2006 Cdn Real Estate Industry 020806 REV2

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Gail Mifsud

(416) 777-7084

Li Zhang

(416) 777-7042

2006CanadianReal EstateIndustry:

Building Growth

February 2006


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2006

Canadian

Real EstateIndustry:

Building Growth

Equity Research

Canada

All expressions of opinion reflect the judgment of the Research Department of Raymond James Ltd. or its affiliates (RJL), at this dateand are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoingreport is accurate or complete. Other departments of RJL may have information which is not available to the Research Departmentabout companies mentioned in this report. RJL may execute transactions in the securities mentioned in this report which may not beconsistent with the reports conclusions. RJL may perform investment banking or other services for, or solicit investment bankingbusiness from, any company mentioned in this report. For institutional clients of the European Economic Area (EEA): This document(and any attachments or exhibits hereto) is intended only for EEA Institutional Clients or others to whom it may lawfully be submitted.RJL is a member of CIPF. 2006 Raymond James Ltd.

Gail Mifsud

(416) 777-7084

Li Zhang

(416) 777-7042

February 8, 2006

PLEASE SEE END OF REPORT FOR IMPORTANT DISCLOSURES


4/268

Table of Contents

Introduction 3

Foreword 3Economic Forecast 5

Canadian Economy Chugs Along 5U.S. Economic Growth Moderating 5

A Polar Canadian Economy 6

Yield Curve Flattens 7

Interest Rates to Edge Higher 8

2006 Canadian Interest Rate Forecast 9

Outlook for the Canadian Economy 11

Real Estate Outlook 14

The Economy and Real Estate A Marriage of Convenience 14

Canadian Property Market Pros and Cons 14

Excess Capital Chases Real Estate 15

Building Growth 16Office Construction Outlook 17

Industrial Market 17

Retail Market 18

Apartment Market 18

Hotel Market 18

Real Estate Equity Market Performance 20

Outlook for 2006 21

2006 Investment Performance Recommendations 23

Top Picks for 2006 25

Runners Up in 2006 26Property Investment and Market Review 29

High Levels of Acquisition Activity Continues 32Capitalization Rates Decline Further in 2005 34

Selected Fundamental Highlights of Investment Market Survey 34

The Canadian Office Market 38

Fundamentals Recovering, Property Values Stabilize 38

Class "A" Vacancy Rate Declines 40

Office Market Posts Solid Positive Absorption 40

New Supply Building 41

New Construction Pipeline Full 42

Rental Rates are Gradually Improving 42Suburban Office Market Rebounds 43

2006 Office Market Outlook 43

The Canadian Industrial Market 45

2006 Outlook for Industrial Market 46

Consumer Spending Drives Retail Property Values 48

Raymond James Equity Research - Canada


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Table of Contents (contd)


Canadian Retail Sales Growth Healthy 48

2006 Outlook for the Retail Market 53

The Canadian Residential Apartment Market 54

Properties Appreciate, Vacancy Stabilizes 54Housing Market Experiencing Record Growth 54

