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Real estate stocks prove a hot property

Preliminary data show sector was the top-performing fund category in August, and managers see long-term gains to come

FUNDS REPORTER

Real estate stocks could lose easily some steam after their recent surge, but the battered sector still has legs, fund manager Keith Taylor says.

"I am still bullish because the valuations are still fairly decent," said Mr. Taylor, a manager with Jones Heward Investment Counsel Inc.

"There could easily be pullbacks, but I think the long-term prospects are still quite solid," said Mr. Taylor, who co-manages BMO Guardian Global Real Estate Mutual Fund.

"In the Canadian sector, dividend yields are about 8.5 per cent. You get paid to wait. ... And a number of the companies have also raised capital over the last six months, so the leverage has come down, and they have opportunities to buy any distressed assets if they happen to come to market."

Real estate equity was the top-performing fund category in August with an average 8.4-per-cent gain, according to preliminary data released yesterday by Globe Investor. (The BMO fund rose 9.7 per cent.)

A rally in the real estate sector has been fuelled in recent months by a declining concern about the ability of real estate firms - particularly in the United States - to refinance debt as credit markets have loosened.

Many real estate investment trusts (REITs) have also reduced their leverage by issuing stock and using the proceeds to pay down debt.

The MSCI U.S. REIT index is trading close to 500 points after surging from under 300, but that is still well off its peak of over 1,000 points in 2007, Mr. Taylor said.

The manager, who has in excess of 30 per cent of his fund in Canadian securities, said he has confidence in the domestic real estate sector.

"The Canadian REITs and real estate sector have not been affected by some of the financing problems with the same severity as the United States," he said.

"We do expect there will likely be a few more bumps in the road. There will be some real estate players that may be shut out of the credit markets going forward - some that may not be able to roll over their debt."

Charles Dillingham, a portfolio manager at Morguard Financial who runs the CIBC Canadian Real Estate Fund, has taken some profits recently, but still believes that real estate "is a market you want to stay in."

Canadian REITs have seen buying interest from domestic and U.S. investors because of their attractive yields now that many income trusts are converting to corporations and royalty trusts have cut distributions, Mr. Dillingham said.

"We have had a heck of a move," the manager said. "REITS have come back to reasonable value but they are no longer fantastically cheap. They are still making good yields, and the good ones will continue to do well."

Mr. Dillingham said he is still "very cautious" in his stock picks, adding that "it's not a market to go for low-quality anything. Names like First Capital Realty Inc., Boardwalk Real Estate Investment Trust, Brookfield Asset Management Inc. and Canadian Real Estate Investment Trust (CREIT) are among his favourites.

"We have gone more heavily into CREIT," said Mr. Dillingham, whose fund was up 8.9 per cent last month. "It is one of the best REITS in the country. It's diverse because it has office, industrial and retail space and is always very disciplined with a low payout ratio."

As long as the economy stays the way it is and starts to improve, then there will be no real concerns, he said. "If in a year from now, the economy is really soft, then you'll start to see more and more tenants getting into trouble and problems develop in the REITS and their income flows."

Given the surge in Canadian real estate securities, he is now looking for more upside from foreign securities. "We are looking for appreciation in the United States, which has come down further, and at England and the Asian market," he said.

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How fund categories fared in August

Top 10 Group avg. 1 mo. return Group avg. 3 mo. returnGroup avg. 1 yr. return Group avg. YTD
Real Estate Equity8.4%16.8%-21.0%14.1%
Financial Services Equity6.6%16.8%-16.2%29.0%
European Equity6.2%12.5%-19.2%10.0%
International Equity5.3%12.1%-14.1%12.0%
Global Small/Mid Cap Equity5.0%12.4%-15.2%23.1%
Cdn. Small/Mid Cap Equity4.8%8.4%-18.2%27.4%
U.S. Equity4.2%10.0%-18.9%6.3%
Japanese Equity4.1%10.4%-9.0%1.9%
U.S. Small/Mid Cap Equity4.0%12.9%-19.6%10.3%
Cdn. Focused Small/Mid Cap Equity3.8%8.3%-18.6%27.7%
Bottom 10
Greater China Equity-5.9%5.8%1.2%27.4%
Asia Pacific ex-Japan Equity-1.5%7.9%-2.0%25.0%
Canadian Inflation Protected Fixed Income-0.4%4.6%-2.7%7.8%
Retail Venture Capital-0.4%-2.2%-15.2%-4.9%
Canadian Money Market0.0%0.0%0.8%0.3%
U.S. Money Market0.0%0.0%0.7%0.2%
Cdn. Short-term Fixed Income0.5%1.1%4.2%2.5%
Precious Metals Equity1.1%-2.3%4.5%33.3%
Emerging Markets Equity1.1%9.9%-12.9%35.7%
Asia Pacific Equity1.1%9.8%-4.2%18.3%
Average for All Funds 2.4%6.9%-10.7%12.2%
S&P 500 Composite 3.4%11.0%-20.4%13.0%
S&P/TSX Composite Index 0.8%4.8%-21.1%20.9%
Source: Globe Investor

© 2007 The Globe and Mail. All rights reserved.

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