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The fall of real estate and the rise of two Canadian REITs

As real estate tumbles, danger brings opportunity for investors, says this U.S. expert, who includes two Canadian REITs among his buys.

Real estate values aren’t what they used to be.

They’ve in freefall in the U.S., and they’re not standing too straight in many parts of Canada, either.

But that very downfall opens up some promising avenues for investors, one U.S. analyst tells his readers — including a couple of Canadian opportunities.

Pick the right real estate investment trust and you have a good investment at a bargain price, plus regular dividend (or distribution) cheques in the mail.

Among the prime REITs to consider, writes Mr. Roger Conrad in Personal Finance, two Canadian trusts get top billing.

Mr. Conrad knows whereof he speaks, since he is America’s foremost expert on Canadian income trusts. He’s a pretty reputable judge of the American variety as well.

It stands to reason that a thumbs-up for a Canadian REIT from a top American analyst should garner a few benefits for its unitholders. So we’ll begin with Mr. Conrad’s Canadian story and his two recommendations.

Canadian advantages

“Canada never had a subprime crisis,” Mr. Conrad informs his American readers. “Nor is there a re-financing crisis, as non-governmental mortgages require at least a 20 per cent down payment.”

He adds: “Its largest banks boast capital ratios two or three times those of even the strongest U.S. banks.”

And while home prices dropped 10 per cent across Canada for the 12 months ended January 31, it was just a fraction of the damage to the U.s. market, he says, and values are still rising in some provinces.

“Canadian REITs are also advantaged in one other way: conservative financial practices,” explains Mr. Conrad. “Management never over leveraged during the boom because they remembered the preceding bust too well.” (There were bad days in real estate back at the turn of this century.)

Even in a slumping Canadian economy, two Canadian REITs have kept their houses in good order.

The lion’s share of the market

The houses in question are apartment buildings, actually. Both Canadian Apartment Properties REIT (TSX-CAR.UN) and Northern Property REIT (TSX-NPR.UN) have maintained low vacancies and steady rent growth.

“Northern is also blessed that the lion’s share of its income is from more remote places where it dominates the market and faces little competition, such as Newfoundland, the Northwest Territories, Nunavit and Yukon,” points out Mr. Conrad.

“In fact, its biggest renters are actually governments, the most reliable renters of all.”

As for Canadian Apartment, “it has built its portfolio on recession resistant properties in the steadier markets of eastern Canada and further insulates operations by cutting operating expenses to 40 per cent of revenue, down from 47.1 per cent in 2007.”

Better still, neither REIT is carrying significant debt. “And neither has had difficulty rolling over its debt in recent months.”

Growth may well slow in 2009, concludes this expert, as both REITs will be cautious with spending on new projects. “But that only enhances the safety of dividends that approach 10 per cent.”

Each of these Canadian REITs is a buy under US$15, he says. On the Over the Counter board in New York, Canadian Apartment closed yesterday at US$9.47 ($11.96 on the TSX) and Northern at US$12.76 ($15.99 on the TSX).

Fewer Canadian investors are liable to hold U.S. REITs (although the tax treatment has been more favourable in the past two years). But a handful of American REITs are “better buys than ever,” says the analyst.

Darlings to dogs

When income trusts were dismantled in the U.S. several decades ago, real estate trusts were left standing. Naturally, they prospered in the real estate boom.

And went down with it, too. They have gone “from darlings to dogs,” says Mr. Conrad. Some are still thriving, however, even though they sit at bargain prices. Two are in the same business as the Canadian REITs singled out above.

With credit tight, apartments are the best residential options for many Americans, even though it’s no longer true than renting is cheaper than buying. Well-managed apartment REITs with quality properties are still holding their own.

Home Properties (NYSE-HME) and Mid-America Apartment (NYSE-MAA) both reported strong fourth-quarter results. Each had low and stable vacancies, steady rent growth and successful property additions. Both use “their local knowledge to great effect,” says Mr. Conrad. Home Properties is a buy up to $40 (now at $28.88), Mid-America under $25 (it has already jumped that barrier to $28.42).

There are two commercial bargains as well, says the analyst. W.P. Carey (NYSE-WPC) pulled off an “audacious” property deal this year, grabbing the mid-town Manhattan headquarters of the New York Times. While rising vacancies will challenge this firm in 2009, it’s a bargain at its current price, a little above book value. It’s a buy up to $25 (now $21.81).

Boston Properties (NYSE-BXP) is a “higher octane play” in Mr. Conrad’s view. Unlike Carey, it has just had a bad time in New York, with one project cancelled and a flurry of writedowns. On the other hand, funds from operations more than cover its dividends and other expenses. This one’s a gamble, a buy for aggressive investors up to $40 (now $31.94).

In truth, more than a few real estate investments seem to be on shifting sands these days. But a solid REIT at a discount price should be one investment even that old wolf Recession can’t blow down.