Canadian Capitalist » REITs

Canadian REITs: No Longer a Bargain

Canadian Capitalist — Mon, 18 Jan 2010 05:20:56 +0000

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.

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Claymore Global Real Estate ETF (CGR)

Canadian Capitalist — Thu, 28 Aug 2008 05:22:32 +0000

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.

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To REIT, or not to REIT

Canadian Capitalist — Tue, 05 Aug 2008 01:47:08 +0000

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.

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Unbundling the iShares CDN REIT Index Fund (XRE)

Canadian Capitalist — Wed, 25 Jun 2008 00:47:21 +0000

Norm Rothery (also featured in this video interview with Jon Chevreau) recently wrote that the ultra-low commissions offered by the discount brokers allow investors with large portfolios to buy the stocks that comprise an index directly and avoid the fees involved in holding ETFs. The concept is interesting but small investors who want to faithfully track an index need a very large portfolio to save money on ETF fees. The simple formula to figure out if it is worth unbundling an ETF is:

Amount at which unbundling an ETF becomes worthwhile = (Number of stocks in the index * Trading commission ) / MER of ETF

XIU, for instance, has 60 stocks, charges a MER of 0.17% and an investor paying $5 at Questrade needs a portfolio in Canadian equities of $175,000 to invest in the underlying stocks directly, assuming he adds money once every year to the portfolio and rebalances at that time. As you can infer from the formula, unbundling becomes practical when the number of stocks in the index is small and the MER is large.

There is one holding in the Sleepy Portfolio that perfectly fits the bill: the iShares CDN REIT Index Fund (XRE). The REIT ETF holds just 12 securities but charges a steep MER of 0.55%. An investor paying trading commissions of $10 only needs to accumulate $20,000 in REITs before he starts to save money by unbundling.

It gets even better — if you are willing to put up with a bit of tracking error, you can hold just three REITs and track slightly more than half the index by putting 50% in RioCan REIT (REI.UN), 30% in H&R REIT (HR.UN) and 20% in Canadian REIT (REF.UN). As REITs are typically a small portion of an investor’s portfolio, the tracking error may not be a huge concern.

Personal Disclosure: We use RioCan REIT as a proxy for the Canadian REIT sector in our personal portfolios.

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Time to buy REITs?

Canadian Capitalist — Thu, 10 Jan 2008 01:36:00 +0000

Not too long ago, investors couldn’t get enough of Real Estate Investment Trusts (REITs) bidding up the asset class so much that the asset class didn’t yield much of a premium over 10-year Canada bonds. How things have changed! Today, XRE (iShares CDN REIT Sector Index Fund) yields 6.8% compared to 3.85% for the 10-year Govt. of Canada bond and has fallen close to 10% since New Year’s Day. Significantly, many REITs are currently trading at significant discount to analyst estimates of NAV. For instance, RioCan (TSX: REI.UN), the biggest REIT in Canada, which makes up close to one-quarter of the index trades at a 18% discount to TD Newcrest’s estimate of NAV. It is always possible that REITs could trade even lower but this may be a good time to tip your toes in the sector.

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Fair Value of REITs

Canadian Capitalist — Wed, 14 Nov 2007 06:53:27 +0000

In an earlier post on REITs, I quoted from David Swenson’s book that the price of publicly traded REITs fluctuates between a premium to a discount to fair value. Obviously, investors would like to invest in or add to their positions in REITs when they trade at a discount to fair value.

To compute the fair value of a REIT, you would need to add up the value of the land and buildings that it owns and subtract its debt obligations, which isn’t an easy exercise. However, if you have access to TD Waterhouse, search for the TDSI Morning Action Notes for the REIT you are interested in. The analyst reports helpfully include a NAVPU (Net Asset Value Per Unit), which you can use as an approximation for fair value. For instance, the report on RioCan REIT estimates the NAV at $23.10, suggesting that RioCan is currently trading at a modest discount. At its current price, RioCan (REI.UN) is yielding 6.25% representing a 2% spread relative to current 10-year bonds. Since I did not have any exposure to REITs, I picked up some units last week but still far from my 5% target allocation.