Apartment Vacancy Forecast to Rise 58

2006 Outlook for Apartment Sector 60

The Canadian Lodging Sector 61

The Lacklustre Recovery 61

A Lodging Industry Rebound 63

Canadian Dollar Impacts Lodging Demand 63

Occupancy Gains, ADR to Follow 64

2006 Outlook for the Lodging Sector 66

Comparative Analysis 67

Financial Position, Operating Risk and Growth Potential 69

Financial and Operating Outlook 69

2006 Outlook 69

FFO Growth Rate and Outlook 74

Adjusted FFO (AFFO) Growth Rate and Outlook 78

Net Asset Values (NAV) 81

Asset Growth and Positive Investment Leverage 85

2006 Acquisition Outlook 85

Debt-to-Equity and Leverage Ratios 86

Public Capital Issues 89

Debt to Gross Book Value 91Debt to Net Asset Value 93

Outlook for 2006 94

Rental Income Leverage 95

Rental Income Growth Pre-Interest Expense 96

Rental Growth Post-Interest Expense 98

2006 Outlook for Rental Income Growth 99

Average Cost of Debt 101

Near-Term Debt Maturities 103

Bank Loans and Floating Rate Debt 104

Interest Coverage Ratio 106Rental Income Interest Coverage 109

Relative Interest Expense 111

Investment Returns Net Income 113

Investment Returns Funds from Operation (FFO) 115

REITs Overviews 117

Appendices 253


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REITs Overviews

Boardwalk REIT 119

Canadian Apartment Properties (CAP) REIT 127

Chartwell Seniors Housing REIT 134

Cominar REIT 142Canadian REIT (CREIT) 149

Dundee REIT 156

First Capital Realty Inc. 163

H&R REIT 171

IPC U.S. REIT 178

Morguard REIT 186

Primaris Retail REIT 193

Retirement Residences REIT 200

RioCan REIT 207

Summit REIT 215

Lodging REITs 223

CHIP REIT 224

InnVest REIT 231

Legacy Hotels REIT 238

Royal Host REIT 246

Figures and Tables

Figures

Figure 1 Canadas Real Gross Domestic Product (GDP) 5

Figure 2 U.S. Real Gross Domestic Product (GDP) 6

Figure 3 CPI Index, 2001-2005 7

Figure 4a 10-Year Commercial Mortgage Rates vs. Bond Yields, 1984-2005 8

Figure 4b Historical Spread Commercial Mortgage Rates and Bond Yields, 1984-2005 9

Figure 5 Ranked Returns for REITs in 2005 (in %) 21

Figure 6 Toronto Office Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 37

Figure 7 Toronto Industrial Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 37

Figure 8 Toronto Neighbourhood Mall Cap Rates vs. Commercial Mortgage Rates,1990-3Q05 37

Figure 9 Toronto Apartment Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 37

Figure 10 Toronto Office Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 39

Figure 11 Toronto Industrial Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 45Figure 12 Toronto Neighbourhood Malls Cap Rates vs. Commercial Mortgage Rates, 1990 48

Figure 13 Canadian Regional Shopping Centre Sales Per Square Foot, 2000-2005 51

Figure 14 Power Centre New Supply (sq ft), 2000-2005 52

Figure 15 Toronto Apartment Cap Rates vs. Commercial Mortgage Rates, 1990-3Q05 54

Figure 16 SAAR Housing Starts in Canada, 1960-2005 55

Figure 17 Percentage Change in Housing Starts, 1990-2005 56

Figure 18 Percentage Change in Building Permits, 1990-2005E 56



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List of Figures and Tables (contd)


Figure 19 New and Resale Housing Price Index, 1993-2005 57

Figure 20 Average Rent for 2-Bedroom Apartments for Metropolitan Areas (1995-2004) 59

Figure 21 Canadian Lodging Cap Rates vs. Commercial Mortgage Rates, 1993-2005 62

Figure 22 Annual RevPAR and GDP Growth, 2000-2006 63Figure 23 RevPAR Growth ($) and Annualized Change 65

Tables

Table 1 Provincial GDP Growth Rates 7

Table 2 Comparative Total Return of Selected Indices 20

Table 3a Raymond James Real Estate Investment Overview 27

Table 3b Real Estate Industry Report Card 28

Table 4 Going-in Capitalization Rate by Asset Classes 32

Table 5 Major Investment Transactions by City, 1995, 2000-1H05 33

Table 6 Major Investment Transactions by Property Type, 1995, 2000-1H05 33

Table 7 Office Cap Rates for Selected Cities 38

Table 8 Canadian Office Vacancy Rate, 2000-2006 40

Table 9 Class A Office Vacancy Rates, 1990, 1995, 2000-2005 40

Table 10 Office Market Statistics, All Classes 41

Table 11 Canadian Office Absorption, 2000-2005 41

Table 12 Canadian Office New Supply, 2000-3Q05 42

Table 13 Net Effective Rents, Central Area Class A, 1999-2006 43

Table 14 National Suburban Class A Office Statistics, 2000-3Q05 43

Table 15 National Industrial Statistics, 1993, 1996, 2000-2005 46

Table 16 Canadian Annual Retail Sales Growth, 2000-2005 49

Table 17 Profile of Canadian Shopping Centre Industry 49Table 18 Shopping Centre Performance of Selected Companies, 2000-2004 50

