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CIBC Sees Up to 10% Return for REITs

World Markets Team Cites Perception of Lagging Retail Sector Will Hurt Returns, Could Drag Them Down to 0%
January 11, 2018
Canadian real estate investment trusts are going to have a hard time outperforming the broader public market because of investor distaste for retail assets, according to a new investment bank report.

CIBC World Markets says Canadian REITs could deliver 0% to 10% total returns in 2018, based on 3% cap-weighted average funds from operations growth and 5% average yields that are mostly flat.

"It seems likely that 2018 will be another stock pickers' year for REITs, with a wide dispersion of returns similar to the over 49 percentage point spread in 2017 between the top and bottom performing REITs," according to the report, whose primary author was analyst Dean Wilkinson.

The forecast comes after the Canadian REIT Index returned 10% in 2017, which CIBC says was influenced by volatility in the Canadian dollar and oil and commodity prices, moderating property fundamentals, interest rate volatility and overall negative sentiments towards the retail sub-sector.

CIBC says the all too common narrative around retail, including a sentiment that "Amazon is taking over all things retail,” has impacted leasing but that retail may be "down but far from out."

The report notes that operating results in the retail sector have been among the strongest in the entire Canadian REIT market with 2017 year-over-year FFO growth of 3% compared to an industry average of 2%.

"While the negative sentiment surrounding the space is undeniable and readily apparent in the significant underperformance of retail-oriented REITs, the actual operating performance is anything but," says the report, adding the expectation of investors of a greater deterioration of underlying fundamentals just might not happen.

Another theme for 2018 the investment bank pointed to was interest rates. CIBC noted consensus for years has been that rates are going up, yet there hasn’t been much movement.

"While undoubtedly, all indicators do, in fact, point to increased rates at the short end of the yield curve, the impact at the longer end, in our view, is questionable at best," says the report.

CIBC notes on a valuation basis, the REITs it covers are trading in line with historical measures on almost every basis, which makes them look at least as attractive as the broader market. The bank also anticipates more development activity in 2018 as management teams seek to maximize the highest and best use of their assets to offset potential slowing in FFO growth.

Another question is whether energy-dependent provinces in Western Canada continue their slow and steady economic recovery.

"There is no question that Canada’s economy, and currency, has witnessed significant challenges related to the sharp decline in oil prices since the summer of 2014, and while the price volatility has stabilized over the past year, we anticipate the aged effect of depressed investment will continue to prevail over much of 2018," said CIBC, adding markets often underestimate the magnitude and duration of these trends on property fundamentals.

Analysts Chris Couprie, Sumayya Hussain, Zain Jafry and Rumjhum Shukla also contributed to the report.

Garry Marr, Toronto Market Reporter  CoStar Group   
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