rbc market prediction

8/7/2019 RBC market prediction

1/13

INDUSTRY | COMMENTJANUARY 12, 2011

Real Estate Investment Trusts

Q1-2011 REIT Quarterly (Summary)

Recommendation

From a universe of 28 TSX-listed REITs, we have seven Outperforms:Calloway REIT, CAP REIT, CREIT, Extendicare REIT, H&R REIT,Morguard REIT and Primaris Retail REIT. Also rated Outperform andincluded in this report are Brookfield Office Properties, First Capital Realty,and Killam Properties Inc.

Highlights Second Consecutive Year Of Outperformance The S&P/TSX Capped

REIT Indexs 2010 total return was +23% (following 2009s +55%). Hence,

the REIT Index outpaced the TSX Index (+18%), 10-year GoCs (+7%) andGlobal REITs (+20%). Owing largely to a weak Q4/10 (-2%) the REITIndex failed to keep pace with U.S. REITs (+29%) and the S&P/TSXIncome Trust Index (delivered an exceptional +27% in its final year).

Fundamentals In Recovery Mode Our outlook for each major propertysector in a sound bite: office turned sooner/stronger than expected;retail interesting set-up: resilient performance, strong landlords andhungry new entrants, but a stretched consumer; industrial a soft cycle,but now turning up; multi-res home ownership peaks and markets cool,while apartments prove stable and countercyclical; and, lodging a slowturn, but now firmly in recovery, still a long road to former peak profits.

Earnings & Distributions Canadas relative stability amid the downturninherently leaves less spring in the recovery cycle. Trend-line earnings

were -2% in 2009, and we expect the same for 2010. We forecast +4% ineach of 2011-2012. Our growth forecast is one-half that expected from U.S.REITs, which were hit much harder through the downturn. With earningsgrowth on the horizon, we believe the cycle of distribution cuts has ended.Yet, in an effort to push payout ratios to more conservative levels, we onlysee modest 2011 increases from a select few.

Lots Of Positives; A Few Cautions In 2011, theres lots in the sectorsfavour, including: i) low interest rates; ii) demographically-derived incomedemand; iii) improving fundamentals, iv) a return to earnings growth; v)good access to reasonably-priced capital; and, vi) an acquisitionenvironment which may continue to offer opportunities. That said,valuations have rebounded tremendously, and we believe cap ratecompression has largely run its course. Its challenging to identify factorsthat could drive material upside surprises to valuations/earnings, while

competitive forces may limit meaningful growth-by-acquisition accretion.Debt and equity are free flowing and attractively priced, yet 2008-2009reminds us this can change quickly.

A Conservative Bias; Expect Singles And Doubles We see 2011 asa year in which listed property reverts to delivering what it is truly designedto do: namely a high and stable cash yield, with the benefit of some taxdeferral, along with capital growth potential which should meet or exceedthe rate of inflation over time.

Priced as of prior trading day's market close, EST (unless otherwise noted).All values in CAD unless otherwise noted.

RBC Dominion Securities Inc.

Neil Downey, CA, CFA (Analyst)(416) 842-7835; [email protected]

Tyler Bos (Associate)(416) 842-4123; [email protected]

Michael Markidis, CFA (Associate Analyst)(416) 842-7897; [email protected]

For Required Non-U.S. Analyst and Conflicts Disclosures, see page 12.


2/13

2

Executive Summary And Recommendations

We are pleased to provide you with theExecutive Summary of our Q1 2011 REIT Quarterly Review and Sector Outlook. Thisrepresents our52ndEdition of theREIT Quarterly. As has been the tradition, the first-quarter publication contains an overview ofCanadian property market fundamentals and serves as our annual outlook for the Canadian listed property sector. We expect thecomprehensive report will be available in several days. In the interim, the key highlights and recommendations included in the Q1/10Quarterly are:

To Start: Five Predictions For 2011To kick-off our report, lets start with five predictions for 2011 (in no particular order):

1. 2011 will finish with more TSX-listed REITs than it begins with At the outset of 2011 there were 28 TSX-listed REITs. Wedo not see a lot of opportunity for M&A to reduce this number, at least not in the near-term. We do see the possibility of severalIPOs this year, as well as the graduation of one or more listings from the TSX-Venture exchange.

2. Equity raising activity will decline 2010 deal volume totalled $5.1 billion, the biggest year on record since 2007. We thinktransaction markets will remain active and one or more IPOs could prove a wildcard in the capital raising figures. Overallhowever we think it will be difficult to match 2010s a deal-a-week pace (56 transactions in total)

3. Target will finally come to Canada The penetration of new entrant U.S. and international retailers into Canada shows no signsof slowing. And, we believe 2011 could be the year in which Target finally comes to Canada, possibly leading a U.S. retailerconsortium (think Target, Kohls, Wal-Mart, others) into a deal to step into the Zellers footprint.

4. A REIT will finally issue a preferred unit We believe one or more REITs may attempt to issue this once talked about, yet notyet tested pseudo-equity, pseudo-perpetual-debt-like instrument. Lets see how the market digests it

5. CMBS origination will return to Canada Having taken a 3 year hiatus, yet now also carrying an enviable track record of verylow delinquencies, we think the conditions could be right for several brand-name, financially strong sponsors (i.e., large capREITs and REOCs) to work together to get this market originating product once again.

