Published: January 1, 2010

Falling rents, asset values and transaction volumes during 2009 have been tough on the real-estate sector and on real-estate investment trusts (REITs). REITs have bled value this year, and though things have begun to improve and will continue to, Fitch still has a negative outlook on the domestic REIT sector for 2010.

Happily, things are better in Canada.

While real-estate values in Canada have fallen, Canada had neither the leverage nor the exposure to subprime borrowers as the United States or other developed countries. As a result, the Canadian real estate market has experienced a much less severe correction. Analysts at Canadian brokerage Canaccord Adams say that commercial real estate in Canada has lower vacancy rates and less supply than in the United States.

In short, the financial crisis has left many Canadian REITs in a relatively strong position. Canadian REITs are generally "in much better shape than the ones in the U.S.," a recent study by Canadian rating agency BDRS found, concluding that Canadian REITs are still well capitalized, have excellent debt structures and generally higher-quality assets.

RioCan Real Estate Trust (TSX: REI.UN) is the largest Canadian real-estate investment trust that exclusively focuses on retail space. Its core strategy is to own and manage community-oriented neighborhood shopping centers anchored by supermarkets. The RioCan has total capitalization of $7.8 billion (as of September 30) and operates 247 retail properties in growing metropolitan areas of Canada, including 13 under development.

About 85% of RioCan's revenue comes from national and anchor tenants such as Wal-Mart (NYSE: WMT), Staples (Nasdaq: SPLS) and the Canadian retailer Zellers. Stable tenancy has given RioCan average occupancy rates above 95% since 1996. It had an occupancy level of 97.1% as of June 30, when the figure was last reported.

As a REIT, RioCan passes its taxable income to shareholders in the form of dividends. (The industry jargon in this case is "unit holder" and "distribution," but income investing can be difficult enough without calling everything by several names!) RioCan has raised its payout every year since 1995.

Although many REITs have cut dividends in this economy, RioCan chief Edward Sonshine recently said he was committed to maintaining the existing dividend. The trust currently pays C$0.115 per share each month, or C$1.38 annually. That's a robust 7.0% yield.

While earnings for the first three quarters of 2009 have been -11% lower than the same period last year, RioCan is taking advantage of weak economic conditions and has been aggressively buying assets on the cheap. RioCan has the resources for this expansion: At the end of the third quarter, it had C$214 million in cash and a total of C$293.5 million in revolving credit facilities at its disposal. Already, RioCan is under contract to purchase C$400 million in additional properties in Calgary, the Vancouver area and suburban Edmonton.

While Canadian real estate is still relatively cheap, the United States is experiencing one of the worst real estate markets since the 1930s. According to the most recent PricewaterhouseCoopers Korpacz Real Estate Investor Survey, which polls major institutional equity investors, the financial crisis has created "lifetime opportunities" in the U.S. real-estate market.

In addition, the Canadian dollar has rallied versus the U.S. dollar so far this year and is now in near parity with the greenback. (The Loonie is usually weak relative to the dollar.) Cheap prices combined with a strong Loonie have put RioCan in a perfect position to acquire U.S. properties at prices that will enable it to bolster earnings and, consequently, future dividends. Sonshine, the CEO, recently said "if there was ever a time to go into the U.S., it's in the next six to 12 months."

Sonshine isn't just talking the talk, he's buying: RioCan announced an 80/20 joint venture in October with Cedar Shopping Centers (NYSE: CDR), a U.S. REIT which, like RioCan, focuses on supermarket- and drugstore-anchored shopping centers. The venture has closed on two shopping centers in Pennsylvania and contracted to purchase seven other properties in the first half of 2010.

The joint-venture REITs were meant to be exempt from the new tax laws applying to Canadian trusts in 2011. However, confusion in the laws and narrow definitions of exempted properties may lead to a certain amount of restructuring on the part of RioCan. That said, most of RioCan's properties qualify for the exemption and the REIT should continue to function essentially as it has.

RioCan is a proven REIT that has demonstrated an ability to consistently raise its payout. While RioCan seeks to increase earnings by buying up Canadian and U.S. properties on the cheap, the time could be right to purchase this stock.

-- Tom Hutchinson
Staff Writer
StreetAuthority

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