargains any more.

Claymore Global Real Estate ETF (CGR)

August 28, 2008


Claymore Canada has introduced a couple of ETFs that track interesting asset classes: Claymore Global Real Estate ETF (CGR) and Claymore Global Infrastructure ETF (CIF). CGR tracks the Cohen & Steers Global Realty Majors index, which is composed of 75 securities representing the US (40%), UK (10%), Japan (13%), Hong Kong (10.5%), Australia (11%) and minor weighting to other countries. The MER for the ETF is 0.65% and yields 4.4%. The major alternatives, all of which trade on the US exchanges, are: Cohen & Steers Global Realty Majors ETF (GRI, tracks the same index as CGR and has a MER of 0.55%, First Trust FTSE EPRA/NAREIT Global Real Estate Index Fund (FFR, MER of 0.60%) and SPDR DJ Wilshire International Real Estate ETF (RWX, MER 0.60%).

While CGR is much more diversified than the iShares CDN REIT ETF (XRE) and has a decent yield, I wonder if it is appropriate to add foreign real estate to a portfolio, considering that most investors’ allocation to REITs is already small, say 5% to 10%. In any case, there is reason to adopt a wait-and-watch stance because according to the prospectus, the ETF will track the underlying index’s returns through derivatives and incur expenses in addition to the MER. Moreover it is not clear if a market for CGR can be sustained because global real estate is cooling (down 20% over one year) after extremely good returns over a five year period.

To REIT, or not to REIT

August 4, 2008


Real Estate Investment Trusts (REITs, pronounced “reets”), which invest in and manage commercial real estate such as office buildings, shopping malls and apartment buildings and distribute most of their income to shareholders, have risk-return characteristics different than those of stocks and bonds and thus provide valuable diversification benefits in a portfolio. But, there is a variety of opinion on how much REITs (if at all) should be added to a portfolio.

In his book, Unconventional Success, David Swensen makes a strong case for adding REITs to a portfolio. Noting that REITs have characteristics of both fixed-income (due to the regular rents paid by the tenant as per the lease agreement) and equities (due to the renewal risk as leases approach expiry), Mr. Swensen suggests a 20% allocation to real estate in his generic portfolio that has 70% in equities (including real estate) and 30% in fixed income.

The Intelligent Portfolio (review), on the other hand, advises caution on REITs. The author, Christopher Jones, points out that stock owners already have exposure to real estate as large public corporations own most of the commercial real estate in the U.S. Given the short history of REITs, he is not convinced that they provide “meaningful” diversification and points out that home owners already have enough real estate in their household assets. In Canada, REITs are included in the TSX Composite Index and corporations such as Brookfield Asset Management (TSX: BAM.A, NYSE: BAM) are heavily invested in real estate. Due to his misgivings, Mr. Jones suggests that investors allocate no more than 10% of their total assets to REITs.

Due to the conflicting messages, I wondered what William Bernstein had to say about REITs. Here’s what he writes in The Four Pillars of Investing (review): “But with some trepidation, I think that there are two sectors worth considering: REITs (real estate income trusts) and precious metal stocks” and concludes that “the maximum exposure you should allow for this asset class is 15% of your stock component”.

In my personal portfolios (and my benchmark Sleepy Portfolio), I have allocated 5% of the total value to REITs but don’t have a good rationale for that specific number (other than it is the minimum allocation to any asset class in the portfolio). Canadian investors can get exposure to REITs through the iShares CDN REIT ETF (TSX: XRE). The XRE is also a prime candidate for unbundling the ETF and directly investing in the underlying securities as the MER for the ETF is a bit on the higher side.

If you are sold on the merits of adding REITs to your portfolio, now may not be a bad time to do so. After providing double-digit returns for many years, REITs are now well off the previous highs and trade at an estimated 15% discount to net asset value (Source: TD Securities) and yielding an average of 7%, a spread of 2.75% over 10-year bonds.