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REIT investors face uncertainty under new rules

Investors have come to rely on real estate investment trusts for predictable earnings and steady payouts, but changes to accounting rules could make the next month of earnings reports a confusing jumble of hits and misses.

The companies will be reporting under International Financial Reporting Standards (IFRS) for the first time, which means they'll have greater flexibility in how they report key metrics, such as funds from operations. They'll also be placing a value on their own portfolios – something international companies have done for years.

"Balance sheets and earning statements are about to get a whole new look," said Neil Downey, an analyst at RBC Dominion Securities Inc. "We believe this has created a blurring of expectations within consensus estimates. And frankly, on some disclosure fronts, we aren't sure what to expect."

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Brookfield Office Properties will be the first to report Thursday. Companies have been given a 30-day extension by the Ontario Securities Commission to put their results together under the new standards, so earnings season will last well into June.

What are the changes?

Canada is among 110 countries that have agreed to the new standards, which are intended to provide a consistent measuring stick and improve transparency and disclosure globally. The reporting standards are "principles-based", rather than "rules-based."

The idea is to provide greater detail when reporting numbers – companies must explain why they have decided to treat a number a certain way in notes sprinkled throughout their financial statements. They have had more than two years to prepare for the new method.

One of the key changes will be how REITs report the value of their holdings. Analysts and investors used to have to do their own guesswork, but now the companies have two choices: Value the portfolio based on current market value or based on historical prices. Either way, it adds up to more information for investors.

"That is a huge value for analysts and investors," said Michael Smith, an analyst at Macquarie Securities. "It's also a big deal for international investors, who may take more notice of the REITs now that they are reporting those numbers."

There are plenty of things that will stay the same, however, said CIBC World Markets analyst Alex Avery.

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"As investors work through the details of the new financial disclosures, comfort can be taken that there are several metrics that will remain unaffected by the changes accompanying IFRS adoption: same-property net operating income growth (cash-basis); occupancy statistics; adjusted funds from operations; and, perhaps most importantly to investors in REITs, the income they generate, and the ability to continue to pay distributions," Mr. Avery wrote in a report.

How have REITs performed this year?

Canadian REITs have been buoyed by a strong Canadian real estate market - which has kept their buildings full - and easy access to the capital they need to keep buying properties to add to their portfolios.

The trusts have gained 9 per cent on the S&P/TSX so far this year, outpacing the broader index, which has returned 4 per cent. Most asset classes have seen strong returns, with retirement and long-term care companies seeing gains of 28 per cent and residential REITs gaining 10.5 per cent. Only the hotel subsector saw a decrease, down 10.7 per cent.

What's expected for the rest of the year

It's been an intense couple of years for REIT investors. In 2008, they suffered through the worst single-year return on record as they watched their units decrease in value by 34 per cent. But in the next year, the trusts were able to tap the capital markets for $4.6-billion and spent upwards of $6-billion adding to their portfolios.

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"With solid Canadian property fundamentals, stable-to-modestly-higher interest rates and prospects for continued large capital flows, we expect REIT prices could be volatile in 2011, with REITs trading close to net asset values and unit prices rising approximately 3 to 8 per cent over the next 12 to 18 months," Mr. Avery said. He expects REIT units will yield between 6 and 7 per cent.

REIT returns


Retirement/long-term care: 28%

Apartments: 10.5%

Shopping centres: 10.1%

Diversified commercial: 8.8%

Office: 7.3%

Hotel: -10.7%

Overall: 8.8%

Source: Bloomberg, CIBC World Markets

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