Charles Dillingham- Morguard Financial Corp.

Veteran manager says REIT sector in great shape.

Michael Ryval 14 December, 2012 | 7:00PM
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A long-time veteran of the real-estate industry, Charles Dillingham believes that real estate investment trusts have never been in better shape. "They've found themselves," says Dillingham, manager of the $61-million CIBC Canadian Real Estate and vice-president of Toronto-based Morguard Financial Corp.

To draw an analogy, Dillingham recalls that the famed golfer Tiger Woods changed his swing several times to adjust to age-related changes in his own body. "That's what REITs had to go through," Dillingham observed several years ago at an industry panel organized by the National Association of REITs in Toronto. "You had guys just buying things, but they didn't go the next step. They weren't focused or disciplined about their acquisitions."

By contrast, today's REITs and other real-estate businesses are making better use of capital, selling off weaker assets and concentrating on those that earn their keep. "There's been an evolution and they've developed different styles. Some have gone for value all the way," Dillingham says.

Others, like Dundee REIT D.UN "have loaded up in the secondary market, and have become specialized at it," says Dillingham. In another instance, Cominar REIT CUF.UN, Quebec's largest commercial property owner, has expanded across the country through last year's purchase of Canmarc REIT.

Dillingham, who owns the above names, believes the activity is reminiscent of the late 1990s after the aborted mergers of several banks. "The banks went off in different directions. In the same way, the REITs have gone off in different directions -- and discovered their own strengths."

Meanwhile, many real-estate enterprises have taken recently advantage of improved fundamentals and strong investor demand to float new issues. "Most of these players have been raising the money to pay off their debt," says Dillingham, listing firms such as H&R REIT HR.UN and Killam Properties Inc. KMP, which he also owns in the fund. The latter, which has a yield of 4.8%, has paid off loans that were costing on average 6.1%.

In another instance, Dillingham cites the prominent shopping-centre owner First Capital Realty Inc. FCR, which raised more than $500 million in 2012 with the goal of improving its debt rating. "They want to get to investment grade because it's much harder to carry unsecured debt. This would give them more freedom to manage their assets."

A Montreal native, Dillingham is a 45-year veteran of the investment industry who got into real estate in the latter part of his career. After graduating in 1966 with a bachelor of business degree from the University of New Brunswick, he went to the University of Western Ontario where he earned an MBA in 1967.

Returning to Montreal, Dillingham was hired by Sun Life Assurance and landed a trainee job on the bond desk. By the late 1970s, he became head of bonds for the firm's health and pension-fund accounts.

In 1980, after Sun Life decided to move to Toronto, Dillingham stayed in Montreal and began managing the in-house pension at Consolidated Bathurst Ltd. That's where he got his first taste of real-estate investments.

"We did some development deals on a small scale. But it was interesting," he recalls, adding that the pension fund had about $700 million in assets. "I'm an investment person, but over the years I became specialized."

In 1992, when Consolidated Bathurst was sold and the pension fund was farmed out, Dillingham moved to Toronto and joined Hospitals of Ontario Pension Plan. He was senior vice-president, responsible for fixed income, real estate, mortgages, international and private investments.

Four years later, Dillingham departed for Morguard Financial Corp. and its associate firm Morguard Investments, which had been active in managing real-estate investments for pension funds. In 1997, CIBC launched CIBC Canadian Real Estate and hired Morguard as a sub-advisor.

Backed by portfolio manager Derek Warren, Dillingham conducts due diligence on many names, focusing heavily on balance-sheet strength and use of leverage. Single positions are limited to about 6% of fund assets. Portfolio turnover was a moderate 68% in 2011.

The CIBC fund, which Dillingham has managed since inception, had a rocky start, since the real-estate sector went into a late-1990s tailspin because of weak fundamentals. But during the early part of the 2000s the 4-star rated fund rebounded and generally saw double-digit returns.

However, the financial crisis in 2008 was painful for the fund, which lost 39.5%. By staying the course, Dillingham steered the fund to a 38.6% gain in 2009. In the 12 months ended Nov. 30, the fund returned 18.4%, compared to 17.3% for the median fund in the Real Estate Equity category. On a five-, 10- and 15-year basis, the fund has performed in the first quartile.

After 15 years of service, Dillingham will step aside at the end of this year, and Warren will assume the portfolio. Meanwhile, four years into the market cycle, Dillingham acknowledges that the sector has lately been under pressure, because of a flood of new issues.

"Right now is a good time to buy," says Dillingham, adding that he has shifted some assets out of the U.S. and into Canada. "You can buy very good quality names. And there's lots of supply."

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Michael Ryval

Michael Ryval  is regular contributor to Morningstar. He is a Toronto-based freelance writer who specializes in business and investing.

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