REITs Post A Second Consecutive Year Of OutperformanceThe S&P/TSX Capped REIT Index appreciated by 15.1% in 2010 and generated a total return of 22.6%. This was on the heels of awhopping +55.3% total return in 2009. Thus, for the second year in a row, returns from REITs materially exceeded the broadermarket, whereby the S&P/TSX Composite Index delivered 17.6% and 35.1% (total return) in 2010 and 2009 respectively. The REITIndex also strongly outperformed the 6.9% total return from 10-year Canada bonds, but it could not keep pace with the S&P/TSXIncome Trust Index, which delivered an exceptional 26.7% total return in its final year of existence.

North American REITs Also Outperform Global PeersThe MSCI U.S. REIT Index, recorded a 2010 total return of 28.9%, comfortably ahead of the return from Canadian REITs. Thisperformance gap was all derived via a Q4/10 negative return of -2.0% from the REIT Index coupled with a strong Q4/10 rally of 7.7%by the MSCI U.S. REIT Index. For the year, North American REITs generally outperformed their global peers as the EPRA/NAREITGlobal Index total return of 20.4% (in U.S. dollar terms) was held back by the relative underperformance of Asian (17.2% total return)and European (9.2% total return) REITs.

Still Not Back To Former Price Highs; Income Is A Powerful CompounderDespite the substantial and widespread rebound in values through 2009 and 2010, REIT price indices remain notably below their cyclepeaks. The S&P/TSX Capped REIT Indexs December 31, 2010 value was -25.3% from its February 2007 peak on a price basis,although on a total return basis the REIT Index had eclipsed its former highs by a slight 0.6%. The MSCI U.S. REIT Index closed2010 at a level that was still -37.4% from its January 2007 high (and, even on a total return basis at year-end it remained -21.3% offthe former peak). The EPRA/NAREIT Global Index finished 2010 -37.2% below its former February 2007 top, and on a total returnbasis, it too remained -25.0% from the old highs.

Property Market Fundamentals: In Recovery ModeOver the last two years, our opening remarks on property market fundamentals have carried the titles: Staring Into A CyclicalDownturn Q1/09 REIT Quarterly andLooking Over The Valley Q1/10 REIT Quarterly. With market fundamentals largelyunfolding as one would expect through the economic cycle, this years section is entitledIn Recovery Mode.

And so, in five separate sections within this edition of the Quarterly we review the outlook for supply/demand, rents and occupanciesfor the major property classes. Positive factors include supply-side dynamics (i.e., new development) which are muted, pretty muchacross the board. In our view, the risks are largely with the still fragile state of the consumer in Canada and the U.S., and all theknock-on effects that could come from any unexpected future income or spending retrenchment.

Real Estate Investment TrustsJanuary 12, 2011


3/13

3

Encapsulating the outlook for each major property class in a sound bite: Office turned sooner and stronger than expected in 2010,with further recovery ahead; Retail an interesting set-up, with resilient performance, strong landlords and hungry new entrants, buta stretched consumer;Industrial it was a soft cycle, but its now turning up;Multi-res home ownership peaks and markets cool,while apartments prove stable and countercyclical; and,Lodging a slow turn, is now firmly in recovery, yet the road to prior peakprofitability will prove to be long.

With Canadian markets showing greater resiliency than their U.S. counterparts through the 2009-2010 downturn (property marketfundamentals lag the economy), it is now likely that the rate of improvement north of the border will lag that of key U.S. property

markets not just in 2011, but possibly for the next several years. In short, the relative stability in Canada has simply rendered muchless spring in the potential occupancy and rental recovery story.

Equity Capital Raising Apex; Reduced Volume Likely In 2011The TSX-listed REITs entered 2010 with a total equity market capitalization of $22.0 billion. By year-end, this figure had increasedby +$9.4 billion, or +43%, to $31.4 billion. Based upon the numberof completed financings, 2010 was the most active year on record,with Canadian REITs and REOCs completing 56 equity and equity-related offerings. In total, these transactions raised gross proceedsof $5.1 billion. This figure was materially ahead of the $3.6 billion raised in 2009 and the anemic $1.3 billion raised in 2008. And,longer term data suggests the 2010 activity was only surpassed by the $5.8 billion (38 offerings) of 1997.

With the cost of equity capital declining through 2010, the $553 million of convertible debenture financings represented acomparatively small component (12%) of total activity. This compares to a longer-term average ratio of approximately 20%.

We do not believe 2011s activity will match 2010s. Having said this, we believe transaction markets will remain liquid, and that

additional IPOs are a possibility. Hence we expect equity and equity-related capital raising activity may continue to exceed thelonger-term annual average of approximately $2.5 billion.

Exhibit 1: Historical Annual Equity And Equity Related Capital Issuance

$0B

$2B

$4B

$6B

1996 1998 2000 2002 2004 2006 2008 2010

0

15

30

45

60

Equity Convertible Debentures Other # Of Deals

Source: RBC Capital Markets

Debt: Widely Available; Nominal Cost Very AttractiveThe ownership of real estate is a capital-intensive endeavour and, despite several outliers, listed REITs and REOCs generally employ

leverage in the 40% to 60% range. Thus, continued access to debt capital is essential to the viability of the industry. With sovereigndebt problems in Europe and massive fiscal imbalances (and ballooning debt problems) in the U.S at the Municipal, State and Federalgovernment levels, we remain just a bit on edge. After all, the availability of debt is currently very good. Yet the events of 2008-2009should still serve as a painful reminder that access to, and the cost of both debt and equity capital can change quickly.

