Priced to sell at Canadian retailers: their real estate holdings
Canadian retailers have been putting a new product on their shelves – their land – and we should thank them for it.
Canadian Tire Corp. is the latest company to announce that it is spinning off its property holdings, with the creation of a $3.5-billion real estate investment trust that should hit the market in the fall.
Before that, Loblaw Cos. Ltd. said it would put its considerable property portfolio into a separate entity, potentially valued at $7-billion. Hudson's Bay Co. and Tim Hortons Inc. could be next.
For skeptics, the moves smack of financial engineering, where companies try to juice their share prices with moves that have nothing to do with improving their underlying businesses. The timing of these moves also raises concern that they are exploiting our insatiable desire for income-generating investments by pushing out new REITs at the top of a frothy market. The 14-member S&P/TSX Capped REIT index has surged more than 170 per cent since early 2009 (not including dividends), or nearly triple the gain for the broad S&P/TSX composite index.
However, not every good purchase has to land in the bargain bin to look attractive. If you like steady cash flow and stable business operations, there's a lot to like in what retailers are now selling.
The hot market for REITs is no doubt contributing to the timing of these upcoming real estate spinoffs, but it's hard to see Canadian retailer executives as uncanny market timers or interest-rate psychics, looking to cash in on a once-in-a-lifetime opportunity.
If Stephen Wetmore, the chief executive of Canadian Tire, were so wily, he wouldn't have sold a quarter-million Canadian Tire shares from his personal holdings in 2012, missing out on a 30-per-cent rally since then.
The truth is these retailers need the cash, and spinoffs are the way to get it. U.S. rivals – from Wal-Mart Stores Inc. and Target Corp. to Home Depot Inc. and Lowe's Cos. Inc. – are a rising menace on the Canadian retailing scene. The home team needs all the help it can get, and extra financial padding is part of it.
REITs have enjoyed a good run, thanks to a long period of exceptionally low interest rates that have made income-generating investments shine next to low-yielding bonds.
But the sector doesn't exactly scream cra-zee. Despite the heady gains, enthusiasm has levelled off: The REIT index is up less than 6 per cent over the past year. REIT unit prices compared to funds from operations – a key valuation metric in this sector – averages less than 17. That's high, but not perilously high.
The index also yields an attractive 4.9 per cent. That's low, but not when you consider that the Bank of Canada's key interest rate is parked at just 1 per cent. At the end of 2006, REITs yielded 5.2 per cent, but the Bank of Canada rate was a much higher 4.25 per cent.
Today's wide spread between yield and rates implies that rate increases are already being priced into REITs, even though the central bank is faced with low inflation, a creaking housing market and a slowing economy – hardly the sort of backdrop to aggressive tightening of monetary policy.
As for the real estate spinoffs themselves, what's not to like? They come with stable tenants and a diversified geographic base. And the aggressive move by U.S. retailers into this country shows that Canadian retail space is in high demand, which should ease concerns about the new REITs being confined to just one retailer each.
It's easy to overlook Canadian retailers when U.S. stores are invading with exciting brands and competitive prices. Canadian real estate holdings, though, deserve a loyal following.