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REITs take a back seat in real estate market

RioCan holds the corner of Richmond and Portland streets in Toronto.


There is a shift taking place in the commercial real estate industry, with real estate investment trusts hunkering down and pension plans and private equity funds picking up the slack.

The hammering that REITs are taking in the market is weighing on their appetite to buy real estate, from office buildings to shopping malls to apartment buildings and factories. REITs accounted for just 29.3 per cent of the $14.7-billion that was invested in Canadian commercial real estate acquisitions during the first half of this year, compared to 48.2 per cent of the $14.8-billion spent in the same period last year, when they were the biggest player in the game, according to a report to be released this week by CBRE Ltd. The volume of acquisitions that REITs made in June fell 49.7 per cent from May.

But CBRE is actually boosting its forecast for the total amount of commercial real estate that will change hands this year, to between $26-billion and $27-billion up from its prior estimate of $24-billion to $25-billion, as private equity firms and pension plans step into the gap. Private equity accounted for 13.6 per cent of investment volume during the first half of this year, up from 2.4 per cent a year earlier. Pension funds accounted for 13.2 per cent, up from 9.8 per cent.

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"This period of opportunity is not being overlooked by those who struggled to compete with the REITs last year," says CBRE chairman John O'Bryan.

The market values of REITs has been sliding because investors are worried about the impacts of rising interest rates. Yields on 10-year government of Canada bonds have risen from below 1.75 per cent in May to above 2.5 per cent. The market is concerned about the impact that this will have on REITs mortgage costs down the road. Rising interest rates also mean that there is more competition for money from investors who are searching for yield.

The hunt for yield had helped to propel REITs to new heights, with the S&P/TSX Capped REIT Index posting a total return of 17 per cent last year. But that index has dropped more than 15 per cent in the last three months, as bond yields have spiked.

Canadian pension plans, meanwhile, are dedicating a higher proportion of their portfolios to real estate than ever before. Pension funds were holding $116.1-billion worth of real estate last year, according to the Pension Investment Association of Canada, and now allocate more than 10 per cent of their assets to the sector.

With the REITs concentrating on improving their existing operations, rather than expanding, CBRE still expects that total amount of commercial real estate investments this year to fall short of the $30.5-billion worth of deals that were done last year. But if its forecast of $26-billion to $27-billion proves correct, 2013 would be the third strongest year on record.

Nearly all of that activity stems from Canadian companies and funds, with foreign players accounting for only 1.6 per cent of the investments during the first half of this year.

"The outlook remains cautiously positive," Mr. O'Bryan says. "With the 10-year bond now settling around 2.5 per cent and spreads remaining tight, deals continue to get done."

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CBRE says the return that investors expect based on the rent or income that the property generates have begun to stabilize this year in the wake of four consecutive years of declines.

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