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Real Estate Seen As Inflation Hedge

April CPI Climbs; Diversification gives REITs an edge over houses

By Garry Marr

June 17, 2008 (Financial Post) Worried about inflation? One Bay St. analyst says it is time to buy back into real estate.

Mandy Samols, of Raymond James, said real estate may be the perfect hedge against inflation.

She points to consumer prices in April accelerating for the first time in five months and the all-items index recording its sharpest month-over-month rise in almost two years, as a reason to look at inflation-proof investments.

"Real estate earned its reputation as an inflation hedge in 1970s, when home values and commercial property climbed along with food and energy," says Ms. Samols.

She argues that homes might not hold their value this time but real estate investment trusts will because they own commercial property and apartment buildings.

Citing sources, the analyst says cap rates on properties in the greater Toronto area have only climbed 20 to 25 basis points. The capitalization rate is the rate of the return on a property, the higher the cap the less a building is actually worth.

"We believe that, given Canada's population concentration in six major urban areas and the [Ontario provincial] government's implemented GTA greenbelt program, that ultimately the shortage of well-located real estate country wide and intensification efforts in the GTA will sustain existing cap rates on such properties in the GTA," said Ms. Samols in her report to clients.

Another key factor in REITs providing cover in an inflationary world is their ability to protect themselves from rising operating costs. In most cases tenants have leases in which they pay heat, hydro and taxes.

REIT landlords also have an ability to raise rents in an inflationary environment. The analyst claims REITs move out of step with stocks, giving investors a diversification advantage and another hedge against inflation.

If all else fails, says Ms. Samols, the Bloomberg Canadian REIT index shows the average yield in Canada is now 6.5% so investors get a healthy return even if the price of units go down.

So if you buy into her argument, what are her best bets?

Toronto-based First Capital Realty Inc. (FCR/TSX) tops the list even though it is not a REIT. Shares in the corporation are currently trading at in implied cap rate of 7%, according to the report. With "A" location properties trading in a 6% cap range, Ms. Samols says there could be further upside for the stock.

Her other safe bet against inflation is Calgary-based apartment owner Boardwalk REIT (BEIun/TSX). "The multi-residential real estate sector is arguably the most defensive investment," of all the real estate classes. "As the economy weakens people postpone buying a home and in doing so increase rental demand," says Ms. Samols.