Charles Dillingham, manager ofCIBC Canadian Real Estate, believes that real estate stocks and real estate investment trusts may be bottoming in the next few months.
"We are still staying only with top-quality companies because the system will remain challenged for a while," says Dillingham, 64, vice-president at Morguard Financial Corp., a Toronto-based unit of Morguard Corp., a leading diversified Canadian property company. "Layoffs in the financial service industry could be much larger than many people think, and impact real estate companies with exposure in that area. We're watching for that." Like many in the peer group, the fund has been hurt in the past year by recession fears and the credit crunch in the United States. The fund dropped 17.7% for the 12 months ended March 31, although it outperformed the median fund in the Real Estate Equity category, which lost 22.7%. Over five years, the CIBC fund has been a top-quartile performer, and its 10-year return of 7.8% is the same as the median fund.
Dillingham, who has managed the $52.8-million fund since inception in 1997, studies general macroeconomic trends and business conditions in local markets, and then blends that view with an assessment of individual companies.
Backed by analysis from Derek Warren, assistant portfolio manager, Dillingham conducts due diligence on many real estate stocks and REITs, focusing heavily on balance sheet strength and use of leverage.
The fund has about 35 names, with a leaning to REITs, which comprise 40% of the portfolio. There is also 33% in common stocks, 20% in U.S. REITs, 2% in convertible bonds and about 5% in cash. "We try to identify good organizations," says Dillingham. "But management is key, and we look for that everywhere, whether in Canada or abroad."
Prominent names include Boardwalk REIT ( BEI.UN/TSX), Brookfield Properties Corp. ( BPO/TSX) and Canadian Real Estate Investment Trust ( REF.UN/TSX). Dillingham limits holdings to about 6.5% of fund assets. Portfolio turnover is moderate, at 73.9% in 2007 and 51.2% in 2006.
First Capital Reality Inc. ( FCR/TSX) is one favourite holding. A leading developer and operator of shopping malls, its stock pays a 5.9% dividend. "It's got top management, a low payout ratio and relatively low debt," says Dillingham. "I look for management that has its interests closely aligned with yours. It has. It meets all the good rules."
The stock is off about 25% from its peak of $28 last May. But Dillingham is standing firm. "It represents great value, although the market doesn't agree with us. We will wait for it to have its day," he says, noting that he is being equally patient with names such as Brookfield Asset Management Inc. ( BAM.A/TSX).
A Montreal native, Dillingham has been involved in real estate investing for half of his career. He graduated in 1966 with a bachelor of business degree from the University of New Brunswick and then earned an MBA in 1967 at the University of Western Ontario.
Returning to Montreal, Dillingham landed a trainee job on Sun Life's bond desk and became a bond and money market trader. By the late 1970s, he rose to 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 fund 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, though, 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 the firm was sold and the pension fund was farmed out, Dillingham moved to Toronto to work for Hospitals of Ontario Pension Plan. He was senior vice-president, responsible for fixed income, real estate, mortgages, and international and private investments.
Four years later, Dillingham departed for Morguard Financial, which had been active in managing real estate investments for pension funds. In 1997, CIBC asked Morguard to run the real estate fund.
Dillingham says the downturn in the past year has seen valuations contract appreciably. For instance REITs are trading at 13 times cash flow, compared to 17. "They've come back to average valuations, though they're not cheap. But if the economy does not go into recession, than we're probably fine."
Meanwhile, he is heartened by the average 5.5% yields in the U.S. REIT market, which appears to be turning around. "REITs have already corrected, and if the damage is controllable, you will get your income and you'll be okay," says Dillingham. "The TSX real estate index is down about 5% year-to-date. But the U.S. REITs are up about 8.5%."
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