Extended Coverage

The Canadian REIT sector has turned the page on 2013’s under performance, when then U.S. Federal Reserve chair Ben Bernanke floated the prospect of tapering the quantitative easing bond buying program, a move that underscored the profound relationship between interest rates and the REIT sector as investors braced for a long-term rate hike.

REITs have delivered a 10 percent total return year-to-date in 2014, with prices within three percent of all-time high territory. Still, Alex Avery, executive director at CIBC World Markets, warns against getting too cozy with interest rate exposed names.

“We are recommending for investors in this market to target REITs that have low interest sensitivity. Look for REITs that specifically engaging in strategies that create value [through] a little bit more active, hands-on, rolling up your sleeves type of real estate work,” said Avery in an interview with BNN.

REITs relying on supercharged cash-flow growth and debt roll-over bolstered by declining interest rates are to be avoided.

Avery recommends REITs strongly positioned in office and industrial properties in the booming Toronto and Calgary markets. Office vacancy rates in Toronto and Calgary sit at six and eight percent respectively.

“We’ve seen pretty significant pick up in the amount of construction activity in offices across the country, most acutely Toronto and Calgary, and that has the do with the fact that there has been a very long period of very solid fundamentals,” said Avery, who points to the constrained nature of Canada’s urban areas to justify their inherent value.

“They’re essentially islands to put it simply. That has created a very tight supply dynamic,” he said.

Investors should consider their tax brackets in order to maximize tax efficiency on their distributions. The return of capital portion of distribution is tax free when received, but there are implications when you sell. Not all REITs are created equal, even when their distribution yield is the same.

“A good example would be Canadian Real Estate Investment Trust ( REF.UN-T ). It offers 3.8 percent distribution yield. For the very highest marginal tax payer in a non-registered account making over $200,000 a year, they would be looking at an after tax effective yield of about two percent instead of 3.8 as advertised,” said Avery.

He recommends positions in Crombie REIT ( CRR.UN-T ), Artis REIT ( AX.UN-T ), Northern Property ( NPR.UN-T ), WPT Industrial REIT ( WIR.U-T ) for exposure to the U.S. and Milestone Apartment REIT ( MST.UN-T ).