Retail Real Estate Investing. Compare RioCan vs Calloway vs Crombie vs Primaris REIT. Are they safe?

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Not surprisingly, large retail space providers are reporting that net operating income for revenue properties declined across the board in 2009 compared to 2008. That trend should continue into 2010, yet most of the REITs real estate investment trusts that specialize in retail space have bounced off their March 2009 lows to return to near their pre-crash prices of 2008.

To try to understand why this has occurred, we asked Adam Cutler, who maintains a private Canadian REIT hedge fund, for his views on the sector and its market leaders: Retail Real Estate Investing – RioCan vs Calloway vs Crombie vs Primaris REIT. Are they safe?

Cutler´s RI.ca Fund invests long and short exclusively in TSX-listed REITs. Subscribers to REITinvestor.ca receive daily updated REIT rankings, regular REIT reports and can view the fund´s investments online. As of November 15, 2009, the fund has returned 22% for 2009 and has at no time been negative.

Why have retail REITs in Canada done so well since their March 2009 lows?

"Like many stocks, retail REITs have bounced back since their lows last March, when investors began to realize that the market had oversold. Many investors had been selling their REIT units because they feared that even the best Canadian REITs would follow the escalating tactic of US REIT´s to pay out monthly distributions in newly issued units in place of cash. Since May 2009, investors have seen, however, that most Canadian REITs are healthy enough to return to the capital markets to raise cash. This trend reinforcing their belief that cash distributions are safe, investors have been jumping back in."

Are they safe?

"For most of the larger retail REITs, the distributions are safe in the near term, but each REIT has its own challenges. Investors need to understand each REIT´s challenges, because these have the potential to weaken the Trust´s performance. Eventually, persisting challenges can lead to a distribution cut and devalue the unit price."

Can you explain some of the REITs´ challenges?

"For example, RioCan REIT, the largest retail REIT, does not make enough operating cash flow from its revenue properties to cover its payout to unitholders. It tops off its Distributable Income by earning third-party fees, increasing debt on properties, and by way of non-recurring sources of property revenue. Next, there´s Calloway REIT. While cash flow from its revenue-producing portfolio has exceeded the payout to unitholders, the Trust recently said that the payout will exceed Funds from Operations (FFO) in 2010. Among the sector´s other leaders, Crombie REIT is still digesting the portfolio of properties it acquired in 2008, and Primaris REIT needs to find a way to increase revenue through development or acquisition if its FFO is to cover its payout. All the REITs mentioned have to address their challenges, moreover, in a market of declining rents."

What are the risks for retail REITs in 2010 & 2011?

"Retail REITs are dependant on their tenants´ success for their own success. We have a concern that a large retailer will collapse in early 2010, which could send all the retail REITs into a tailspin. The REITs that would best weather this event are Crombie REIT, with its large grocery base, and Calloway REIT, with 27% of revenue from Walmart. In general, given the weak growth prospects, we are neutral on retail REITs through 2011."

Which retail REITs do you like and why?

"For much of 2009, Primaris REIT was a #1 or #2 ranked REIT in our 1-5 quant ranking model, significantly because of their great liquidity. So far, however, they have been unable to put their cash to work. Our concern now is that, until they can find an accretive use for the large cash reserve, these funds have begun to work against them. RioCan REIT is Canada´s largest REIT and definitely has a great management team. They recently made their first investment in the US, and they expect to increase their US investments by up to 25% of total book value during the next few years. This strategic move signals to us that RioCan REIT has outgrown opportunities in Canada. We are somewhat optimistic that they can be successful south of the border. As with most investments, timing is everything."

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