The low interest rate environment that’s prevailed in the aftermath of the 2008-09 global meltdown variously known as “The Great Recession” and/or “The Great Financial Crisis” has allowed North American real estate investment trusts (REIT) to fix and strengthen their balance sheets.

Unit prices for US and Canadian REITs have rallied strongly over the past half-decade, as they attracted traditional bond investors because of their relatively high yields while financial and operating metrics benefitted from their ability to raise low-cost capital.

A series of events–unfortunate, if you’re a REIT investor–has raised the important question of whether this party is over.

A better-than-expected employment report from the US Dept of Labor on May 3 sent the yield on the global standard for risk-free return higher, and a month-long rout of dividend-paying equities ensued.

Indications from US Federal Reserve Chairman Ben Bernanke that the central bank’s program of “quantitative easing” could end sooner rather than later inflamed speculation of higher rates from here. And, indeed, yields on risk-free instruments such as the Canadian 10-year government bond and the 10-year US Treasury note are rising.

Unit prices of real estate investment trust (REIT) on both sides of the border have experienced a strong uplift in an environment of shrinking benchmark yields, as investors sought the best combination of yield and risk as the rate of return on ostensibly risk-free assets such as government bonds approached zero.

Based on historical data, going back to the beginning of the long-term period of declining interest rates that began in the early 1980s, it’s safe to assume that interest rate increases are likely to be met by REIT price declines. In fact all you have to do is check the tape this week to see this happening in real time.

It’s difficult to draw any hard-and-fast conclusions about the direction of REIT returns relative to rising interest rates based on the recent historical record, however, as most of the period has been dominated by a secular–or long-term–decline in interest rates.

There is a negative correlation between the FTSE NAREIT Equity Index and the 10-year US Treasury yield that suggests an inverse relationship.

This conclusion would be more compelling if the few periods of sustained rate increases since 1972 were met with declines in the NAREIT Index. Contrariwise, increases occurred simultaneously: During the five-year period from December 1976 to October 1981 10-year Treasury rates leaped from 6.87 percent to 15.15 percent but the value of the NAREIT Index gained an impressive 15.8 period during the same period.

It’s important to step back at moments such as this and not be carried away by the frenzy of crowds. Official rates have spiked, yes, but the yield on the 10-year US Treasury note has just pierced 2 percent, while the similar Canadian bond yield has also just climbed above 2 percent.

At the same time, this is only speculation about what the Fed will do with its program of “quantitative easing” in coming months. Commentary from voting members on the key central bank’s Federal Open Market Committee has been far from conclusive, and data, to be fair, remains mixed.

For example, though the US Dept of Labor reported on Friday morning, June 7, that a better-than-expected 175,000 jobs were created during May, the unemployment rate ticked up to 7.6 percent from 7.5 percent. And the Fed has said it will maintain its easing until the unemployment rate is below 6.5 percent.

One Direction?

Rising interest rates and talk of cessation of the Fed’s extraordinary activities to keep them low indicates the US economy is returning to a more normal condition. This would almost certainly help the Canadian economy, as the North American duo still comprises the biggest bilateral trade relationship in the world.

Underlying operations for retail, industrial and office REITs actually stand to benefit from a return to long-term growth trends.

Theoretically, unemployment in both countries will decline and wages and disposable income will rise, thus allowing for increased consumer spending, with the knock-on effect of higher rents.

Of course longer-term shopping trends must be taken into account in the age of the Internet; investors must be selective when it comes to identifying REITs that own and operate properties occupied by retailers that still enjoy old fashioned foot traffic.

On the other side of this coin are REITs that own industrial properties used to warehouse all the goods bought and sold through websites such as Amazon.com and Zappos.com.

You need to be selective in this environment. The good news about REITs is that high yields are a sort of hedge against price declines: If you buy a high-yield REIT, any price decline will be mitigated by high income in the meantime.

Top Picks

Our preferences in the REIT space are based on predictability of cash flow and stability of dividends. We like apartment-focused REITs for their generally defensive characteristics and strong internal growth profiles. Select industrial, office and retail-focused REITs will benefit from strengthening underlying economic fundamentals.

Exposure to the US is a plus, as is strong presence in Western Canada, due to the respective regions’ forecast growth in the medium term.

Artis REIT (TSX: AX-U, OTC: ARESF) owns and operates a diversified portfolio of office, retail and industrial assets, with a concentration in Western Canada.

Management reported improvement across all operating metrics during the first quarter, including net operating income (NOI), funds from operations (FFO), adjusted funds from operations (AFFO) and debt-to-gross book value. Metrics on a per unit basis also continue to show growth.

And Artis recently earned an investment-grade rating by DBRS, which will help the REIT lower its cost of capital for the future.

Total debt-to-gross book continued to decline, partly due to appreciation in the portfolio’s assets but also due to a decision by management to reduce leverage; management expects to continue this effort through 2013 and into 2014.

At the end of the first quarter mortgage debt-to-gross book value was 46.1 percent, down from 47.3 percent at the end of 2012, and total debt declined to 50.2 percent from 51.5 percent.

