By Frank Mayer and Mark Rothschild

While not on the scale of its neighbor to the south, the Canadian REIT market has undergone its own less-heralded run in recent years. Established in 1993, the Canadian REIT market has grown to encompass 26 REITs with an equity market capitalization exceeding C$16 billion (U.S. $13.6 billion). There are Canadian REITs focused on almost every property type including retail, office, industrial, residential, hotel and health care. There is even a Canadian REIT focused on acquiring U.S. office properties.

Canada and U.S. Vacancy Rates, Year-End 2004
	Office	Industrial	Retail	Apartment
Canada	11.0%	4.8%	4.5%	2.7%
U.S.	15.4%	10.8%	6.8%	6.7%
Sources: Desjardins Securities, Colliers, REIS, CMHC, RERC

Sources: Desjardins Securities, U.S. Consensus

Unlike U.S. REITs, Canadian REITs are not corporations but are mutual fund trusts. These trusts are typically not taxable and distribute to unit holders the majority of their cash flow. With emphasis on a high level of distributions/dividends, most Canadian REITs focus on the acquisition of properties with high occupancies and stable cash flows. For the most part, they are discouraged from participating in value creation or development projects.

Recent legislation in Ontario extended limited liability to many Canadian REITs, removing what was a significant concern to many investors. This legislation was followed by the recent announcement from Standard & Poor’s that it would add income trusts to its Canadian indices. Several Canadian REITs should qualify for inclusion to the main S&P TSX Index thus creating additional demand for their units.

Fundamentals for real estate in Canada are, for the most part, stronger today than in the U.S. Vacancy rates are lower across all property types, as presented in the table below. Retail and industrial vacancy rates have remained stable in mid to low single digits. The office market has been the weakest Canadian commercial property sector with the national vacancy rate currently at 11 percent. Rental rates have been firm with moderate increases in retail and industrial space. The apartment segment has been weaker of late reflecting increased home buying induced by lower mortgage rates and newly developed condo units being offered for rent, especially in Toronto and Calgary.

Canadian REITs (Canadian dollars unless stated otherwise)
Name	Ticker	Recent Price*	Market Cap ($mil)*	Recent Yield	2005E AFFO Payout Ratio	Focus
Alexis Nihon REIT	AN.UN	$12.14	$309.8	9.1%	111.2%	Quebec diversified
Allied Properties REIT	AP.UN	$14.05	$145.9	8.4%	97.5%	Office
Boardwalk REIT	BEI.UN	$17.85	$948.0	7.1%	106.8%	Multi-residential
Borealis Retail REIT	BRE.UN	$12.81	$432.4	8.4%	94.7%	Retail
Calloway REIT	CWT.UN	$17.70	$643.6	7.7%	97.8%	Retail
Canadian Hotel Income Properties REIT	HOT.UN	$10.25	$406.7	8.8%	105.9%	Hotel
Canadian REIT	REF.UN	$17.10	$960.2	7.4%	85.7%	Diversified
CAP REIT	CAR.UN	$14.05	$713.1	7.7%	94.7%	Multi-residential
Chartwell Seniors Housing REIT	CSH.UN	$13.74	$388.4	7.8%	89.1%	Retirement Housing
Cominar REIT	CUF.UN	$17.52	$580.1	6.6%	91.0%	Quebec diversified
Dundee REIT	D.UN	$25.38	$628.0	8.7%	111.5%	Office/Industrial
H&R REIT	HR.UN	$17.56	$1,692.6	7.4%	90.3%	Diversified
Innvest REIT	INN.UN	$11.07	$507.2	10.1%	106.6%	Hotel
IPC US Income REIT (U.S.$)	IUR.UN	$8.56	$360	8.8%	98.7%	U.S. Office
Lanesborough REIT	LRT.UN	$5.85	$45.2	9.6%	108.0%	Multi-residential
Legacy Hotels REIT	LGY.UN	$7.09	$737.8	4.5%	84.2%	Hotel
Morguard REIT	MRT.UN	$10.28	$457.9	8.8%	98.8%	Diversified
Northern Properties REIT	NPR.UN	$17.72	$232.6	7.1%	85.0%	Multi-residential
O&Y REIT	OYR.UN	$15.70	$927.0	7.0%	101.0%	Office
Retirement REIT	RRR.UN	$9.55	$871.0	8.8%	97.7%	Retirement Housing
Retrocom Mid-Market REIT	RMM.UN	$9.25	$102.4	11.1%	102.5%	Retail
RioCan REIT	REI.UN	$17.44	$3,202.1	7.2%	97.7%	Retail
Royal Host REIT	RYL.UN	$5.30	$131.2	6.8%	66.7%	Hotel
Summit REIT	SMU.UN	$17.42	$1,079.5	8.8%	97.5%	Industrial
Sunrise Senior Living REIT	SZR.UN	$10.70	$289.8	8.1%	NA	Retirement Housing
TGS North American REIT (U.S.$)	NAR.UN	$5.65	$162.7	13.5%	158.3%	Office/Retail
All $ figures in Canadian $ unless otherwise noted Sources: Desjardins Securities