Table 19 Rental Apartments Vacancy Rates, Selected Urban Centres,

1992, 1995, 2000-2005 58

Table 20 Canadian Hotel Transactions, 1993-2005 61

Table 21 Key National Lodging Statistics, 2000-2006 65

Table 22 Funds From Operation (FFO) Growth Rate 75

Table 23 Funds From Operation (FFO) Per Diluted Unit Growth Rate 77

Table 24 Adjusted FFO (AFFO) Growth Rate 79

Table 25 Adjusted FFO (AFFO) Per Diluted Unit Growth Rate 80

Table 26 Premium to Net Asset Value, 2002 vs. 2005 82

Table 27 Implied Cap Rate Based on Recent Stock Price 82

Table 28 Valuation- Commercial REITs (Net Asset Value) 83

Table 28b Valuation Lodging REITs (EV/EBITDA Multiples) 84

Table 29 Percentage Growth of Assets 87

Table 30 Debt to Equity at Book Value 88

Table 31 New Equity Capital 89

Table 32 2005 Capital Markets Activity 90

Table 33 Debt to Gross Book Value 92


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List Figures and Tables (contd)


Table 34 NAV Leverage, 2002 vs. 2005 94

Table 35 Rental Income Leverage 96

Table 36 Rental Income Growth 98

Table 37 Percentage Growth in Rental Income Before Interest Expense 100Table 38 Percentage Growth in Rental Income After Interest Expense 100

Table 39 Average Cost of Debt 102

Table 40 Debt Exposure at Latest Interim Period 103

Table 41 Bank Loans and Floating Rate Debt 105

Table 42 Interest Coverage 108

Table 43 Rental Income Interest Coverage 111

Table 44 Relative Total Interest Expense 113

Table 45 Net Income Return on Equity 114

Table 46 FFO Return on Equity 116

Appendices

Appendix I U.S. REIT Yields by Property Type 255

Appendix II U.S. P/FFO Multiples by Asset Class 255

Appendix III U.S. Real Estate Capital Market Transactions 255

Appendix IV U.S. Cap Rates by Asset Class, 2Q98-4Q05 256

Appendix V U.S. Spread, Prime Mortgages vs. 10-Year Treasuries 256

Appendix VI CMBS Market 256

(Images for cover page from bigstockphoto.com and morguefile.com)


9/268Raymond James Equity Research - Canada

IndustryPerspective and

Outlook


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INTRODUCTION

In the 2006Raymond James Canadian Real Estate Review, we begin with a

brief economic overview, including a forecast of economic and financial variables

that influence the growth prospects of the real estate industry. A review of each

property sector is also presented, along with the investment outlook for 18

publicly-traded real estate companies under our research coverage universe. To

evaluate future growth and investment return potential, our industry overview is

followed by a detailed comparative analysis of the real estate industrys financial

and operating parameters. The last section includes brief individual company

reports which highlight major portfolio and financing activities completed during

the year, and outlines the strengths and challenges faced by each firm. This

section also includes the company stock recommendation and target price,

forecast earnings model, operating summary and valuation analysis.

FOREWORD

In keeping with the tradition of this publication, we have built our forecast upon

economic fundamentals to determine the repercussions for the Canadian real

estate industry. Twin influences of historically low interest rates and an insatiable

demand for yield investments have had a profoundlypositive impact on

valuations of both real property and real estate stocks since 2000. Traditionally,

real estate stocks have correlated positively with bond yields, rising and falling in

tandem. We saw this relationship play out in early spring 2005 (and spring 2004)

as REIT stocks declined approximately 12% on the heels of a 40 basis-point

increase in 10-year Canadian bond yields. Over the long term, we do not see this

relationship disengaging; however, we anticipate that the strength of this union

will diminish as the Canadian REIT market broadens. We anticipate that the

Canadian REIT market will mirror the U.S. REIT market in that it isinstitutionally adopted as a unique investment asset class combining the stable

characteristics of fixed-income investments and the growth-like opportunities

found in common equities.