The REIT’s weighted average interest rate declined by another 11 basis points compared to the end of 2012.

As for operations, total revenue was CAD71.5 million for the quarter, up from CAD52.8 million a year ago, with growth driven by acquisitions as well as same-property expansion. Same-property revenue was up 2.4 percent, beating management’s guidance for flat performance.

FFO for the quarter was CAD0.38 per unit, up from CAD0.34 in the fourth quarter and CAD0.31 a year ago. The payout ratio based on the current quarter is 71.1 percent of FFO versus 87.1 percent in the first quarter of 2012.

Artis REIT is a strong buy under USD16 for its attractive yield and solid market exposure, including Western Canada and a growing presence in the US.

Canadian Apartment Properties REIT (TSX: CAR-U, OTC: CDPYF) raised its distribution by 2.6 percent, its third payout increase in less than a year.

Management reported 21.1 percent growth in first-quarter operating revenue, primarily due to contributions from acquisitions completed in what was a record growth year in 2012.

Net operating income (NOI) increased as a result of the solid revenue growth, including 3.8 percent in same-property NOI. NOI margin was down slightly at 55.1 percent due to higher utility costs but remains strong. Average monthly rents increased across all segments of CAP REIT’s residential suite portfolio, resulting in overall growth of 2 percent.

Despite in the approximate 20 percent increase in the weighted average number of units outstanding, growth was highly accretive, with net funds from operations per unit up 8.7 percent and the payout ratio improving to 79.3 percent from 83.5 percent a year ago.

As for the balance sheet, coverage ratios remain very strong, with interest coverage continuing to exceed two times. CAP REIT’s weighted average interest rate declined further, and management continued to focus on extending debt maturities with the use of 10-year term mortgage debt.

Total mortgage refinancings of CAD253 million were closed during the quarter, including CAD152.6 million for renewal of existing mortgages and CAD110.4 million for additional top-up financing. The average term to maturity for these financings was 10 years, with a weighted average interest rate of 2.94 percent, much lower than the maturing rates.

Management expects to execute between CAD575 million and CAD625 million in total mortgage renewals and refinancings in 2013. And liquidity is strong, despite the record portfolio growth of 2012.

CAP REIT boasts solid internal growth prospects that continue to translate to strong returns for investors. Buy under USD25.

Dundee REIT (TSX: D-U, OTC: DRETF), one of the two Best Buys identified in the May 2013 issue, reported adjusted funds from operations for the first quarter of CAD0.61 per unit, up from CAD0.57 in the fourth quarter of 2012. Year-over-year comparative property NOI growth was 0.7 percent.

The payout ratio for the period was 76.3 percent, up slightly from 74.3 percent a year ago but down from 80.9 percent in the fourth quarter.

Management reported high overall occupancy, though the rate did decline by 40 basis points from the fourth quarter, and in-place rents continue to rise.

Committed occupancy as of the end of the first quarter was still a healthy 94.7 percent, above the national industry average of 91.5 percent.

The sequential slip was driven by a 69,000 square foot tenant, Jacobs Engineering, leaving Highfield Place in Edmonton, 20,000 square feet of contraction by the Alberta government in suburban Calgary and negative absorption of 21,000 square feet in the Toronto suburban west market.

Leasing activity remains strong as well, with the REIT completing 713,000 square feet during the first quarter, 57 percent for renewals and 230,000 square feet for new tenants.

To date, Dundee has leased 67 percent of its 2013 expiries. Overall leasing spreads are 12 percent over expiring rent, with a 7 percent positive spread on renewals. And management is completing deals at market rents higher than original internal estimates.

Management noted that all the REIT’s debt metrics are stable, with the ratio of debt-to-gross book value decreasing to 47.3 percent from 48 percent at the end of the fourth quarter and the weighted average interest rate steady at 4.5 percent.

Dundee REIT is a buy under USD39.

Northern Property REIT’s (TSX: NPR-U, OTC: NPRUF) financial results are beginning to stabilize following the sale of the seniors housing portfolio during the second quarter of 2012, though management did report an uptick in vacancies.

Vacancy rose to 6.4 percent from 6.2 percent as of the fourth quarter due to industry slowdowns in Northern British Columbia, specifically related to natural gas activity.

During the spring drilling programs come to a close and road bans are put into place, though incentives played an important part of minimizing the effects of vacancy.

In April the town of Fort Nelson signed a fair-share agreement with the BC provincial government to fund infrastructure improvements to the tune of CAD10 million per year for the 20 years beginning in 2015. Management expressed cautious optimism that vacancy will decrease with construction season starting in June and, with gas prices increasing, the possibility of higher activity late in 2013.

Northern Property posted FFO per unit of CAD0.50 in the first quarter, down from CAD059 a year ago. The decrease is a direct result of the sale of the seniors housing properties in the first half of 2012. FFO per unit from continuing operations was CAD0.50 and CAD0.48 in the same quarter last year, which demonstrates that the REIT is beginning to replace some of the lost income from the asset sales.

Management anticipates it’ll take another 12 to 18 months to fully replace what was lost, as new developments come online and new acquisitions are completed.