Balance Sheet Lenders: The Mortgage MarketBalance sheet lenders continued to be the principal providers of real estate debt through 2010. Loan to value (LTV) ratios returnedto the historical norm of around 65% early-on in 2010. This was up from 50% in the midst of the 2008-2009 global financial crisis(that is if a borrower was able to secure a loan at all!) and a figure which we believe was more like 60% at the end of 2009. Theindicative spread on a five-year, fixed-rate commercial mortgage was quoted on December 31, 2010 at +180bps, thus offering an all-in



4/13

4

cost of financing of approximately 4.2%. We note the year-end 2010 mortgage spread was spot-on the historical average. Yet, with a43bps decline in the loan spread, combined with the 35bps decline in the five-year GOC benchmark, these had the effect of reducingthe nominal cost of a commercial mortgage by -78bps (from 5.0%) from the start of the year. Comparatively, the all-in cost of debtfinancing was only better in Q3/10, when it bottomed at 3.8%. We expect that loan spreads will remain unchanged over the course of2011.

Large Loan Volume Could AccelerateThe large loan market also showed continued improvement in 2010 (with average LTVs expanding from ~55% in 2009 to ~60%, andspreads narrowing to an average of +190bps from +325bps). Interestingly, last years deal volume appeared to be only half of 2009s,but we believe this was simply due to the chunky nature of the market. For 2011, we see a very good pipeline for the large loanmarket and we believe that quality offerings could allow transaction volumes to exceed the $1.5 billion mark (more than 2x 2010volume).

2011 Is The Year For A Canadian CMBS ComebackOver the past two years, Canadian CMBS versus U.S. CMBS delinquencies have been a tremendous study in contrasts. Recent dataplaces Canadian delinquencies at 0.6% versus a whopping 8% in the United States. Despite this performance, the Canadian marketplace has been closed to CMBS originations for three years. In the U.S., market momentum continued to build throughout 2010, withUS$12 billion of origination volume (versus US$3 billion in 2009). We believe the motivation of lenders and borrowers alike (thedebt securitization process can have benefits for both), along with the outlook for improving property market fundamentals should beenough to allow for the re-start of the Canadian CMBS market in 2011. Conservative underwriting standards, transparent structuresand brand name sponsorship, including contributions to the property pools by one or more of the largest and most credible REITs

and REOCS (the likes ofRioCan REIT, Calloway REIT, CREIT, First Capital Realty, H&R REIT all come to mind) will be keyto restarting originations.

Real Estate Unsecured Debt Has Now Been Cycle-Tested!Yield spreads on real estate senior unsecured debt narrowed significantly in the latter half of 2009, and this served as a catalyst for anew cycle of issuance in 2010. In this regard, unsecured debt issuance totalled $1.4 billion and $1.2 billion in 2010 and 2009,respectively. Listed REITs and REOCs represented $1.2 billion of last years activity (at an average spread of approximately+250bps), compared to $0.9 billion of activity (at an average spread of +600bps in 2009).

Since the beginning of the millennium, Canadian real estate unsecured debt issuance has totalled $9.1 billion ($6.3 billion by REITsand REOCs, and $2.8 billion by pension fund entities). Despite the 2008-2009 credit storm and recession, the sector has emerged withnot even so much as a single credit downgrade, much less a covenant breach or default Hence, we believe that unsecured real estatedebt has now been a cycle-tested and proven success story.

Today, we believe existing issuers have good access to senior unsecured debt. Nominal yields are slightly lower than debenturesoriginated in 2006/2007, despite the fact that spreads are nearly two times as wide. Provided that market conditions remain favourablewe would expect 2011 issuance to at least equal the maturity schedule of approximately $1.2 billion ($400 million fromREITs/REOCs, and $800 million from pension funds). On top of this, we believe it is reasonable to expect as much as $1 billion ofnew issuance for REITs and REOCs.

Balance Sheets De-Lever; Confidence Restarts Offensive Strategies And Allows Liquidity To DrawdownConfidence in operations and access to capital allowed the sector to raise capital for investment (acquisition and development)purposes in 2010. This is in contrast to late 2009, which financing was completedprimarily for the purposes of strengthening balancesheets and improving corporate liquidity. We estimate the group currently carries $3.6 billion of liquidity (consisting of $1.2 billionof cash and $2.4 billion of available/undrawn lines of credit). Relative to $46 billion in total debt, this places the estimated liquidityratio at 8% on a weighted average basis, down materially from 13% one-year ago. This 8% ratio is back in line with pre-crisis figures

Cap Rates Compress; We Think The Cycle Has Largely Run Its CourseSignificant equity capital raising and extremely receptive (and low cost) debt have been the perfect recipe for accelerated transactionvolumes and continued cap rate compression. While the final numbers have yet to be tallied, we expect that 2010 investment markettransaction activity could reach $18 billion, up some +40% from 2009s $13 billion and in-line with the 10-year historical average. In2011, we expect trading velocity will remain healthy and we believe the volumes could rise +10% or so, to the $20 billion mark.