In 2005, the key topics of discussion included the inclusion of income trusts (and

REITs) in the benchmark S&P/TSX Index and the potential change in the tax

status and treatment of distributions from income trusts. While fears that the

former Liberal government would tinker with the tax status of trusts failed to

materialize, it created uncertainty in the stock market. As a result, REITs

experienced an average 10% decline in stock prices in the month of September

2005. This decline was shortlived as REITs rallied back in November as a

minority government on the cusp of a non-confidence vote decided that every

vote mattered and elected to leave the tax status of income trusts alone.

Nonetheless, in our usual discussion of potential investment risks for the real

estate sector, a new risk emerged at the forefront political risk.



Our concerns have been somewhat pacified as a newly elected Conservative

government, with a loosely knit party, no experience at the helm of this country

and a slim minority to boot is likely to: 1) Make a mistake on social policy first,

and then follow up with a mistake on fiscal policy; 2) Buy voters with tax cuts

and incentives, and 3) Avoid a web of political disasters that their predecessors

tangled in. We believe, however, that this issue has the potential of re-emerging

in the future as the prior government failed to address the real matters at hand the still unequal tax treatment of income trusts versus common stocks, foreign

investors taxed at a lower rate than domestic investors in income trusts, and the

premium paid in the market for income trusts, which places traditional, tax-paying

corporations on an unequal footing.

In real estate circles, talk centred around the abundance of capital bidding up

asset values to new heights, debates on the viability of cap rates remaining at

these historically low levels, the proliferation of REITs as a global investment

vehicle, and the global reach and investment mandate of public and private real

estate investors alike.

It is clear that the sphere of influence has gravitated away from an age-old

reliance on location and asset specific property supply/demand fundamentals.

Increasingly, investors employ a world-view or macro industry perspective

i.e., cap rates for commercial properties may be low in Canada, but prices can be

justified as they are attractive from a global perspective or the lodging sector is

two years into a multi-year upswing that should produce strong earnings growth

and the potential for valuation multiple expansion for industry participants.

Needless to say, it is more challenging to forecast the equity performance of real

estate stocks in this unpredictable and volatile environment. More than ever, it

appears that the market is moved by sentiment and speculation rather thanfundamental stock analysis; perhaps reflecting the speed and delivery of

information (right or wrong) today. Regardless, we remain dedicated to detailed

quantitative and qualitative stock analysis, which includes a review of

management strategy and execution ability; analysis of operational performance

and asset quality; a financial review of leverage, rental income productivity, FFO

growth and returns on equity; and lastly, valuation metrics such as net asset value

price-to-FFO and price-to-AFFO metrics. We continue to employ these metrics

in guiding our stock ratings and expectations.

We hope that you find this publication a useful and informative tool. This report

would not have been possible without the dedication and support of DarrenMartin, Director of Research; Gina Epondulan, Josie Klingbeil and Cynthia Lui,

our dynamic publishing team; the senior management teams of the companies

included in this report (you know who you are), and lastly, our clients for their

continued support of our research over the years.



ECONOMICFORECAST

Canadian Economy Chugs Along

In 2005, the Canadian economy continued to expand as reflected in the real Gros

Domestic Product (GDP) growth rate of 3%. This pace of growth was slightly

ahead of 2004s GDP growth rate and an improvement from 2% in 2003. For

2006, the consensus growth rate for GDP is 3.1%, effectively predicting more ofthe same. Early indicators point to a slower rate of Canadian GDP growth in

2007 at 2.9%, reflecting a pull-back in global economic growth and the drag of a

high Canadian dollar on domestic production.