Comparative Valuations

As in the U.S., growing demand for investment in Canadian real estate continues to be fueled by low interest rates and investor demand for stable cash flows. A portfolio of industrial properties that two years ago would have sold at a 9 percent capitalization rate and one year ago at an 8 percent cap rate, was recently sold at a reported 7 percent cap rate. Recently, a power center was sold at a cap rate in the 6 percent to 6.5 percent range, a new high water mark for Canadian commercial real estate. Similar to the U.S. market, demand comes primarily from REITs, pension funds, opportunity funds, endowments and foreign buyers, notably Germans and Israelis. With interest rates in Canada expected to remain low, we expect pricing to remain strong and competitive.

Valuations for Canadian REITs have, however, lagged their U.S. counterparts. Cash flow multiples are lower for Canadian REITs and yields are higher. While the average U.S. REIT currently trades at 13.3 times 2005 FFO per share and 16.3 times 2005 AFFO per share, Canadian commercial REITs trade at 11.7 times FFO and 13.7 times AFFO, according to our data. The average yield for all Canadian REITs is 7.1 percent weighted (7.6 percent un-weighted), compared to U.S. REITs that yield on average 5.1 percent.

This valuation gap reflects U.S. REITs trading at valuations relatively consistent with private market real estate transactions while, in our opinion, Canadian REITs trade primarily on current yield. Income trust funds also invest in oil and gas and business income trusts are major buyers of Canadian REITs. Many of these competitive investments offer yields in excess of 10 percent compared to the Canadian REIT weighted average of 7.1 percent.

International investors now are recognizing this value and are investing in Canadian REITs for the first time. Most notably, we have seen an increased level of interest in Canadian real estate securities from U.S. investors.

The dynamics in the Canadian commercial real estate market are being noticed by U.S. REITs as well. Historically, U.S. REITs have not invested in Canada, with Kimco Realty Corporation (NYSE: KIM) standing out as the most significant exception. Kimco has acquired a number of shopping centers in a joint venture with Canada’s largest retail REIT, RioCan (TSX: REI.UN). With the increased globalization of REITs, we expect U.S. REITs to enter the Canadian market in a much larger way in the next few years. ProLogis (NYSE: PLD) recently announced the acquisition of land in the Toronto area where it plans to develop 1.75 million square feet of industrial space. Alexandria Real Estate Equities, Inc. (NYSE: ARE), The Mills Corporation (NYSE: MLS) and Entertainment Properties Trust (NYSE: EPR) have also made deals north of the border.

Canadian Apartment REIT (TSX: CAR.UN) provides an opportunity for a large U.S. residential REIT to acquire a portfolio of more than 23,000 rental units in a market where the vacancy rates are lower than in most American markets. Summit REIT (TSX: SMU.UN) owns a portfolio of industrial real estate exceeding 29 million square feet. While Summit currently trades at 10.0 times 2005 FFO per unit/share, the average U.S. industrial REIT trades at 14.4 times 2005 FFO per share.

We believe that the globalization of real estate investing and the increasing interest of U.S. investors and U.S. REITs in Canada will be a potent factor in improving the relative valuation for Canadian REITs as compared to U.S. REITs.

Frank Mayer and Mark Rothschild are both real estate analysts with Canadian-based Desjardins Securities.