An investment trends survey conducted quarterly by the Altus Group, a leading independent real estate consultancy, shows that caprates generally ended 2010 at levels which were about 75 basis points lower than at the start of the year. The year-over-year change inyields from the Q4/09 survey to the Q4/10 survey, by category, registered: CBD Office (-70ps, to 6.1%),Retail strip (-75bpsestimated, to 6.9%),Retail mall (-70bps, to 5.7% ),Industrial (-85ps, to 7.0%), andApartments (+/-0bps, at 6.1%).



5/13

5

Having taken a bit of a backseat to the well-funded and highly motivated REITs and REOCs through 2010, we believe several mid-size pension funds will also be very competitive bidders for investment property offerings in 2011. Directionally, we still believe theweight of money should hold property values firm, with the potential for a still modestly downward bias in yields. And, for mostlisted REITs and REOCs, meaningful accretion from growth-by-acquisition strategies may prove difficult to achieve. Despite theaforementioned, we also believe the 18-month cap rate compression cycle (by our estimation) has largely run its course. If this viewbecomes more widespread, it could be a catalyst for bringing a new wave of vendors to the market.

LTVs Markedly Improve; Cash Flow Coverage Improvement More GradualCollectively, since the outset of 2009, Canadian REIT prices have increased by close to 65%. The strong rebound in unit prices (alongwith some material help in the form of equity issuance) has dramatically improved the industry average D/EV ratio from 66% at thebeginning of 2009, to 58% at the beginning of 2010, to 52% currently. The reduction in the average LTV ratio has also been dramaticalthough slightly less impressive. We estimate the sector-average LTV is now 53%, down 6 percentage points over the course of thepast year and 10 percentage points from the March 2009 high of 63%. By way of reference, in Q1/07, peak property values drove thesector-average LTV to a long-term low of 45%. Based upon continued high cash distribution rates, we would still favour furthergradual and modest deleveraging for Canadian REITs over time.

The recent improvement in cash flow coverage ratios has been less dramatic than the D/EV and LTV figures. History shows a modestand gradual downwardtrend in group-average EBITDA/interest from 2004s 2.7x to 2009s 2.3x. Reflecting equity issuance andfinancial deleveraging, interest rate roll down, and modest organic growth, we expect group-average EBITDA/interest coverage touptick to 2.4x for 2010, with a stable to possibly modestly upward bias thereafter.

More IPOs Possible; Not Expecting M&A Activity, At Least Not In H1/11

There were three REIT and one REOC IPOs in 2010. On a fully-distributed value, these new companies carried an initial equitymarket capitalization of $1.1 billion, while the public portion of the equity raises totalled $0.8 billion. If our views on yieldcompression (or, more specifically, a material lack thereof) are shared by portfolio owners, this could spur several to consider the IPO-route in 2011. Moreover, if our expectation with respect to a reasonably active roster of investment property offerings provesaccurate, then REITs should also have plenty of potential investment opportunities to review, hence reducing any great impetus topursue merger and acquisition activity, at least in the near-term.

Earnings Growth: Things Are Looking Up (Again)Q3/10 trend-line earnings growth registered +3%, marking the return to positive territory after suffering four consecutive quarterlydeclines. While we expect some moderation in Q4/10 with our trend-line earnings growth forecast for the quarter at a modestlypositive at +1%. For full-year 2010 we expect a decline of -2%, owing primarily to the weakness in H1/10. For 2011 and 2012, weexpect interest savings and improved operating results to drive annual growth of +4%. Ultimately the 2011 transition to IFRS (fromGAAP in 2010) could throw a wrench into our comparables. We intend to adjust as best possible in order to provide a reasonable

picture of like-for-like earnings.

Exhibit 2: Trend-Line Earnings Growth (1999 To 2009 And 2010E To 2012E)

6%

4%

1%

6%

3%

1%1%

4%

8%

5%

-2%-2%

4% 4%

-4%

0%

4%

8%

1999 2001 2003 2005 2007 2009 2011E

Note: Excludes lodging REITs. Source: RBC Capital Markets estimates



6/13

6

Distribution Outlook: The Cycle Of Cuts Has Come And Gone; Increases Will Be Modest And From The Minority In20112010 saw four distribution increases (including two from H&R REITs schedule of intended distribution increases) and nodistribution cuts. This was on the heels of 2009s one-to-eight ratio, which was the worst on record. The average AFFO payout rationow stands at approximately 91% of forward 12-month estimate basis. With the return to positive earnings growth in H2/10, webelieve that the cycle of distribution cuts has now run its course. Looking forward to 2011 and 2012, we believe that positive earningsgrowth could provide for a modest number of distribution increases from less than a half-dozen entities. In this regard, we believe that

many REITs and REOCs could (and should) seek to dial-down their AFFO payout ratios to levels which inherently provide a greatermargin of safety for equity holders.