For 2006, the

consensus growth rate

for GDP is 3.1%,

effectively predictingmore of the same

FIGURE1: CANADA'SREALGROSSDOMESTICPRODUCT(GDP)

(Yearly Annualized % Change)

5.2%

1.8%

3.4%

2.0%

2.9% 3.0% 3.1%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2000

2001

2002

2003

2004

2005E

2006E

YOY%C

han

ge

Source: Statistics Canada, Bloomberg Consensus Estimates

U.S. Economic Growth Moderating

Given that the Canadian and U.S. economy are so intimately linked, it warrants

discussion on the economic outlook for our southern neighbors. The figure belowdepicts the U.S. GDP growth rate from 2000 to 2006. Clearly, the U.S. economy

has bounced back from eking out a 0.8% GDP growth rate in 2001. A bloated

government with hefty expenditures, personal and dividend tax cuts, and

historically low interest rates provided the needed stimulus to reinvigorate the

U.S. economy in the post September 11 period. After peaking at 4.2% in 2004,

the U.S. GDP growth rate is forecast to record a 3.1% growth rate in 2005. For

2006, economists are anticipating a slightly stronger rate of growth at 3.4%. In

an effort to curb inflation and a run-on in housing prices, outgoing U.S. Federal

Chairman, Alan Greenspan has increased the Federal Funds rate 14 consecutive

times to 4.75% (discount rate at 5.75%). Today, the benchmark bank rate is atits highest level since May 2001, while the U.S. prime rate stood at 7.25%. In hi

last monetary address, however, Greenspan indicated that the central bank was

keen on raising rates; however the dialogue of the report removed the reference

at a measured pace. This caused a stir in the markets as Greenspan has had a

long history of broadcasting to the market the Central Banks intentions with

respect to the direction of interest rates.



Undoubtedly, incoming Fed chairman Ben Bernanke will be watched and heard

closely for indications of whether he intends to continue to push interest rates

higher. The twin deficits, a sagging dollar, an inverted yield curve, record persona

debt levels, and an over-heated housing market present considerable threats to

the future growth prospects of the U.S. economy. There is also mounting

evidence to suggest that the U.S. economy is slowing down in the early days of

2006, which may curb Bernankes ability to continue to raise rates and ward offinflation.

FIGURE2: US REALGROSSDOMESTICPRODUCT(GDP)

(Yearly Annualized % Change)

3.7%

0.8%

1.6%

2.7%

4.2%

3.1%3.4%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2000

2001

2002

2003

2004

2005E

2006E

YOY

%C

hange

Source: FOMC, U.S. Department of Commerce, Bloomberg Consensus Estimates

A Polar Canadian Economy

On the surface, a 3% growth rate for Canadas GDP seems like a healthy rate o

growth, particularly when compared to our G-7 allies. What the national GDP

growth rate fails to capture, however, is the polarity in the economic growth rate

across the provinces. Over the past few years, the divergence in the economic

prospects of the regions is strikingly evident. Commodity rich provinces including

Alberta, B.C. and Saskatchewan have fared well driven by the mining, oil and

gas, agriculture, and forestry and transportation industries. Conversely, the

Maritime Provinces have had rather limited growth as pipeline construction have

failed to offset the failing fishery and forestry industries. Ontario and Quebec

have chugged along given its core financial and service sectors. Selected

markets within Central Canada, however, largely focused on the automotive,

aerospace and textile manufacturing industries have experienced lackluster

growth. Overall, global demand for Canadian natural resources has paved the

way for continued economic expansion (albeit regionally focused) and buoyed the

Canadian dollar.

The national GDP

growth rate fails to

capture the polarity

in the economic

growth across the

provinces



Despite solid economic growth, evidenced by the highest capacity utilization rates

in five years, a 30-year record low unemployment rate of 6.6%, real wage growth

and record business profits, inflation remains benign. The CPI Index has

remained range bound from an annualized change of 1.7% at the low end to 2.8%

at the high end over the last five years. The Bank of Canada continues to set

monetary policy on the basis of a target band for inflation in the 1% to 3% range

and is focused on core inflation levels at 2%. Since 1995, the long-term average

for annualized change in the CPI Index has been historically low at 2.0%, while

core inflation clocked in at 1.8% over the same period.

