Keep An Eye On Canadian REITs

Keep An Eye On Canadian REITs
Recent Sell-off In Canadian REITs Could Be Buying Opportunity

Alfred Lee, CFA, DMS
Investment Strategist, BMO ETFs
Global Structured Investments
alfred.lee@bmo.com

November 30, 2010

Recent Developments:

• Although there were no specific macro-economic or company specific events between the dates of November 8 and 12, both Canadian and U.S. REITs were hit particularly hard. It is likely that the U.S. REIT sell-off was partially caused by that week’s rise in yields of both 10- and 30-year U.S. Treasuries. In turn, this slump in U.S. REITs likely caused Canadian REITs, which have a tendency to follow their U.S. peers, to fall despite healthier economic conditions in Canada.
• A report put out on November 9 indicated that the REALpac/FPL Canadian Real Estate Sentiment Survey did in fact turn down, a signal of increased concern about commercial real estate conditions. However, the reading on the Survey came in at "67," well above the critical "50" mark which is therefore considered a positive sign. Any reading above 50 suggests respondents to be more positive of commercial real estate conditions than not.
• As our readers are aware, we have been bullish on the Canadian REIT sector for much of the year. Since our "Seeking Income In REITs" report on July 15, where we recommended investors gain exposure to the sector through the BMO Equal Weight REIT Index ETF (ZRE), the ETF has seen an increase of 12.2%, including the sell-off it took in early November.
• We continue to favour Canadian REITs since the sector reported Q3 earnings which were roughly inline with expectations. Moreover, the sector has shown accretive activity and resilient top line growth. Canadian REITs have a tendency to trade at a discount to their U.S. peers in terms of AFFO (Adjusted Funds From Operations) multiples and they continue to do so despite more robust economic activity north of the border.

Opportunity:

• The Canadian REITs sector has seen a steady rise since July, making it difficult for investors who like to time their entry points to get in. However, during the week in early November when REITs sold off, ZRE fell below its 50-day moving average (MA). Since then, ZRE has recovered with its Relative Strength Index (RSI) indicator showing it gaining positive momentum. Should ZRE cross over the 50-day moving average, this will likely be a bullish signal. (Chart A)
• The BMO Equal Weight REIT Index ETF (ZRE) is an efficient way for investors to get broad exposure into the Canadian REIT sector. The ETF tracks the Dow Jones Equal Weight Canadian REIT Index, which holds 17 different Canadian REITs. Currently ZRE is yielding 6.38%, which is a 36 basis point pick up from its market-cap oriented peer. Unlike a market-cap weighted index, an equal-weight index reduces the impact should any one of the larger REITs decide to cut its distribution.

Chart A: Canadian REITs Bouncing Back

Source: StockCharts.com, BMO ETFs

Chart B: Dow Jones EW REIT Index Has Outperformed S&P/TSX Capped REIT Index and S&P/TSX Total Return Index Since Its Inception

Source: Bloomberg, BMO ETFs

Chart C: Canadian REITs Outperforming U.S. Peers but Trade at Better Valuations

Source: Bloomberg, BMO ETFs

*All prices as of market close November 26, 2010 unless otherwise indicated.

Disclaimer:
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

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