Investment Recommendations And Outlook: Back To Hitting Investment Singles And Doubles In

2011In many ways, we believe the environment remains very favourable for publicly traded real estate. Property market fundamentals arein recovery mode, interest rates remain very low, there is ample access to both equity and debt capital, and investor demographics playpositively for the sector today (even more so, now that the sun has set on the income trust vehicle) and into the future. Having saidthis, we are cognizant of the reality that two consecutive years of REIT outperformance have raised valuations materially, and thatinterest rates can go up (as well as down). With this in mind we believe that 2011 will likely be a year in which listed REITs andREOCs revert to delivering to investors what they were designed to do: namely a high and stable cash yield, with the benefit of sometax deferral, along with capital growth potential which should meet or exceed the rate of inflation over time. To sum it up, we see2011 as a year where the sector is back to hitting investment singles and doubles, instead of the triples and homers of 2009-2010.

REITs Close Out 2010 At A +9% Premium To NAVOur estimates place the group-average premium to NAV at +9% as of December 31, 2010. This data point represents solidappreciation in unit prices through 2010, along with rising NAVs on the back of cap rate compression. Based upon some 15 years ofhistorical data, our estimates show a valuation peak in September 1997 at a +28% premium to NAV and a subsequent cyclicalvaluation trough in February 2000 at a -15% discount to NAV. In the most recent cycle, valuation peaks were achieved in February2004 and February 2007 at NAV premiums of +21% and +17%, respectively. The current cycles valuation trough was recent anddeep, at a -27% discount to NAV in November 2008. Since we began tracking this valuation metric in the mid-to-late 1990s, CanadianREITs have traded on average at 104% of NAV, while the trailing 12-month P/NAV has averaged 109%.

Exhibit 3: Group Average Premium/(Discount) To Estimated NAV (Jan-1996 to Dec-2010)

28%

21%17%

9%

-17%

-11%

-15%

-27%

13%

-13%

(30%)

(20%)

(10%)

0%

10%

20%

30%

Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Source: RBC Capital Markets and Thomson One

Steady Cap-Rate Compression Drives Notable NAV GrowthAt the outset of 2010, we had forecast that modest cap rate compression would likely offset modest NOI erosion, thus resulting inaverage NAV/unit growth within the -2% to +4% range. For the second consecutive year, yield compression exceeded ourexpectations, thus driving +16% average capital value growth (on top of +9% in 2009). Turning to 2011, we expect a return to



7/13

7

slightly positive same property NOI growth and the prospect for very modest yield compression to drive average NAV/unit growth of+5%.

Buoyed By Interest Rates, AFFO Multiples Climb Well-Through The Long-Term Average; Yield Spreads Remain CloseTo NormsOn various earnings-based measures, sector valuations appear to approximate fair value. The groups 6.4% AFFO yield is now 150bpsbelow the long-term average. Alternatively stated, the forward 12-month AFFO multiple of 15.6x is 3.0x above the long-termhistorical average. Examining yield spreads relative to both the risk-free rate and other risky assets, we see that the group offers riskpremiums, which remain in-line with the long-term average historical spread over 10-year Government of Canada bonds, but they arenow some 45bps below the 85bps historical average yield spread over an index of corporate bonds. Lastly, as of the pricing date ofthis report, the group is trading at a +9% premium to NAV, which is approaching the upper end of our band of fair value and ismodestly above the long-term average NAV premium of +4%. On a one-year forward basis, our expectations for mid-single digitNAV growth, should reduce this premium down to the 4% long-term average. Current unit prices equate to an average impliedproperty yield of approximately 7.2%.

Exhibit 4 provides a simplified recap of REIT valuations as of December 31, 2005 through 2009, and as of the January 11, 2011pricing date of this report.

Exhibit 4: Industry Valuation Recap Year-End 2005 Through 2010 And Current

Metric 2005 2006 2007 2008 2009 2010 LTA1 Current*

AFFO Yield2 6.3% 5.7% 6.4% 9.7% 7.3% 6.4% 7.9% 6.4%

Premium Vs. 10Y GOC (bps)2 231 158 240 703 374 331 336 331

Premium Vs. Moodys BAA(bps)

2-2 -55 -37 175 99 45 85 36

Price/AFFO2 15.9x 17.7x 15.7x 10.3x 13.6x 15.6x 12.6x 15.6x

NAV Premium/(Discount)3 11% 12% -6% -16% 8% 9% 4% 9%

Notes: 1Long-Term Average is derived from approximately 15-years of historical data. 2Metric derived via market-cap weighted average basis. 3Metric

derived via simple average basis. Current as at market close EST on January 11, 2011. Source: RBC Capital Markets

Investment Strategy Wrap-Up: Lots Of Positives Along With A Few Balanced And Cautionary ThoughtsThere are lots of variables working in the sectors favour, including: i) low interest rates; ii) demographically-derived demand forincome; iii) improving property market fundamentals, iv) an apparent return to earnings growth in 2011; v) good access to reasonablypriced capital; vi) the ongoing effect of a potentially positive funds flow phenomenon (now that the sun has set on income trusts); andvii) an acquisition environment which may continue to offer capital investment opportunities. Having said this, both direct and listedproperty valuations have rebounded tremendously from 2009s cyclical lows. It is also somewhat challenging to identify factors thatcould drive further material valuation or earnings-related upside surprises for the sector.

We also suspect the now 18-month long cycle of cap rate compression has largely run its course. And, for most listed REITs andREOCs, meaningful accretion from growth-by-acquisition strategies may also prove difficult to achieve. While credit markets appearto be free-flowing, and at yield spreads (and nominal yields) which are attractive to borrowers, the events of 2008-2009 still serve as apainful reminder that access to, and the cost of, debt and equity capital can change quickly.