The FFO payout ratio for the first quarter of 2013 was 77.2 percent, up from 64.4 percent in 2012.

Northern Property continues to maintain one of the strongest balance sheets among multi-family Canadian REITs, with debt-to-gross book value at 41.5 percent, a debt service coverage ratio of 2.13 and interest coverage of 3.6 times.

Management completed approximately CAD18 million of mortgage renewals and financing in the first quarter–a relatively light total–on a weighted average rate of 3.21 percent.

In the days leading up to management’s first-quarter conference call Northern Property locked in fixed rates on three mortgages at 2.68 percent, 2.72 percent and 2.73 percent for 10-year, Canadian Mortgage and Housing Corp-insured mortgages. The potential for financing over the rest of 2013 is approximately CAD100 million, with about CAD40 million up during the second quarter.

A high-quality REIT focused in one of Canada’s key growth provinces, Northern Property is a buy under USD30.

RioCan REIT (TSX: REI-U, OTC: RIOCF) is Canada’s largest real estate investment trust.

RioCan reported operating FFO of CAD124 million, an increase of CAD21 million, or 20 percent, compared to operating FFO of CAD103 million in the first quarter of 2012. On a per unit basis operating FFO increased by CAD0.04, or 11 percent, to CAD0.41 from CAD0.37 a year ago.

The increase is primarily due to the increased NOI from rental properties of CAD19 million, which is due to acquisitions, same-property growth of 0.3 percent and 1.4 percent for the Canadian and US portfolios, respectively, and the completion of greenfield developments.

Management also reported higher development fees, which were partially offset by higher interest expense and higher general and administrative expense.

RioCan completed two senior unsecured debenture offerings thus far in 2013. The first was a five-year CAD250 million offering with a coupon of 2.87 percent that was completed during the first quarter. The second offering was a 10-year, CAD200 million offering with a coupon of 3.72 percent completed early in the second quarter. The latter replaced a 5.65 percent debenture initially due in 2015.

By refinancing it early management smoothed out its debt ladder to extend 2015 maturities and put the REIT on its preferred pace to have 10 percent to 15 percent of its debt mature each year. This allows RioCan to opportunistically manage its debt structure and manage risk. It also ensures it’s not exposed to the potential volatility arising from sudden moves in interest rates and exposure to large maturities that could leave it vulnerable in any given year.

Coverage metrics continued to improve. Interest coverage was 3.02 times as of March 31, 2013, while debt service coverage was 2.21 times. RioCan’s debt to total asset ratio on a proportionate basis was 43.7 percent, up slightly from 43.6 percent as of Dec. 31, 2012.

As for operations, during the first quarter RioCan leased 352,000 square feet, compared to 332,000 square feet in 2012, with a significant increase in base rates to CAD19.70 per square foot from CAD15.84 a year ago. Management reported a normalized retention rate of 85.8 percent, down from 91.2 percent a year ago. Trends were solid across all of its categories, including new-format retail, grocery and urban retail.

As for portfolio occupancy, in Canada RioCan is running at 97 percent, up from 96.9 percent a year ago.

In the US occupancy is 97.4 percent, and renewal retention remains very strong. Management reported “a good uplift” in same-store growth, with average rents of approximately USD20.22 a foot.

RioCan, with a portfolio of high-quality locations anchored by a diversified array of high-quality tenants on both sides of the border, is a buy under USD27.   

Other Action

We’ve raised our rating on Canadian REIT (TSX: REF-U, OTC: CRXIF) from “hold” to “buy” based on the company’s solid first-quarter results, including a 6.4 percent dividend increase, as well as the fact that this selloff has left it at a compelling valuation.

Canadian REIT has now raised its dividend four times during the past 12 months.

The diversified REIT with retail, office and industrial properties is run by a highly disciplined management team with a tight focus on operations and maintaining portfolio quality. It also features a relatively low payout ratio and a strong balance sheet. Canadian REIT is now a buy under USD44.

Dundee Industrial REIT (TSX: DIR-U, OTC: DREUF), spun out from Dundee REIT in October 2012, boosted its dividend by 3.7 percent.

Bay Street looks on the REIT quite favorably, with all five analysts who cover the stock rating it a “buy.”

Dundee Industrial offers exposure to an improving Canadian industrial sector, stable cash flows, solid growth prospects and an attractive yield of approximately 7 percent. Buy Dundee Industrial REIT under USD11.

InterRent REIT (TSX: IIP-U, OTC: IIPZF) made the most dramatic change to its distribution policy in the aftermath of first-quarter results, boosting its rate by 25.5 percent. Even with the increase InterRent’s payout ratio remains among the lowest in the industry.

We like this owner of multi-family residential properties in the key Toronto market enough following its results for the first three months of the year and the dividend increase to boost it from “hold.” Buy InterRent REIT under USD6.

We’ve cut Cominar REIT (TSX: CUF-U, OTC: CMLEF) to “hold” due to a rising payout ratio amid declining recurring funds from operations and occupancy, though debt metrics have improved. Cominar REIT is a hold.