Real assets

While real estate-based mutual funds tend to underperform in times of sharply rising interest rates as well as during severe economic downturns, these funds have benefited from rising property values and low interest rates for more than a decade. According to mutual fund category performance figures from Morningstar Canada, the category’s robust 10-year average annualized gain of 11% as of July 31 handily beat the 7% average annualized return for both the international equity and Canadian equity categories as well as the 3.65% annualized return for global fixed-income over the same period.

Tom Dicker, vice president of Toronto-based 1832 Asset Management LP and lead portfolio manager of Dynamic Global Real Estate, is optimistic that the favourable market for real estate investing has more room to run. Global growth may have slowed from a year ago, but still is positive.

“The demand side for real estate is supportive pretty much everywhere in Canada and the U.S. – except in the traditional retail sector,” Dicker says.

Low interest rates have been good for REITs due to the healthy and “visible” long-term cash flow they produce, Dicker says. REITs also held up well during recent stock market corrections.

“Real estate tends to be less cyclical than many businesses,” Dicker says. “Many properties have contractual rents and long-term leases with predictable revenue. However, real estate is not recessionproof.”

During severe recessions, banks may turn cautious about lending and some building owners may find their occupancy rates and rental income declining, Dicker says.

“We look to invest in companies paying a reasonable and responsible yield that can grow on an annual basis with a fair degree of predictability,” Dicker says.

On a geographical basis, about 70% of the Dynamic fund’s assets under management (AUM) are based in Canada and the U.S., with some exposure to Asia and Europe. About 35% of AUM is held in Canada, which is overweighted on a global basis, although exposure to Alberta is minimal due to the negative impact of low energy prices.

“Canada is a wonderfully good place to invest in real estate,” Dicker says. “The fundamentals are stable, and there is a strong banking system that proved itself during the global financial crisis. The country has attractive long-term growth prospects with strong immigration, and [Canada’s real estate market] is not the boom-and-bust environment of the U.S.”

On a sector basis, the Dynamic fund’s biggest weighting is in multi-family residential real estate, which constitutes about 25% of AUM. Dicker also likes industrial real estate, particularly warehousing tied to e-commerce. A top holding in this sector is San Francisco-based Prologis Inc., a global owner/operator of industrial space with US$90 billion in assets. The fund also has holdings in specialty areas such as self-storage, cellphone towers and data centres.

Another key holding in the Dynamic fund is Canadian Apartment Properties REIT, the largest multi-family residential REIT in Canada. This REIT has been doing a good job selling off capital-intensive properties and buying higher-quality assets, says Maria Benavente, portfolio co-manager of the Dynamic fund. “Landlords are achieving double-digit rental income growth on turnover of apartments,” she says.

In the U.S., there are attractive opportunities in residential REITs focusing on the single-family rental market in the U.S. sunbelt from Arizona to Florida. A top holding in the Dynamic fund in this sector is Tricon Capital Group Inc., a Toronto-based company that holds most of its assets in U.S. rental housing. The company has assets of US$7.3 billion and, with growing scale, developed expertise in using technology to manage and maintain multiple properties more efficiently, Benavente says.

Seniors’ housing and health care-use properties also are promising; in this sector, the Dynamic fund holds Chartwell Retirement Residences, Sienna Senior Living Inc. and Ventas Inc.

Jeff Sayer, vice president of Toronto-based Ninepoint Partners LP and lead portfolio manager of Ninepoint Global Real Estate Fund, views the current economic environment as a mid-cycle growth slowdown. With interest rates low and possibly heading lower, he does not anticipate a global recession and says there could be years left in an extended moderate growth cycle.

“Global REITs generally tend to be a defensive investment, offering a steady income stream, modest capital appreciation and protection against inflation in the form of real assets,” Sayer says. “[REITs] also have low correlation to Canadian equities and Canadian income, [thus] offering attractive diversification opportunities.”

Sayer runs a concentrated portfolio of 25 to 35 names with allocations of about 75% to the U.S. and 25% to Canada. The Ninepoint fund hasn’t invested in the Asia-Pacific region for a while due to lacklustre growth prospects, and recently sold holdings in the U.K. and Germany.

“The European economy is slowing to a greater extent than in North America,” Sayer says. “Germany’s manufacturing has hit a slump recently, and we are also concerned about the impact of a hard Brexit.”

The Ninepoint fund is overweighted in industrial and residential REITs, which together account for about half the portfolio. Sayer likes REITs tied to technology-driven businesses, such as e-commerce, communications and cloud services. Solid fundamentals for multi- and single-family rental housing support high exposure to residential. Holdings in this last sector include Minto Apartment REIT and InterRent REIT.

The Ninepoint fund also holds about 14% in commercial office REITs, but has no exposure to traditional retail, hotels or resorts, which would be hurt during an economic slowdown, Sayer says. The fund’s office REITs focus on growth areas such as West Coast tech and medical centres rather than oversupplied traditional office space in cities such as New York.

A top holding in the Ninepoint fund is Equinix Inc., the world’s largest data centre and co-location provider through which several enterprises have servers in the same location. Equinix has 200 centres across five continents, and customers include huge cloud storage providers as well as thousands of smaller businesses.

“The digital transformation of business is a massive addressable opportunity, with more big data and analytics being moved to the cloud,” Sayer says.

Rather than seeking REITs with the highest yields currently, Sayer looks for REITs with the best potential to grow their distributions. Equinix’s dividend, for example, has a five-year compound growth rate of 10%.