REIT returns to remain attractive, fuelled by low rates and solid fundamentals

TORONTO, April 10, 2013 /CNW/ - Canada's commercial real estate sector and REIT investment market appear set to outperform for a fifth-straight year, according to CIBC World Markets Inc.

"All of the fundamentals seem to be supporting [the] continuation of [an] extended recovery" from the market lows of 2008, says Allan Kimberley, Vice-Chairman, Real Estate Investment Banking at CIBC.

In a series of notes released today at the bank's 18^th annual real estate conference in Toronto, CIBC says low interest rates, the continued availability of equity and debt, and healthy supply-demand fundamentals have set up Canada's real estate capital markets for another strong year. These conditions are relatively unchanged from 2012 which saw "record levels of new issuance, total returns exceeding those of the broader S&P/TSX Composite index, a growing list of IPO and M&A activity, against a backdrop of declining volatility," says Mr. Kimberley.

Alex Avery, a CIBC Equity Analyst who covers the commercial real estate sector, also sees favourable property and REIT market conditions continuing in 2013, with one caveat.  "While current real estate and REIT investment market conditions remain highly attractive in many respects, property and REIT pricing have risen largely to reflect the favourable current environment.  We expect attractive returns from Canadian REITs in 2013, but more modest than seen in recent years."

Mr. Avery says returns from REITs in 2013 will be driven by attractive distribution yields and modest further appreciation in unit prices. Over the next 12-18 months he's forecasting returns to "average 5-10 per cent, comprising close to 6 per cent in average yield and 0-5 per cent in capital appreciation."  REITs most likely to outperform will be ones that deliver the highest funds from operations (FFO) growth, he says.

"With more than a dozen new REIT formations during 2012, and the potential for as many in 2013, the Canadian REIT universe is expanding rapidly to offer investors numerous new alternatives," he adds.  "We believe these new entrants offer the greatest opportunity for investors to outperform the broader REIT group, with smaller, growth-oriented REITs offering significantly higher FFO growth potential than the larger capitalization, more established REITs. However, these new entrants also tend to lack liquidity and a public track record of financial results and/or of management ability to execute strategy."

Two factors that can spoil attractive property fundamentals - the cost and availability of debt and supply of new developments - remain muted and will likely remain so this year, according to Mr. Avery.

"Wide spreads and forecasts for higher, but still low benchmark interest rates suggest favourable borrowing conditions could continue. Committed and proposed development activity currently remains measured in the context of the overall inventory of investment property in Canada, notwithstanding development proposals having picked up sharply in recent months."

In a separate note, Avery Shenfeld, Chief Economist at CIBC, says the real estate market will be supported by "national vacancy rates for both office and industrial space [which] are likely to remain well-contained" while "retail properties will continue to benefit from new entrants from the U.S."

Meanwhile, the combination of historically low interest rates, accessible credit markets, a high-yield market that continues to expand and healthy corporate fundamentals should support M&A activity. "We expect M&A activity could continue in 2013, with privatizations among the higher-quality and larger capitalization REITs, and mergers between smaller capitalization REITs," says Mr. Avery.

In 2012, real estate was the third most active sector in Canadian M&A, behind oil and gas, and diversifieds.

The notes by Mr. Avery, Mr. Kimberley, Mr. Shenfeld are available at:
http://files.newswire.ca/256/2012REYIR.pdf

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SOURCE: CIBC