We Have A Conservative Bias And Believe Investors Should Think About Singles & Doubles For 2011In consideration of these factors, we are generally hesitant to make investment bets which are dependent upon material cap-ratecompression or externally-derived earnings growth. Instead (and keeping valuation considerations in mind), we generally favourREITs and REOCs that have lower payouts, evidently more self-sustaining business models, and broadly less reliance upon debt andequity capital markets

Overall, we believe that REITs and REOCs will deliver acceptable risk-adjusted returns to investors through 2011. In our opinion, the

sector will be back to delivering what it is sustainably designed to do. Namely, a generous (averaging ~6% currently), partially tax-advantaged cash yield (paid monthly), coupled with the potential for long-term income growth and value appreciation that meets orexceeds the rate of inflation. Thus, a 10% total return might be a reasonable sector expectation for 2011.

In short, we this is more likely to be a year in which investors should reasonably expect REITs to deliver singles and doubles, asopposed to knockem out of the park home runs.

Exhibit 5 on the next page summarizes our list of ten Outperform-rated entities and provides a brief investment thesis for each.



8/13

8

Exhibit 5: Investment Recommendations And Summary

REIT Rating Risk Price Yield Target Target Multiple Investment Thesis and Comments

BrookfieldProperties(US$)

O Avg $17.36 3.2% $18.75 20x 2012E AFFO Owns, develops and manages premier office properties in high-growth andhigh-barrier to entry markets. Business model adds value through leasing,development and capital recycling. In-progress transformation into a globaloffice pure play could lead to a trading multiple expansion. Multiple capitalaccess points provide BPO with many levers to manage its financial flexibility.

Calloway REIT O Avg $24.15 6.4% $25.75 16x 2012E AFFO Owner of a 22MM sf portfolio of primarily new-format, Wal-Mart-anchoredretail centres. Newer assets and long-lease terms should prove defensive, asshould the portfolios focus upon value-oriented retail in what is still atentative consumer / economic recovery. Financial leverage has been reducedover the past year, which we see as a positive event.

CanadianApartmentProperties REIT(CAP REIT)

O Avg $17.29 6.2% $19.00 15.5x 2012E AFFO Integrated owner and manager of a national portfolio of 27,000 residentialrental apartments. The sector tends to be somewhat countercyclical to thehousing market, which is now cooling after a number of hot years. CAP REITreasonably raised fresh equity which we see as an important de-leveragingmove which gives us confidence in the REITs ability to fund substantial capitalimprovements over the next 4 years and continue with its tuck-in acquisitionprogram. Capital and operating strategies meanwhile are driving good organicgrowth and we believe the units carry a reasonable valuation.

Canadian REIT(CREIT)

O Avg $31.71 4.4% $35.00 16.5x 2012E AFFO High quality, diversified portfolio (both by geography and property-type).Strong, conservative management team. Low AFFO payout ratio. Low financialleverage. One of the longest track records of any REIT. Several headwinds in2009-2010 (industrial and office vacancy erosion; dilution from un-deployed

equity issuance and asset sales) should turn to modest tailwinds in 2011+

ExtendicareREIT

O AA $9.63 8.7% $11.00 11x 2012E AFFO A large-scale, efficient owner/operator in the needs-driven nursing homeindustry. Long-term funding uncertainties and substantial operating andfinancial leverage make the units suitable only for the more risk-tolerant.Modest valuation and attractive cash yield offer interesting total returnpotential. Even a small improvement in investor sentiment (which could comeif occupancy begins to improve) could lift the current valuation, thus leadingto potential outsized returns.

First CapitalRealty

O Avg $15.11 5.3% $16.25 17.5x 2012E AFFO Focused on necessity-based, every-day retail real estate (shopping centresanchored with food and drug stores, and purveyors of everyday necessities).Should be a defensive business. Offers an interesting income + value-addbusiness model, which we expect over time should allow FCR to generateslightly higher NAV growth than that of the average REIT.

H&R REIT O Avg $19.75 4.6% $22.00 15.5x 2012E AFFO High quality portfolio consisting of primarily long-term triple net leases. Offershighly predictable cash flows, with contractual rent steps to assist in inflation

protection. Construction of The Bow is on-budget, and major sources offunding have been secured. Low AFFO payout with good visibility indistribution increases over the next 12+ months, and, we believe, lots of roomto for increases thereafter. Low payout currently offers reasonable earningsretention and NAV/unit growth. A reasonably valued, total return story in ourview.

KillamProperties

O Avg $10.49 5.3% $10.75 16x 2012E AFFO A small-cap REOC with an attractive, stable dividend yield. Operationaloutlook seems to be generally stable and capable of generating modestAFFO/share growth. 2010 acquisitions were $115 million (expanding theapartment portfolio into ON) and a similar figure is likely for 2011.

Morguard REIT O Avg $14.69 6.1% $15.25 14.5x 2012E AFFO An attractively valued REIT that has substantially improved its asset quality,trading liquidity (greater float) and reduced its leverage over the past severalyears. The business is managed in a risk-averse manner. The stock seemscompletely absent any sort of catalyst, yet scores well on stability/reliability.