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REITs: Risks and Returns

Canadian Capitalist — Wed, 25 Jul 2007 23:29:39 +0000

In response to an earlier post on iShares CDN REIT Sector Index Fund (XRE), some readers were interested in the historical risk and return characteristics of REITs. David Swensen writes in Unconventional Success that real estate is riskier and more rewarding than bonds and has less risk and lower returns than equities:

Shorter-term data on market returns confirm the notion that real estate sits between stocks and bonds in risk and return characteristics. Returns covering the quarter century from 1978 to 2003 for an index of marketable real estate securities stand at 12.0 percent per annum, poised between the 13.5 percent per annum return for the S&P 500 and the 8.7 percent per annum return for intermediate-term U.S. Treasury bonds.

Publicly traded REITs have an interesting attribute: they trade at prices that are sometimes significantly different from fair value:

At one point in 1990, by Green Street’s estimate, real estate securities traded at more than a 36 percent discount to fair value. By 1993, the stock market reversed itself, valuing real-estate-related holdings at a 28 percent premium to fair value. The yin and yang continued. In late 1994, the discount reached nine percent, while in 1997, stock market investors paid more than a 33 percent premium to fair value. In the late 1990s, a poor market for real estate securities (that coincided with a wonderful market for most other securities) brought valuations to a deficit of more than 20 percent, a level reached in early 2000. As the non-real estate portion of the market entered bear territory, real estate securities took on bull characteristics, leading to a greater than 22 percent premium to fair value in early 2004.

Though the data used in the book is based on U.S. based REITs, there is no reason to think that the market is very different in Canada. It would be interesting to find out fair value data for Canadian REITs to initiate or add to REIT positions when they are trading at a discount to fair value. Do you know where we can obtain such data?

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A Tour of ETFs: iShares CDN REIT Sector Index Fund

Canadian Capitalist — Wed, 11 Jul 2007 11:52:52 +0000

A Real Estate Investment Trust or REIT is an asset class that allows you to get exposure to real estate in your portfolio. Real estate is an interesting asset class because historically it has offered a higher return than bonds (but less than equities) albeit at a higher risk (again less risk than equities). Also, real estate has low correlation with other asset classes and adding it to your portfolio will reduce overall volatility. An allocation of 5%-10% to REITs seems reasonable but some recommend going as high as 20%.

The iShares CDN REIT Index Fund (TSX: XRE) is composed of REITs that are listed on the TSX. The MER on the fund at 0.55% is on the high side and might be acceptable for smaller investments. However, if you have a large portfolio you may want to invest in the underlying REITs directly because the two largest REITs – RioCan (REI.UN) and H&R (HR.UN) – make up 36% of the fund.

PS: I noticed that Million Dollar Journey has published a primer on REITs, which you may want to check out as well.

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The Role of REITs in a Portfolio

Canadian Capitalist — Thu, 22 Dec 2005 03:32:43 +0000

I received the following query by email and I thought I would expand my reply into a post:

Quick question on your asset allocation. Most of it makes sense – Bonds, US/Canadian/International Equities. But why the REIT as a major asset class?

Real estate tends to have a low correlation with other asset classes, so its inclusion reduces the overall volatility of a portfolio. Also, Burton Malkiel notes in The Random Walk Down Wall Street that REITs have produced comparable rates of return to common stocks over the 25-year period from the 1970s through the mid-1990s. REITs also tend to provide an attractive yield (that at least keeps pace with inflation) and are highly liquid. REITs are also well-diversified asset class and own shopping malls, apartments, hotels, retirement residences, office buildings etc. Note that the passive investment portfolio recommended by David Swensen has a 20% weighting in REITs.

However, I do think that REITs are currently overvalued. The iUnits S&P TSX Capped REIT Index Fund (XRE) is currently yielding 5.63% compared to the 4.5% yield of the 10-year bond. The spread is well below historical averages.

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