TORONTO (TheStreet) -- Real estate investment trusts have been a staple in investors portfolios for many years. Their stability and income make them a natural fit for investors desiring both yield and capital appreciation. Too often, however, investors never look beyond their borders to find the "best of the best" investment.

There are multiple reasons why many prefer to stay within the confines of their own borders: differing accounting standards, tax implications, legal/regulatory differences and, at times, the difficulty in monitoring one's positions.

What if you were told that there is a best in class REIT located just north of the United States? Sound appealing? Then if you were told that just about any retail REIT that wants to do business in Canada typically goes to this REIT to get it done, would that be interesting? These are not rhetorical questions, these questions are a roadmap to RioCan REIT (RIOCF.PK in the U.S. or REI in Canada).

RioCan describes itself as "Canada's largest real estate investment trust with a total capitalization of approximately $13 billion as at March 31, 2012. It owns and manages Canada's largest portfolio of shopping centers with ownership interests in a portfolio of 333 retail properties, including 10 under development, containing an aggregate of 80 million square feet including 46 grocery anchored and new format retail centers containing 12 million square feet in the United States through various joint venture arrangements."

The five driving factors of REIT performance and stability (those attributes which draw investors into the REIT sector) are:
  • Diversity: In order for a REIT to produce consistent results, they must have a diverse portfolio - both geographically and by tenant.
  • Occupancy: Occupancy is the life blood of a REIT as tenants create the net operating income and funds from operations.
  • Leverage: While it is best for a REIT (or any company) to utilize leverage to increase returns, too much leverage increases the chance of financial distress. With a REIT, consideration must be paid to the use of mortgage debt relative to total debt as encumbered assets do not necessarily add a "safety cushion" for investors.
  • Funds from operations: Ultimately, the product of the REITs operating performance has to show up in the REITs funds from operations.
  • Distributions: At the end of the day, many REIT investors are income focused investors and the purpose of number 1 through 4 above is to ensure dividend stability and growth.


As some are not as familiar with the Canadian provinces as they are with the states, here are a few facts to help put RioCan's geographic diversity in perspective (from Statistics Canada):
  • The population is not distributed uniformly throughout Canada's territory. The vast majority of people who make up the population of Canada live in the southern part of the country, near the American border, leaving the northern areas largely uninhabited.
  • The strongest concentrations of population are located, firstly, along the axis extending from Québec city to Windsor, that is, along the St Lawrence River and lakes Ontario and Erie, and secondly, in Western Canada, in Vancouver and Victoria in British Columbia and the area extending from Calgary to Edmonton in Alberta.
  • In 2006, Canada's population was very largely concentrated in four provinces: Ontario, Quebec, British Columbia and Alberta. Approximately 86% of Canadians in 2006 were living in one of these four provinces. The 12.7 million Ontarians alone account for nearly 40% of Canadians.
  • In 2006, more than four immigrants out of five (85%) choose to settle in Quebec, Ontario or British Columbia. Ontario alone received half of Canada's newcomers in 2006, whereas the demographic weight of that province was less than 40%.

With that in mind, here is a snapshot of RioCan's geographic diversity:

(Source: company filings, compiled by Rubicon)

As the above chart and table shows, RioCan is strategically located in the most populated areas of Canada and some of the higher growth areas of the United States. Geographically, the RioCan portfolio is adequately diverse.

The following is a snapshot of the company's tenant base:

(Source: Company filings)

The top 10 tenants represent only 30% of the company's annualized revenue and have longer remaining lease terms. Due to these factors, the company's tenant base is adequately diverse.

RioCan REIT has desirable diversification attributes as they are located in more populated geographic areas as well as higher growth areas and their tenant base is stable with no outsized exposure to any one tenant.


While most retail REITs typically have an occupancy rate in the low to mid 90% area, RioCan again stands out with its above average occupancy rate as shown below.

Occupancy rates above 95% for the last fifteen years help make RioCan the best in class retail REIT. As a comparison, here are some of their "peers" occupancy rates:

RioCan leads the pack in terms of occupancy. Again, best in class.


RioCan is a conservatively levered company, like most investment grade REITs. Below is a snapshot of their debt to capitalization and corresponding interest coverage. Both of these metrics are strong and well within covenanted limits.

Funds From Operations

Funds from operations has steadily increased (with the exception of 2009 due to lower prices on properties available for sale), growing at a compound annual growth rate of 6.8% over the last ten years.


Since the financial meltdown and their entry into the United States, while funds from operations has increased, the number of units outstanding has increased by 43 million since 2008, leading to flat distributions per unit over the same timeframe.

One factor that must be considered for US residents is that there is a 15% Canadian withholding rate (25% for non-Canadian/non-US residents). As such, the taxable nature of the account must be considered when valuing the distribution. Taxable US accounts can claim a credit for the withholding, whereas tax-advantaged accounts cannot.

IFRS and the Balance Sheet

RioCan reports according to International Financial Reporting Standards (IFRS). One of the biggest differences is that IFRS defines an investment property as a property held to earn rentals or for capital appreciation or both. A key characteristic of an investment property is that it generates cash flows largely independent of the other assets held by an entity. Investment property is initially measured at cost; however, subsequent to initial recognition, IFRS requires that an entity choose either the cost or fair value model to account for its investment property. The fair value model requires an entity to record a gain or loss in net earnings arising from a change in the fair value of investment property in the period of change.

Profile and Peer Comparison

RioCan is cheap to U.S. peers on a price/book basis and an EV/EBITDA basis, has a higher dividend than the group and is larger in terms of assets and market capitalization. In other words, an investor can get a bigger company (with better diversification) cheaper and with a higher yield. One thing to note is the leverage. The company is more highly leveraged than their peer group, which is a concern. This is also a reason they have been utilizing the equity market as it brings leverage down. The company has emphasized the de-levering the company is a priority and they have, thus far, been good to their word.

Bottom Line

RioCan REIT is amongst the best in class across the five driving factors of REIT stability and consistency. Investors who want to invest in one of the best in class retail REITs should look to Canada as part of their universe of opportunities, they will not be disappointed.

Going forward, it is reasonable to expect a continued expansion into the United States, continued outlet expansion in Canada (in their joint venture with Tanger Factory Outlet Centers ( SKT - Get Report) and growth from their development pipeline. While this might keep the dividend from experiencing significant growth, there is room for growth and it should be expected (keep in mind that nearly 20% of the dividend is in shares).

Good management, a history as a successful operator, a strengthening balance sheet, relatively cheap valuation and the highest dividend yield in the sector points to opportunity.

Michael M. Terry contributed to this report. Terry is a CFA and founder of Rubicon Associates LLC. He has nearly 20 years of experience in the investment management industry focused on the analysis, investment and management of fixed income and preferred stock portfolios.