Report: CIBC Analyst Turns Bearish on REITs

After a great 25-year run, one CIBC analyst has turned decidedly negative on Canada’s REIT sector.

The thesis from CIBC’s research report goes something like this. REITs have grown over the last 25 years because there was very little institutional money chasing real estate. There’s far more competition these days, primarily from non-taxable pension funds who have significant tax advantages to publicly-traded REITs.

In addition, pension funds can borrow at lower rates than many REITs, which allows them to bid higher when attractive properties come available.

When a publicly-traded REIT disposes of a property, any capital gain is passed onto unit holders. This creates a taxable event. Pension funds have no such disadvantage.

REITs in the United States can defer taxes by investing the proceeds of a sale into a similar investment within a certain amount of time.

This is referred to as a like-kind exchange. Similar rules exist in many other countries, while other places don’t charge capital gains taxes.

For many REITs, this capital gains issue isn’t a big deal. They’re acquiring far more assets than they sell. A portion of the distribution is classified as capital gains and investors simply pay the tax.

Or a REIT can implement a strategy like RioCan Real Estate Investment Trust (TSX:REI.UN). RioCan is sitting on numerous properties in the Toronto area that have appreciated significantly since they were purchased. RioCan plans to redevelop many of them, which is an uncomplicated way around the capital gains problem. There’s no tax if you don’t sell.