Breaking Ground on a New Cycle
Our economic and real estate industry outlook calls for: (1) a broad-based decline in the Canadian economy across the
country; (2) a drop-off in real estate transactions (both public and private) and capital markets investment activity; (3) an
increase in debt spreads and lower asset prices; (4) weakness in real estate fundamentals including occupancy, rents,
margins, and FFO growth; (5) continued stock market volatility; and (6) potential for further compression in price multiples
towards the historical trough. Based on this analysis, we would advise clients in the short-term to “underweight” the
Canadian REIT sector. However, we continue to believe in the long-term investment merits of the sector as our analysis has
shown that real estate stocks underperform leading into a recession, but outperform during the recovery (typically 8
quarters after the recession ended). Moreover, our selected top picks offer very compelling double-digit total returns,
reflecting investor panic-selling of all stocks. Our top picks are trading at significant discounts to underlying value and very
depressed pricing multiples relative to peers.
Over the long-term, we believe the sector is better equipped to manage through this economic downturn given the
following considerations:
• Current Price to FFO multiple of 9.0 times is below long-term historical average of 12.0 times across several real
estate cycles. Although the trough is 6.0 times, we would indicate that the real estate sector is in more favourable
financial and fundamental shape than in previous cycles.
• Debt leverage for the group is reasonable at 59% based on historical book cost. In previous cycles, this ratio was
materially higher (i.e. +75%). For the most part, the group does not have material financial and/or development
commitments. Declining bond yields should also help to offset the expected increase in debt spreads, resulting in
overall stable financing rates.
• Manageable debt roll, available credit facilities and limited short term debt. The average mortgage term to maturity
stands at 6.1 years, which suggests that approximately 16% of the mortgage debt matures in a given year. In addition,
our analysis indicates that real estate companies have access to available credit facilities. Lastly, short-term debt
remains a very small proportion of total debt (less than 10% on average) for the group. The combination of these
factors minimizes re-financing risk for the sector.
• Real estate fundamentals relatively sound heading into the recession, and the decline in occupancy and rents not
expected to be material. Quite simply, this reflects the fact that supply has been relatively constrained over the past 20
years across all asset classes.
• Publicly traded real estate companies have relatively high-quality assets, cash flow stable assets with above-average
occupancy rates, and below average lease roll. Real estate management teams have taken advantage of this past cycle
to move up the quality spectrum with respect to asset quality and focus on well-tenanted assets in good locations.
This will help to ensure that cash flow remains relatively healthy despite declining fundamentals.

In the short term, we believe the following issues will weigh on the sector:
• Excessive payout ratios from a cash flow, funds from operations, and adjusted funds from operation perspective. The
average 2009 FFO payout ratio of 81% and AFFO payout ratio of 95% are too high. Over the past year, several real estate
companies elected to reduce their payout ratios to more sustainable levels. In the year ahead, we expect more real estate
companies will follow suit.
• Reliance on debt and equity capital markets to provide funding. Real estate is a leveraged sector and the REIT model
effectively requires companies to pay out nearly all of their cash flow. As a result, the industry is heavily dependent on
access to capital (debt and equity) to fund growth. This reliance is even heavier when we consider that the sector’s payout
ratios are too high. Currently, debt capital remains constrained and equity valuations have been crushed. Looking forward,
we believe that many real estate companies will be in operation mode and others will be struggling under the weight of
their debt/cash flow obligations.
• Reversion of asset values as property prices are re-priced with higher capitalization rate assumptions, higher vacancy,
lower pro forma rents, and declining terminal multiples. This will provide a drag for real estate companies when it comes to
refinancing existing loans, securitizing unencumbered assets, pledging assets for operating/credit lines, and trying to
extract favourable pricing on asset sales.
For 2009, we anticipate modest total returns for Canadian REITs reflecting the likelihood of Price/FFO multiple contraction as
the economy and fundamentals weaken. In simple terms, this reflects a 1.1% FFO per unit growth rate and 9.5% distribution
yield, contributing to an 11.0% return. Recall that over the long-term, both real estate indices and real property returns have
averaged 12%. Our target prices assume an average price-to-FFO multiple of 7.0 times based on our 2009E FFO estimates
and 9.0 times based on our 2009E AFFO estimates, implying the sector pricing will move slightly lower. Our revised target
prices provide a weighted average total return of 16%. We note, however, that the target returns have never been as extreme
as in the current market and we attribute this to market volatility.
