As lead counsel to two publicly-traded REITS and several other private real estate investment trusts, mortgage trusts and limited partnerships, I try to attend the RealREIT conference held each September in Toronto. The conference presentations on the state of Canadian capital markets for real estate are relevant to our clients who are actively raising capital for their real estate ventures. As well, there is usually quite a bit of discussion about the commercial property markets.
The ninth annual RealREIT conference held on September 19, 2012 included several individual presentations and panel discussions. As a few sessions were held concurrently, and because I was called out to help a client negotiate an agreement during part of the day, I was only able to attend about half the sessions. This report is therefore shorter than it could have been. However, having spoken with a few colleagues who attended sessions I did not, I understand that overall the messages were generally the same.
As in many previous years, the conference was opened with a presentation by Carolyn Blair, Managing Director, RBC Capital Markets Real Estate Group, on the state of the Canadian REIT market. Ms. Blair reported that the REIT market remains very strong, having out performed every other public market sector in terms of overall return, liquidity and volatility since 2008. Highlights of Ms. Blair’s presentation included:
- real GDP in Canada is up 1.9% in the 12 months ending August 31, 2012, and is 4.7% above pre-recession levels;
- Canadian employment increased 1% in the 12 months ended August 31, 2012, and is 1.9% over pre-recession levels;
- interest rates are unlikely to increase materially in the foreseeable future. However, interest rate spreads on commercial mortgages have increased in the past 12 months and many lenders have established interest rate floors;
- for the first time, Canadian REITs hold as much real estate as pension funds;
- more equity was raised by Canadian REITs in the 12 months ended August 31, 2012 than in any previous calendar year;
- in terms of returns from investment in REITs:
- the average annual total return (which include distributions and gains in market price) on the TSX REIT index since 2001 is a compounded 14.5%, as compared to a 5% return on the TSX and a 6% return on bonds;
- much of that has been since the market correction in 2008. Total returns on TSX REITs were 55% in 2009, 22.6% in 2010, 21.7% in 2011 and 15.2% year-to-date in 2012;
- the cash yield on TSX-listed REITs in the 12 months ended August 31, 2012 averaged 4.8%, down from 5.8% in the previous 12 month period, evidencing price increases driven by strong investor demand for REITs; and
- TSX-listed REITs historically have traded at a 4.8% premium to Net Asset Value. Current trading prices are at a 9.3% premium to asset value, again evidencing strong investor demand for REITs;
In summary, Ms. Blair stated that in an environment where GDP growth is modest, interest rates are low and expected to remain low, commodity prices are below their recent peaks and the U.S. economy is showing signs of recovery, it is a good time to invest in real estate through an investment in REITs.
William Wong, also a Managing Director of RBC Capital Markets Real Estate Group, moderated a panel discussion on whether the “good times” for real estate can continue. Panelists included Steve Carroll, Managing Director and Senior Global Portfolio Manager, CBRE Clarion Securities; Tom Dicker, Portfolio Manager, Dynamic Funds; Dennis Mitchell, Chief Investment Officer and Senior Portfolio Manager, Sentry Investments; and Michael Smith, Managing Director, Real Estate Equity Research, Macquarie Securities Group. Generally, the panel agreed that, indeed, the good times will continue, but with overall returns tempered from those in the previous three to four years. Overall, the panel predicted total returns on the TSX-listed REITs of 8% to 12% in 2012. Other highlights of this panel discussion were:
- “lower and slower” – we are in for a long period of low interest rates and slow (but positive) economic growth;
- investor demand (including from pension funds) for income is substantial and demand for real estate continues to grow. Capitalization rates will continue to go down, especially for higher quality properties, simply because of high demand and low supply;
- worldwide, we are at a 40-year low in the construction of real estate properties – new supply is “anaemic”;
- for the most part, tenants are doing well, and rental income will grow slowly, adding to price increases for real estate;
- the Canadian REIT market has grown to a $50 billion market capitalization (as compared to $16.6 billion in 2009, which was down from $32 billion in 2007 – we all should have invested in REITs in 2009!). and will continue to grow;
- globally, access to capital for real estate remains strong, even in markets (such as parts of Europe) where economies are in difficult circumstances. Investors seek to own high quality real estate regardless of economic circumstances;
- the panel considers Australia to present many good investment opportunities and noted that Tokyo and London are particularly vibrant markets;
- Canadian interest rates are lower than they should be, due to economic woes in the United States and Europe. One view was that from a macro perspective, the biggest risk to Canada is economic recovery in Europe and the United States, as it will result in higher interest rates and a flow of funds out of Canada;
- the panellists are worried that ongoing strength in the REIT market will lead to a “make a REIT” marketplace, where principals without an existing real estate business or backgrounds will seek to tap into investor demand for real estate securities. This is reminiscent of historical market frenzies. They cautioned investors and analysts in the audience to ensure new entities are supported by strong existing management teams.
Andre Kuzmicki, Executive Director, Program in Real Estate and Infrastructure, Schulich School of Business then moderated a panel discussion on “What Role Can REITs Play in Pension Fund Portfolios: The Canadian versus the United States Experiences”. The panel was comprised of senior pension fund trustees and advisors, William Briscoe, Managing Director and Chief Operating Officer, Triovest Realty Advisors; Michael Latimer, Executive Vice President & Chief Investment Officer, OMERS; John Parsons, Managing Director, MacGregor Associates; and Sharon Sallows, Director, Ontario Teachers Pension Plan; Trustee, RioCan REIT; Trustee, Chartwell Seniors Housing REIT.
The panel quickly stated that, in fact, REITs generally have no role to play in pension fund portfolios, that pension funds prefer direct investment in real estate properties and have sophisticated internal management teams in place to identify and manage real estate. As such, they do not need to rely on REITs to identify or manage real estate for them. This is contrasted with the United States, where pension funds regularly invest in REITs and enter into joint ventures and partnerships with REITs for investment and development properties.
At the same time, the panellists suggested that as the Canadian REIT marketplace continues to gain scale and market share, REITs may become attractive investment for pension funds (particularly smaller funds) seeking investment in a particular market sector or seeking access to real estate generally (as the supply of quality Canadian properties continues to dwindle).
I then attended a panel discussion moderated by Sandy McNair, President, Altus InSite, on challenges in operating a REIT in today’s market environment. The panel was comprised of Tom Burns, Executive Vice President & Chief Operating Officer of Allied Properties REIT; Steve Evans, Co-Chief Executive Officer, Pure Industrial REIT; and Louis Forbes, Executive Vice President & Chief Financial Officer of Primaris Retail REIT.
When asked what challenges they have to balance in operating their businesses, answers included balancing the temptation to quickly re-lease vacant retail space to the first available tenant versus the need to evaluate the overall needs of the property. Another balancing challenge for a growth-oriented REIT such as Pure Industrial is to match property acquisitions with the availability of cash-flow. In terms of what issues worry them in the operation of their business, the panellists all mentioned interest rates and the consequences of interest rates rising, particularly if those increases were not matched by economic growth.
I was not able to attend any of the afternoon sessions. However, in speaking with colleagues who did, it seems that the messages were the same as in the morning:
- strong demand for “yield” (income-producing assets) will continue to keep prices for real estate high and should result in a slight reduction in capitalization rates;
- interest rates will remain low for the foreseeable future;
- total returns (cash distribution plus gains in unit prices) on REITs will continue to grow, but at a more moderate pace than in the past four years;
- economic growth will continue at a slow pace;
- real estate, whether owned directly or through a REIT or other entity, should be part of every investment portfolio because it is a “hard” asset, providing protection against inflation, while providing ongoing income.