Primaris Retail

REIT

O Avg $19.45 6.3% $20.75 16.75x 2012E

AFFO

Fully-internalized platform has been in place for more than a year and appears

to be operating seamlessly. Internalization should lead to enhanced franchisevalue over time in the eyes of investors. Late 2009/2010 acquisitions(Sunridge Mall, Woodgrove Centre and Cataraqui) have improved portfolioquality while deploying the balance sheet more appropriately, thus allowingfor a better display of earnings power per unit in 2011. Current challenge isthe high price (low cap rates) at which malls have recently transacted (~6%cap rate on EMTC). But, perhaps this simply means Primaris units are evenmore attractively valued than we appreciate.

Stock Rating Legend: TP Top Pick, O Outperform, SP Sector Perform, U Underperform.Risk Qualifier Legend: Avg Average, AA Above Average, Spec Speculative.Source: RBC Capital Markets



9/13


10/13


11/13

Canadian REITs And REOCs Valuation Table (Continued) NePage 3 of 3

Footnotes (all amounts are stated on a diluted basis):

1) Current distribution and yield are based on the current annualized monthly/quarterly distribution.

2) Payout Ratio = Run-Rate Cash Distribution / 2011E AFFO.

3) Adjusted Funds From Operations = FFO, adjusted for non-recoverable maintenance capital expenditures, significant straight-line rent adjustments and other items.

4) TransGlobe Apartment REIT 2010E represents the 232 day "stub year" from the May 14 IPO to December 31, 2010, hence P/FFO and P/AFFO multiples are not meaningful.

6) Leisureworld Senior Care - Figures shown in 2009A are pro forma; 2010E represents the 284 day "stub-year" from the March 23 IPO date, hence P/FFO and P/AFFO multiples are not meaningful.

7) Brookfield Office Properties Canada 2009A reflects the REIT's predecessor, BPO Properties. 2010E is pro-forma, as if the REIT conversion occurred January 1, 2010.

8) H&R REIT FFO/unit shown above excludes non-operating. Including these items, 2008/09 FFO/unit were $1.59/$1.34. 2010E/11E/12E are $1.48/$1.41/$1.51.

9) NorthWest Healthcare Properties REIT 2009A are 9-months annualized pro-forma; 2010E represents the 281 day "stub year" from the March 25 IPO to December 31, 2010, hence P/FFO and P/AFFO multiples a

Source: RBC Capital Markets and Thomson One

5) Chartwell REIT FFO/unit shown above excludes unrealized gains and losses on derivative financial instruments, unrealized foreign exchange gains and losses, and, writedowns on mezzanine loans. Including th

$0.88/$0.61. 2010E is $0.62.

January 12, 2011


12/13

12

Required Disclosures

Non-U.S. Analyst Disclosure

Tyler Bos and Michael Markidis (i) are not registered/qualified as research analysts with the NYSE and/or FINRA and (ii) may not beassociated persons of the RBC Capital Markets, LLC and therefore may not be subject to FINRA Rule 2711 and NYSE Rule 472restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

Conflicts DisclosuresThis product constitutes a compendium report (covers six or more subject companies). As such, RBC Capital Markets chooses toprovide specific disclosures for the subject companies by reference. To access current disclosures for the subject companies, clientsshould refer to https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send a request to RBC CMResearch Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7.

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including totalrevenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated byinvestment banking activities of the member companies of RBC Capital Markets and its affiliates.

Distribution of Ratings

For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - BuyHold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick/Outperform,Sector Perform and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same

because our ratings are determined on a relative basis (as described above).

Distribution of Ratings

RBC Capital Markets, Equity Research

Investment BankingServ./Past 12 Mos.

Rating Count Percent Count Percent

BUY[TP/O] 673 50.60 193 28.68

HOLD[SP] 598 45.00 130 21.74

SELL[U] 59 4.40 10 16.95

Conflicts PolicyRBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. Toaccess our current policy, clients should refer tohttps://www.rbccm.com/global/file-414164.pdfor send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower,Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.

Dissemination of Research and Short-Term Trading Calls

RBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having regardto local time zones in overseas jurisdictions. RBC Capital Markets' equity research is posted to our proprietary websites to ensureeligible clients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additional distributionmay be done by the sales personnel via email, fax or regular mail. Clients may also receive our research via third-party vendors.Please contact your investment advisor or institutional salesperson for more information regarding RBC Capital Markets' research

RBC Capital Markets also provides eligible clients with access to SPARC on the Firm's proprietary INSIGHT website. SPARCcontains market color and commentary, and may also contain Short-Term Trade Ideas regarding the publicly-traded common equity ofsubject companies on which the Firm currently provides equity research coverage. SPARC may be accessed via the followinghyperlink: https://www.rbcinsight.com. A Short-Term Trade Idea reflects the research analyst's directional view regarding the price ofthe subject company's publicly-traded common equity in the coming days or weeks, based on market and trading events. AShort-Term Trade Idea may differ from the price targets and recommendations in our published research reports reflecting theresearch analyst's views of the longer-term (one year) prospects of the subject company, as a result of the differing time horizonsmethodologies and/or other factors. Thus, it is possible that a subject company's common equity that is considered a long-term 'sectorperform' or even an 'underperform' might be a short-term buying opportunity as a result of temporary selling pressure in the market;conversely, a subject company's common equity rated a long-term 'outperform' could be considered susceptible to a short-termdownward price correction. Short-Term Trade Ideas are not ratings, nor are they part of any ratings system, and the Firm generally

https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1https://www.rbccm.com/global/file-414164.pdfhttps://www.rbcinsight.com/https://www.rbcinsight.com/https://www.rbccm.com/global/file-414164.pdfhttps://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1


13/13

13

does not intend, nor undertakes any obligation, to maintain or update Short-Term Trade Ideas. Securities and Short-Term Trade Ideasdiscussed in SPARC may not be suitable for all investors and have not been tailored to individual investor circumstances andobjectives, and investors should make their own independent decisions regarding any securities or strategies discussed herein.