At December 2005, total CPI stood at 2.2%, with the core inflation rate at 1.6%.

Contributors to the annualized growth in the inflation index were gasoline prices,

homeowners replacement costs, and restaurant meals. Offsetting components

included lower prices for computer equipment and supplies, fresh vegetables andtraveler accommodations. Overall, we believe that inflation remains low due to

cheap imports of consumer goods and declining prices for goods manufactured in

Canada. In the near-term, the newly elected Conservative governments plan to

trim the GST by 1% (effective in April 2006) is expected to reduce total inflation

by 0.6%. Although this is not anticipated to have a lasting impact on total

inflation, our economic forecast is for the next 12-month period.

Yield Curve Flattens

Not only has inflation pressures

remained contained, so too have long-

bond yields. Ten year Canadian bond

yields trended down nearly 30 basis

points to 3.9% in 2005. Long bond

yields have failed to react to the Bank

of Canada pushing up short-term rates.

Since September 2005, the Bank of

Canada has increased the prime rate to

3.5%, up 1% after four consecutive

rate hikes.

We believe that

inflation remains low

due to cheap imports

of consumer goods anddeclining prices for

goods manufactured in

Canada

TABLE1: PROVINCIALGDP GROWTHRATES

(in mlns dollars) 2002 2004 % Change

Newfoundland/Labrador $14,344 $14,994 4.5%PEI $3,263 $3,376 3.5%Nova Scotia $24,833 $25,665 3.4%New Brunswick $20,165 $21,005 4.2%Quebec $225,581 $235,916 4.6%

Ontario $450,316 $472,665 5.0%Manitoba $34,092 $35,578 4.4%Saskatchewan $30,621 $33,437 9.2%Alberta $128,334 $139,475 8.7%British Columbia $131,557 $141,778 7.8%Canada $1,068,540 $1,130,405 5.8%

Notes:

1) GDP chained at 1997 dollars

Source: Statistics Canada

FIGURE3: CPI INDEX, 2001 -2005

Source: Statistics Canada

Percentage change from the same month ofthe previous year

All items excludingenergyAll items



Certainly, Canadian bond yields remain low, reflecting higher demand for

Canadian bonds from global investors. Canadian bond yields are comparatively

higher on a global basis, can be used as a tool to hedge commodity investment,

and bond investors like to diversify outside of the U.S. economy. Another

explanatory consideration is the fact that the borrowing requirements of Canada

three levels of government have declined over the past several years. Since

1997, the federal government has reduced its capital markets debt by $2 billion to$10 billion per year. In 2005, the federal government borrowed $35 billion, while

the provincial and municipal governments collectively borrowed $38 billion. In

2006, the combined borrowing of the three levels of government is forecast to fal

nearly 7%, largely due to lower borrowing by provincial and municipal

governments. Theoretically, the decline in government borrowing requirements

merits lower bond yields as the underlying credit risk is reduced.

Interest Rates to Edge Higher

In the table below, we have graphed 10-year commercial mortgage rates and the

10-year Canadian bond yield. Over the past 15 years, the diagram illustrates thacommercial mortgage rates and bond yields have moved lower in tandem. At

year-end, the risk spread stood at 145 basis points, down 50 basis points from 19

basis points in early 2000. The decline in the risk spread reflects the abundance

of debt capital available and willingness by lenders to accept a lower risk

premium. The average cost of mortgage debt for commercial REITs has decline

by more than 100 basis points to 6.1% in 2005, down from 7.2% in 2000.

