Scotiabank REIT analyst Mario Saric has a “screaming yes” on his sector after a 23 per cent sell-off this year. But risks remain apparent.
In a research report this week, Mr. Saric noted that value-oriented portfolio managers were inquiring as to whether now is a good entry point for REITs, and his answer is where the “screaming yes” originated. He pointed to unit prices that are 26 per cent below net asset value on average, a level of cheapness that has only happened four per cent of the time REITs have been available.
The problem is interest rates and rising bond yields are increasingly attracting income investors away from REITs. Specifically, REIT cap rates – essentially the rate of return on property investments based on the income they generate – are less attractive relative to corporate bond yields.
Mr. Saric notes that despite the price weakness in the sector this year, the difference between the average cap rate and BBB-rated corporate bond yields is at an “ominous level” - too small, in other words, and historically this has led to REITs underperforming the TSX.
I think it’s important that Mr. Saric specified that it was value investors asking about buying REITs. Growth investors, with their shorter time horizons, are unlikely to be interested because the lack of competitiveness with bond yields will limit short-term returns.
Value investors have longer time horizons. U.S.-based value investors Charles Brandes once said that what growth investors pay in valuations, value investors pay in time invested. Over the long term, domestic REITs are unlikely to trade at an over 20 per cent discount to net asset value and the revaluation process will result in strong returns for patient investors. This will particularly be the case for REITs that are able to raise payouts.
Mr. Saric top picks for value investors are Allied Properties REIT, Canadian Apartment REIT, Dream industrial REIT, Granite REIT, Flagship Communities REIT and RioCan REIT