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Rob Carrick

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Realty check

Rob Carrick

TORONTO (GlobeinvestorGOLD)—You know it has to come sometime.

Sooner or later, the rip roaring market for residential real estate in this country is going to fizzle. When it does, it won't just be the price of your home that's affected.

Own shares of any of the many retailers that are leveraged in some way to the real estate market? As housing goes, so go the fortunes of some of these companies.

Put any money in real estate investment trusts? REITs, like other income trusts, have done very well in the recent low interest-rate environment, but the picture will change somewhat when rates rise.

It's important to understand that there aren't any credible forecasts out there for a collapse of residential real estate along the lines of what some parts of the country, notably Toronto, saw in the early 1990s. While there's arguably a case for calling the real estate market in some U.S. and European cities a bubble, the same can't be said about Canada.

Still, there's no getting around the fact that rising rates make housing less affordable for some buyers by driving up their interest expenses. The more rates rise, the more both resale housing and new home construction would be affected.

There are implications here for a wide variety of retailers that cater to homeowners.

Home shopping

Roughly 15 per cent of sales at furniture stores come from people moving into newly built homes, one retail analyst said. He added that a loss of sales resulting from falling home sales would exacerbate another situation in this business—growing competition among retailers who are getting into the furniture and home furnishings area.

"I find it stunning all the square footage being put into that industry," the analyst said. "It reminds me of the movie theatre industry about three or four years go. You just know there's going to be a fallout."

Retailers who are more focused on renovation—Home Depot Inc. and Rona Inc., for example—might fare better in a rising rate environment, the analyst said. This is because home renovations might pick up as people make the decision to fix up their homes rather than move.

Still, it's worth noting that Home Depot shares are down about 45 per cent over the past year. In better shape are Lowes Cos., up about 2.3 per cent, and Canada's Rona, up about 2.5 per cent year to date (Rona only went public late last year).

There's no question that a rising rate environment isn't the ideal one for REITs, but this doesn't mean that you should give up on this type of income trust.

The right REIT

"If you have a rising rate environment, then that means the economy is improving and that you have the potential for inflation being built in," explains Oscar Belaiche, a trust specialist who manages the Dynamic Focus Plus Diversified Income Trust Fund. "This in turn would mean increased demand for (office) space, which would mean rising rental rates."

Improving fundamentals in commercial real estate would help to counteract the negative affect of higher rates on REITs, which is increased debt carrying costs.

In any case, Mr. Belaiche said REITs have a degree of insulation against rising rates because the average term of debt in many cases is in the area of five years or longer. This limits the amount of debt that would have to be renewed at higher rates in the year ahead.

The most vulnerable REITs to rising rates are those with lower yields, while higher-yielding REITs are more likely to be unscathed, Mr. Belaiche said. Among the higher-yielding REITs right now are InnVest, Royal Host, TGS, all just above 13 per cent. The lowest yields are found on CAP and Residential Equities, which are just below 8 per cent.

As for the residential housing market itself, one leading forecasting group isn't particularly worried about the impact of higher rates.

Clayton Research Associates says that even with rising rates—and rising prices—housing remains affordable because incomes have moved steadily higher in recent years.

"Realistically, without there being a really large shock in interest rates, you're not going to get dramatic movements in the market," said Peter Norman, vice-president at Clayton Res

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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