FIGURE4A: 10-YEARCOMMERCIALMORTGAGERATESVSBONDYIELDS, 1984-2005

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

11.0

12.0

13.0

14.0

15.0

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Percentage(%)

Bond Yield Commercial Mortgage Rate

5.55%

4.10%

Source: Mortgage rates provided by Standard Life, Bond Yields by Bank of Canada

The decline in the risk

spread reflects theabundance of debt

capital available and

willingness by lenders to

accept a lower risk

premium



Since the mid-1980s, the spread on commercial mortgage rates and bond yields

has ranged from 100 to 200 basis points. The spread peaked in February 2000 at

2.2% and hit a trough in February 1984 at 0.5%. Given the prospect for bond

yields to remain low and availability of excessive capital that needs to be placed,

we anticipate that the spread will continue to remain stable or slightly erode in the

near term.

FIGURE4B: HISTORICALSPREADCOMMERCIALMORTGAGERATESANDBONDYIELDS,

1984 - 2005

0.00

1.00

2.00

3.00

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Spread (bps)

Source: Mortgage rates provided by Standard Life, Bond Yields by Bank of Canada

2006 Canadian Interest Rate Forecast

The prospect of continued Canadian economic growth will likely spur the Bank

of Canada to push short-term interest rates higher in the first half of 2006.

However, we believe that the Banks ability to increase rates will be hampered

by the strength of the Canadian dollar. We believe that as the impact of a

US$0.87 dollar filters through the Canadian economy and adversely impacts

economic growth, the Banks incentive to raise rates will diminish. We anticipate

that long-term rates will move up gradually in response to short-term rates in the

first half of the year. The still-benign inflation rate outlook and an anticipated

slow-down in the pace of Canadian economy will prevent long bond yields from

rapidly accelerating in the near term.

Accordingly, we anticipate that REITs will continue to experience strong

investment demand given the attractive risk-adjusted spread over long bonds,which stands currently at 250 basis points. If anything, we anticipate that this

spread will continue to come under pressure, given the relative stability and

quality of the underlying income stream from real estate companies today.

The implication of this interest rate forecast on the Canadian real estate industry

includes the following:

Based on current mortgage rates approximating 5.5%, real estate companies

have the potential to reduce their average cost of debt by 9% or 60 basis

points from the current average rate of 6.1%.

The still-benign inflation

rate outlook and an

anticipated slowdown in

the pace of Canadian

economy will prevent

long bond yields from

rapidly accelerating



An average cap rate of approximately 6.5% to 7.5% for higher-quality incom

properties provides a still accretive acquisition spread of 1% to 2%, lower

than the 2.5% available during 2002. Accordingly, we are likely to continue to

see a moderation in asset growth for the commercial REITs.

The average commercial REIT yield spread over 10-year bond yields is

currently at 2.5%, compared to 3.7% for year-end 2002.

The recent increase in short-term interest rates enhances the appeal of long-

term mortgage financing. Hence, we will continue to witness REIT

management teams extending the weighted average term of mortgage debt.

The current level of interest rates will continue to spur housing demand, albeit

at a moderating pace. The utilization of variable rate financing is likely to

become unfashionable as short-term interest rates have risen rapidly in the

near term.

Low interest rates will continue to foster a preference for debt leverage (ove

equity issuances), and we are likely to see debt-to-equity and debt-to-gross

book value leverage ratios move higher. Interest coverage ratios and rental income interest coverage ratios are

expected to remain healthy.

The availability of debt capital at attractively low interest rates has led to

significant financing savings realized by real estate companies. This has been

reflected in a decline in the average cost of mortgage debt for the REIT sector.

This downward trend of interest rates has also translated into lower interest

expense, which has helped mask weakness in same-property operating income

over the past two years. The abundance of low-cost capital and accretive

spreads over financing has also spurred strong acquisition growth during this

period. These factors have meant that operating income continued to rise and

FFO to expand, despite somewhat weak property fundamentals over the past few

years. Given a more favourable outlook for real estate fundamentals and

relatively stable bond yields, we believe that real estate companies have

weathered through the storm.

Low bond yields have also served to enhance the appeal of both real property an

REITs, since both provide higher yields. This has resulted in rising property

values and declining yields on property transactions and REIT stocks. This view

is reinforced by the reduced spread of commercial mortgage rates over bond

yields. Looking forward, we anticipate that modest increases in interest rates wi

be offset by growth in underlying operating income for real estate companies.

