Tight credit markets and the slumping economy have the unit prices of real estate investment trusts looking like roadkill. But, say analysts, cash distributions appear to be safe — for the most part.

For the year ended Jan. 31, 2009, the S&P/TSX capped REIT index fell by 40%. By and large, unit prices have been soundly thrashed. For example, a unit of Toronto-based Dundee REIT, which holds a portfolio of office and industrial properties, traded at $11.89 as of Jan. 31, a 62.7% drop from $31.90 a year earlier.

Barely any REITs have announced distribution cuts, however. In fact, some types of REITs — apartment and retail REITs, for example — are in relatively good positions to maintain their yields. Rental revenue and occupancy levels, which are key to the performance of these investments, haven’t been as severely affected by the downturn as they have for other types of REITs, such as those managing vacation properties and seniors’ homes.

“[Although] you won’t see anyone raising distributions, you won’t see too many REITs cutting them, either,” says Frank Mayer, chairman of Toronto-based Vision Capital Corp. , manager of Vision Opportunity Fund which focuses on publicly traded Canadian real estate securities. “Or else what would be their appeal?”

If a REIT does cut distributions, it may be for reasons not related to the downturn, such as drops in rental revenue. “[The REIT] may have been paying out too much cash to begin with,” says Mayer. “It may have mortgages that are maturing or debt coming due — you need to look at its overall financial picture.”

In general, REITs have been hit by the abrupt tightening of commercial lending. “Capital has become less available,” says Mayer, “and that has limited the number of transactions, which has pushed down real estate values. As a result, the prices of real estate securities have also plunged.”

REITs generally fall into the following categories: apartment, retail and office space, nursing and retirement homes, and hotels. Here’s a look at their prospects.

> Apartment Reits. If there’s a stable leg in the wobbly REIT market, it’s the residential sector. Total returns for apartment REITs declined by 18.2% for the year ended Dec. 31, the smallest drop among the REIT categories, according to a report from Toronto-based CIBC World Markets Inc.

“Unlike a hotel or shopping REITs, people can’t avoid having a place to live,” says Shant Poladian, equity research analyst of real estate with Canaccord Adams Inc.in Toronto. Also, as unemployment increases during the recession, there will be more demand for apartments, as people are more likely to rent than purchase a home.

Housing REITs — for example, Calgary-based Boardwalk REIT and Canadian Apartment Properties REIT of Toronto — may also benefit more from less expensive financing than other types of REITs. Unlike commercial or retail REITs, which use conventional insurance to cover their debt, housing REITs use debt insurance provided by Canada Mortgage and Housing Corp. of Ottawa. It charges lower insurance rates than conventional insurance policies and requires a lower equity amount when supporting apartment REIT projects.

“Because the federal government guarantee is there, the credit crunch on the residential side is not as severe,” says Mayer, “Money is not only available, but cheap.” With lower insurance rates, these REITs have more cash to pay out to investors.

But one black cloud over apartment REITs is the spectre of housing oversupply. In markets in which newly built condos outnumber buyers — Toronto, Edmonton and Calgary — apartment owners may be forced to lower rents to compete with declining condo prices. “Supply is the No. 1 thing that keeps us up at night,” says Roberto Geremia, president of Boardwalk REIT. “We adapt to the needs of the market in good and bad times, which may mean focusing on occupancy until the market gets hot again.”

> Retail And Office Reits. Declines in consumer spending are making life miserable for REITs that invest in retail space. According to the CIBC World Markets report, retail REITs as a group lost 34% in 2008.

“There’s no question the trade is facing a significant softening of demand,” says Peter Woolford, vice president of policy development and research for the Toronto-based Retail Council of Canada. “In a downturn like this, you would expect that some retailers in a weak situation will not be able to continue. They may close their doors; they may get bought out; they may go bankrupt; they may simply shrink.”

@page_break@So, if you think choosing a retail REIT with big box stores or “anchors” will keep you safe, think again, adds Poladian. Typically, REITs with tenants such as Mississauga, Ont.-based Wal-Mart Canada Corp. were believed to be more stable in recessions than REITs with smaller tenants. But with larger tenants, rental rates are usually capped for a prolonged period, which protects the REIT but doesn’t add to its income stream.

“From a landlord perspective, there should be no impact to the rental stream coming from Wal-Mart — in a good market or a bad market,” says Poladian. “It’s more a question of what happens to the other 80% of the tenants.”

Looking at the amount of a retail REIT mortgages coming due this year is also crucial, says Harry Levant, owner of Vancouver-based www.incomeresearch.ca. “This is one of the risks of investing in retail REITs,” he says. “Financing isn’t as available; if it is, the rate charged on it will be higher than usual.”

Rossa O’Reilly, real estate analyst with CIBC World Markets in Toronto, is more positive in his outlook for retail REITs. “The sharp drop we have seen in REITs’ unit prices reflects stock market investors’ sentiments toward REITs, not the way REITs’ businesses are actually going,” he says. “If you look at history, the amount of vacancy which has occurred in economic recessions occurs from new additions being added to the market, not from the amount of space being occupied. It’s also very difficult for new space to be added, since most of the prime locations are already locked up.”

Levant suggests the drops in unit prices for shopping centre REITs have been excessive. “Once this economic uncertainty passes, whether that’s in two quarters or two years, shopping centre REITs will become attractive again,” he says. “Their unit prices should recover to levels beyond what they are now.”

As for office REITs, the future is a little more problematic. “It will take office REIT prices longer to recover than shopping centre REITs,” says Levant. “They are more sensitive to the overall economic activity.”

> Nursing And Retirement Homes Reits. Canada’s boomer population is aging, but returns on retirement and nursing home trusts will not be getting any better, Levant says. The CIBC World Markets report notes the category lost 45% in 2008 — the most severe drop of all the sectors.

“The problem with retirement REITs is that your tenant is not a high-margin tenant,” says Levant. Services required by tenants range from a simple room rental to full- blown assisted living.

Although most retail and apartment REITs have a set number of fixed costs for maintaining properties, retirement and nursing homes require higher paid staff, such as on-call nurses and caregivers.

“If most seniors could afford to pay top rates for assisted living that would be one thing,” Levant says. “But there are not enough who can.”

> Hotel Reits. Even before the current downturn began, this sector had been hit hard by events such as the 9/11 crisis and the relatively high Canadian dollar. As the credit crisis took hold, unit prices were pounded.

“Hotel REITs have greater price volatility than other REITs,” says Levant. “Especially during economic upheaval, unit prices are on a slippery slope.” IE