Relative to the broader market index, we believe the Canadian real estate Index will produce a competitive total return in-line
to slightly lower. In part, this reflects our belief that Canadian REIT prices will rebound from a rather sharp sell-off in the fourth
quarter of 2008, but will continue to be dragged down by their high correlation to financial services1.
Our relatively cautious outlook reflects the following considerations: (1) the absence of debt capital will lead to higher debt
costs and refinancing debt maturities will prove difficult for smaller, less mature, and highly levered real estate companies; (2) a
slowdown in economic fundamentals will drag occupancy and rental rates lower across all asset classes; (3) fundamental
weakness will translate into lower income, weaker operating margins, and declining funds from operations; (4) equity capital
markets are likely to remain closed through much of 2009, limiting REITs' ability to grow portfolios and undertake M&A
transactions; (5) payout ratios remain elevated on an adjusted funds from operations basis, when combined with weakening
fundamentals are likely to lead to further distribution cuts; and, (6) cap rates will edge higher reflecting higher cost of capital
for public and private investors alike.
Overall, the two themes that we emphasized in last year’s publication remain relevant including: (1) hold companies with solid
operating platforms, integrated management teams, and stable operations; and, (2) hold real estate companies that have
nominal financial and operating risk. Given a tough financing market, we would strongly caution against firms with high
leverage (60%+ of gross book value), significant upcoming debt maturities (greater than 15% of total debt amount), material
lease roll-overs (+12% of total square feet), and too high adjusted funds from operation payout ratios (greater than 95%).

With an emphasis on balance sheet strength and cash flow stability, we believe the following real estate companies will
outperform in 2009:
Boardwalk REIT (BEI.UN-TSX, Target Price=$27.50, BUY, Projected Total Return=10%)
• Continues to perform in-line with expectations, primarily due to its focus in Alberta’s growing economy.
• Ample debt capacity and liquidity to address near-term debt maturities.
• Active unit repurchase program underscores management’s confidence in the units’ intrinsic value.
CREIT (REF.UN-TSX, Target Price=$23.00, BUY, Projected Total Return=21%)
• A coveted portfolio of commercial assets that appeals to a broad range of potential investors.
• Ability to offset difficult acquisition market through same-property growth and significant mezzanine financing.
• Historical track record of increasing distributions to investors while maintaining a financially conservative discipline.
• Amongst the lowest FFO and AFFO payout ratios in the industry.
Dundee REIT (D.UN-TSX, Target Price=$21.50, BUY, Projected Total Return=99%)
• Compelling valuation as the stock trades at 49% of our NAV estimate.
• Strong balance sheet with $80 million in cash and nominal debt roll over the next two years.
• Excellent leasing activities with approximately 40% of 2009 maturities leased.
H&R REIT (HR.UN-TSX, Target Price=$12.00, Speculative BUY, Projected Total Return=56%)
• Compelling valuation – 41% discount to our NAV estimate.
• Minimal operating risk – average lease term = 11.7 years; <15% of total square footage in next five years.
• Mortgage debt is long term (weighted average term = 9.2 years) – minimizes interest rate risk.
• 50% of mortgage debt is non-recourse – reduces tenant-specific risk.
Morguard REIT (MRT.UN-TSX, Target Price=$11.00, BUY, Projected Total Return=33%)
• Sponsorship by Morguard Corporation (MRC-TSX), a well known real estate investment and advisory firm.
• Significant cash balance and low debt leverage allow the REIT to capitalize on acquisition opportunities, unit repurchase,
and/or increase distribution.
• Portfolio of retail assets have undergone renovation and repositioning of anchor tenants.
Conclusion
Based on our analysis, we would advise clients in the short-term to “underweight” the Canadian REIT sector. However, we
continue to believe in the long-term investment merits of the sector as our analysis has shown that real estate stocks
underperform leading into a recession, but outperform during the recovery (typically 8 quarters after the recession ended).
Moreover, our selected top picks offer very compelling double-digit total returns, reflecting investor panic-selling of all
stocks. Our top picks are trading at significant discounts to underlying value and very depressed pricing multiples relative to
peers. Our top picks include Boardwalk REIT, Canadian REIT, Dundee REIT, and Morguard REIT. Note that we also have a
Speculative BUY rating on H&R REIT.