Canadian REITs Beat-up - Trading at Discount to NAV

First Asset kicks the REIT tires at the end of August in a commentary on their funds:

REITs = seem beat-up like some cheesy DIY super hero
"Real estate equities on aggregate are currently trading at a ~13% discount to NAV while they generally trade at a premium. Implied cap rates are ~375bps higher than the benchmark 10 Year Government of Canada bond yield, slightly tighter than the long term average. A 25bps change in cap rates affects NAV by an average of 8-9% for our universe under consideration; alternatively a 25bps increase in cap rates implies REITs must grow same-property NOI by 3-4% in order to maintain current valuations. Assuming REITs trade at NAV, we estimate that the market is pricing in a 50bps expansion in cap rates. Given that the private market has not yet seen any expansion in cap rates, we view this expectation as premature.

Cash flow for the next year looks poised to increase on the back of favorable financing terms, continued strength in property fundamentals, and little in the way of forecast new supply. Based on our mid to high single digit cash flow growth outlook, and 5-6% distribution yield, high single to low double digit total returns appear achievable on a twelve month view. We acknowledge that higher interest rates could result in multiple compression which would temper our total return view."

The REIT ETFs from BMO (ZRE) and iShares (XRE) were both down about 15% from May highs.  The following charts show that today you can buy into these REIT funds at late 2011 prices !

XRE

ZRE

Most REITs’ existing debt, which is renewing at 10% a year, is priced 1.5-2% above todays market rates for new debt.  So there is still an opportunity for REITs to to reduce interest costs when debt is refinanced.