Analyst Certification

All of the views expressed in this report accurately reflect the personal views of the responsible analyst(s) about any and all of thesubject securities or issuers. No part of the compensation of the responsible analyst(s) named herein is, or will be, directly oindirectly, related to the specific recommendations or views expressed by the responsible analyst(s) in this report.

DisclaimerRBC Capital Markets is the business name used by certain subsidiaries of Royal Bank of Canada, including RBC Dominion Securities Inc., RBC Capital Markets, LLCRoyal Bank of Canada Europe Limited and Royal Bank of Canada - Sydney Branch. The information contained in this report has been compiled by RBC CapitaMarkets from sources believed to be reliable, but no representation or warranty, express or implied, is made by Royal Bank of Canada, RBC Capital Markets, itsaffiliates or any other person as to its accuracy, completeness or correctness. All opinions and estimates contained in this report constitute RBC Capital Markets

judgement as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Nothing in this reportconstitutes legal, accounting or tax advice or individually tailored investment advice. This material is prepared for general circulation to clients and has been preparedwithout regard to the individual financial circumstances and objectives of persons who receive it. The investments or services contained in this report may not besuitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. Thisreport is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed,and a loss of original capital may occur. RBC Capital Markets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, whichincludes profits attributable to investment banking revenues. Every province in Canada, state in the U.S., and most countries throughout the world have their own lawsregulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, the securitiesdiscussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act assecurities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that

jurisdiction. To the full extent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liability whatsoever for anydirect or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copiedby any means without the prior consent of RBC Capital Markets.

Additional information is available on request.

To U.S. Residents:This publication has been approved by RBC Capital Markets, LLC (member FINRA, NYSE), which is a U.S. registered broker-dealer and which accepts responsibilityfor this report and its dissemination in the United States. Any U.S. recipient of this report that is not a registered broker-dealer or a bank acting in a broker or dealercapacity and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report, should contact and place orders withRBC Capital Markets, LLC.To Canadian Residents:This publication has been approved by RBC Dominion Securities Inc.(member IIROC). Any Canadian recipient of this report that is not a Designated Institution inOntario, an Accredited Investor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in any other province) and thatwishes further information regarding, or to effect any transaction in, any of the securities discussed in this report should contact and place orders with RBC DominionSecurities Inc., which, without in any way limiting the foregoing, accepts responsibility for this report and its dissemination in Canada.To U.K. Residents:This publication has been approved by Royal Bank of Canada Europe Limited ('RBCEL') which is authorized and regulated by Financial ServicesAuthority ('FSA'), inconnection with its distribution in the United Kingdom. This material is not for general distribution in the United Kingdom to retail clients, as defined under the rules ofthe FSA. However, targeted distribution may be made to selected retail clients of RBC and its affiliates. RBCEL accepts responsibility for this report and itdissemination in the United Kingdom.To Persons Receiving This Advice in Australia:This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material has been preparedfor general circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipient should, before acting onthis material, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If this material relates to the acquisition opossible acquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosure document prepared in respect of that product andconsider that document before making any decision about whether to acquire the product.To Hong Kong Residents:This publication is distributed in Hong Kong by RBC Investment Services (Asia) Limited and RBC Investment Management (Asia) Limited, licensed corporationunder the Securities and Futures Ordinance or, by Royal Bank of Canada, Hong Kong Branch, a registered institution under the Securities and Futures Ordinance. Thismaterial has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. Hong Kong personswishing to obtain further information on any of the securities mentioned in this publication should contact RBC Investment Services (Asia) Limited, RBC InvestmentManagement (Asia) Limited or Royal Bank of Canada, Hong Kong Branch at 17/Floor, Cheung Kong Center, 2 Queen's Road Central, Hong Kong (telephone numberis 2848-1388).To Singapore Residents:

This publication is distributed in Singapore by RBC (Singapore Branch) and RBC (Asia) Limited, registered entities granted offshore bank status by the MonetaryAuthority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of anyrecipient. You are advised to seek independent advice from a financial adviser before purchasing any product. If you do not obtain independent advice, you shouldconsider whether the product is suitable for you. Past performance is not indicative of future performance.

. Registered trademark of Royal Bank of Canada. RBC Capital Markets is a trademark of Royal Bank of Canada. Used under license.Copyright RBC Capital Markets, LLC 2011 - Member SIPC

Copyright RBC Dominion Securities Inc. 2011 - Member CIPFCopyright Royal Bank of Canada Europe Limited 2011

Copyright Royal Bank of Canada 2011All rights reserved


rbc market prediction

Documents