The REIT idea, but not for everybody

Some iconic names in the Canadian retail sector are looking at taking on additional debt.  The chosen vehicle is that time-honoured problem-maker from the 1980s. the real estate investment trust or REIT.  Companies use REITs to "unlock" the value in their real estate holdings, thereby boosting profits and, potentially, dividends.  Loblaw Companies has already gone this route, and Canadian Tire is planning to be the next in line.  The announcement alone gave CT's shares a big boost, as this story relates.

Another company under pressure to fold its real estate into a REIT is the ubiquitous weak-coffee-and-bland- food purveyor, Tim Hortons.  Tim's has fallen prey to a so-called "actvist investor", a hedge fund that has built up a stake in the company apparently with no other goal in mind than to compel it to go the REIT route and pay out a big dividend.  If you've ever wondered how smart those hedgies are that command such fat fees from their victims investors, you might want to take notice of this story.  Tim's CFO has gently pointed out that the company does not own most of the properties from which it peddles its java, so a REIT is a complete non-starter.  I'd have thought that might have become apparent when the hedge fund did its due diligence, but what do I know?

The downside of spinning out a REIT is, of course, that the properties disposed of in this way can no longer be used by the parent company to support its own debt.  This could become an issue in a future downturn.  Companies such as Loblaw, Can Tire and Tim Hortons are relatively non-cyclical in nature and can therefore probably afford to take that risk.  However, it's an iron law in financial markets that a good idea will eventually mutate into a thoroughly bad one, as lenders try to apply it to less and less appropriate borrowers.  REITs went spectacularly wrong three decades ago; don't rule out the possibility that history will repeat itself.

It seems odd to be watching companies strapping on new forms of debt while soon-to-be-leaving-us Bank of Canada Governor Mark Carney continues to fret about all the "dead money" on corporate balance sheets.  Sooner or later, some of those companies will start to buckle under pressure from "activist investors" to bring that money back to life, by paying it out in special dividends.  Gov. Carney, of course, wants to see the cash deployed into productive investments, but there's not much evidence that anyone has the stomach for that.

UPDATE, 14 May: Federal Finance Minister Jim Flaherty says the Government is unconcerned about the revival of REITs, even though it has a negative impact on Ottawa's tax take. He seems to believe that REITs are a positive for commercial real estate development, rather than just a tax-efficient borrowing vehicle for corporations and a higher yielding asset for investors.  There may be some REITs that contribute to new development activity, but it would be a stretch to think that's what Loblaw or Canadian Tire are using them for.