Dundee Shows REIT No Haven as Bond Yields Rise

Dundee Real Estate Investment Trust and Calloway REIT are bearing the brunt of a rout among real estate, utility and telecommunications shares as rising bond yields reduce demand for high-dividend stocks.

Dundee and Calloway are the two worst-performing REITs this year through yesterday among 14 stocks in the Standard & Poor’s/TSX Capped REIT Index. The index has slid 8.5 percent since reaching a record high on April 30, three days before a stronger-than-expected U.S. jobs report sparked a rise in bond yields and speculation the Federal Reserve may begin to slow monetary stimulus. The index dropped seven straight days through June 5, the longest skid in three years.

“If you can get a guaranteed return of 4 percent versus a riskier stock paying a similar yield, obviously you’ll see a transition,” Michael Gregory, Toronto-based senior economist with BMO Capital Markets, said in a phone interview on June 5. “For those who moved into dividends as a substitute for fixed income, as rates begin to rise you’ll see flows back into the bond market.”

Dividends have provided some relief for investors in Canadian stocks, which are on track for their third year of underperformance against U.S. stocks. The broad S&P/TSX Composite index has risen 6.7 percent in the last 12 months, the worst performance among 24 developed markets tracked by Bloomberg. With dividends included, that return rises to 10 percent.

Vincent Delisle, investment strategist with Scotia Capital Inc.’s portfolio strategy group in Montreal, said the dividend trade and hunt for yields is at an end.

‘Head Fakes’

“Cyclicals will benefit from a rotation out of dividend-paying sectors,” Delisle said in a phone interview on June 5. High-yielding dividend stocks are “the priciest ones, they’re all trading at premiums,” he said.

Telecommunications and utilities have been the two worst-performing industries in the S&P/TSX in the past month, slumping 4 percent and 7.1 percent respectively.

These industries have been dragged down by weakness among companies including Canadian Utilities Ltd., down 9.1 percent, and Rogers Communications Inc., down 7.2 percent in that period.

“We’ve had head fakes in 2010, 2011 and 2012 but this year bond yields are turning and the upside is for real,” Delisle said.

Canadian 10-year government bond yields have risen 37 basis points to 2.04 percent since May 2, while yields on the U.S. 10-year Treasury note have jumped 45 basis points to 2.08 percent yesterday.

‘Step Down’

Ten-year U.S. yields will rise to 2.4 percent by the end of the year and increase to 4 percent at the end of 2014, levels not seen since 2008, Gregory estimates.

Yields on 30-year bonds jumped the most in seven months on May 3 after a government report showed the U.S. economy created 165,000 jobs in April, compared with economist forecasts of 140,000 in a Bloomberg survey, and the previous month’s tally was revised higher.

They continued to rise after Fed Chairman Ben S. Bernanke said May 22 the central bank could “take a step down in our pace of purchases” of Treasuries and mortgage debt it buys within “the next few meetings.” The Fed has been buying $85 billion in debt a month this year to keep yields low and foster investment in the U.S.

The Fed has pledged to maintain record-low borrowing costs as long as the jobless rate remains above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent.

Energy Attractive

“Absent continued disinflation and external shocks, we think the path of least resistance for bond yields will be a slight increase to 2.7 percent by year-end,” Stefane Marion, chief economist and strategist with National Bank Financial, said in a report June 4, referring to the U.S. 10-year yield. Marion changed his asset allocation, lowering utilities, telecommunications and staples stocks to underweight and energy stocks to overweight.

“We believe that earnings of Canadian energy producers will find support from the recent depreciation of the Canadian dollar,” Marion said. The Canadian dollar declined to C$1.03 per U.S. dollar yesterday from around parity on May 8.

REITs receive preferential tax treatment from the government and invest in income-producing real estate, such as shopping malls and nursing homes, and pay out most of their earnings to investors through unit distributions.

Still Borrowing

The REIT index rose 0.5 percent for a yield of 5.23 percent at 4 p.m. in Toronto today after Canada posted the biggest jobs gain in a decade and U.S. employment rose more than analysts estimated.

Michael Cooper, chief executive officer of Dundee REIT, said the rise in market interest rates is not affecting business.

“We’re able to borrow lots of money at very low rates,” Cooper said in a phone interview from Toronto today. “I wish the stock was doing better. We have lots of good days, and we have some days that aren’t as good. But the integrity of the business is in great shape.”

Calloway interim Chief Executive Officer Huw Thomas said the company is stable and the rising yield environment has not had any impact on their retail tenants.

“We have to manage for the long-term,” Thomas said in a phone interview today. “I’ve met with a number of unit holders, and we talked about the market in general and they see all REITs are down. If Calloway was down substantially and the rest were flat, I’d get many more calls.”

REIT Spinoffs

Brian Huen, managing partner with Red Sky Capital Management Ltd. in Toronto, said established REITs are too expensive, and would rather own them indirectly through holdings companies such as Dundee Corp. or a retailer like Canadian Tire Corp., which is planning to spin off its real estate holdings into a REIT. Loblaw Cos. is also crafting a REIT from its retail properties.

In such a case, investors will get a boost from real estate holdings that were undervalued while held within a company’s balance sheet, he said.

“The valuation arbitrage exists and the window of opportunity is now,” Huen said in an interview by phone June 3. His firm manages about C$220 million ($216 million). “You don’t want to do it when values are low. The window of opportunity is probably for the next six months to a year. You’re still seeing lots of interest in REITs.”

Want Yield

Companies have raised $782.8 million from six Canadian initial public offerings this year, including Milestone Apartments REIT and Agellan Commercial REIT, to account for 58 percent of the $1.36 billion raised from initial offerings, data compiled by Bloomberg show.

Companies raised almost $500 million in seven REIT IPOs last year, more than any other industry in Canada, the data show.

“Retail and institutional investors are trying to figure out a solution to a problem -- they want to lend against a real asset and get yield for it,” Eric Bushell, chief investment officer with CI Investments Inc., said in a phone interview from Toronto. He manages C$40 billion for Signature Global Asset Management.

“That’s why you have companies like Loblaw’s and now Canadian Tire spinning out their real estate. They’re restructuring, which is exactly what we did during the income trust cycle. The risk is a ’herding’ behavior -- investors are left with no option but to pursue this strategy.”

Before it's here, it's on the Bloomberg Terminal.