This growth will mitigate the potential erosion of property values as cap rates

edge slightly higher. The REIT industrys conservative balance sheet, well-lease

high-quality portfolio and improving fundamentals will help the sector cope with

the eventuality of higher interest rates.

The availability of debt

capital at attractively

low interest rates has

led to significant

financing savings

realized by real estate

companies

Low bond yields have

also served to enhance

the appeal of both real

property and REITs,

since both provide a

higher yield



Outlook for the Canadian Economy

As we reflect on the Canadian economy, our trepidation remains the following: 1)

The implication of a sustained higher Canadian dollar on domestic producers,

particularly auto, textile and aerospace manufacturers in Central Canada; 2) The

ability of personal consumption to continue to support economic growth; 3) Lack-

luster business investment, which will be required to compensate for a potential

pull-back in personal spending, and 4) The decline in our productivity levels

relative to other G-7 countries, which threatens our standard of living in the long

term.

Offsetting these concerns includes our belief of the following: 1) Government

spending is likely to continue to expand given a newly formed government; 2) A

new minority government is likely to implement tax cuts for businesses and

consumers to remain in power and secure future votes; 3) Despite all of the talk

of high consumer debt levels, Canadians enjoy a relatively high level of equity in

their homes and have not been as spend-bent as our U.S. neighbors, and 4) The

balance sheets of Canadian businesses are relatively strong with cash reservesshored up for investment.

This economic outlook forms the framework for the following forecast:

The variance in the GDP growth rate between Canada and the U.S. is

expected to narrow in 2006. The foundation for continued Canadian economic

growth appears sound and includes high capacity utilization rates, strong

employment growth, record business profits, and high levels of business and

consumer confidence. In addition, the promise of personal tax cuts and other

incentives should provide continued stimulus to the Canadian economy in the

near term. The growth in the U.S. economy appears to be moderating as the

twin deficits, record levels of personal and corporate debt and an over-heatedhousing market threaten future growth. Real estate values and REIT FFO

multiples have wiggle-room in Canada, while they appear to be heady in the

U.S.

While increases in short-term interest rates appear to remain on the agenda of

both the Bank of Canada and the U.S. Federal Reserve, we believe that both

Central Banks will be forced to reconsider future hikes. For Canada, the

Bank of Canada will be faced with a high currency putting the brakes on

domestic production growth. In the U.S., the newly appointed Federal

Reserve chairman will have to balance the urge to raise rates to offset

inflationary pressures with the risk that continuing increases will spark a

correction in the housing market and cripple consumer confidence and retail

spending which has propped up the economy over the past five years.

The incremental benefit from real estate debt refinancing may continue to

generate lower financing cost. The current spread between an average 6.1%

portfolio mortgage debt cost and 10-year commercial mortgage rates is

approximately 60 basis points.



Debt capital availability is forecast to remain abundant in the year ahead. Th

risk spread of 145 basis points (commercial mortgages and 10-year bond

yields) is expected to be stable with a bias to the downside. This also reflects

improving property fundamentals and lenders willingness to tolerate higher

loan-to-value ratios.

Income capitalization rates will remain low as excess capital continues to

invest in real estate. The supply of properties for sale will remain relatively

healthy as private families take advantage of historically low cap rates.

Interest coverage ratios are forecast to remain healthy as the potentially

higher cost debt is offset by operating income growth.

The accretive spread on acquisitions is forecast to remain positive, but may

narrow slightly as cap rates lag rising bond yields in 2006.

The Canadian office market will continue to recover due to strong

employment growth and limited amounts of large, contiguous space available

in the core markets of Toronto, Calgary and Vancouver. Net effective rental

rates are forecast to improve in the year ahead. Shopping centre rental rates are expected to continue to trend upward,

reflecting strong demand amongst retailers to expand into new locations and

different retail formats. Strong levels of consumer confidence, supported by

strong employment levels and wage growth, will positively impact retail sales.

Industrial occupancy and rental rates will trend lower as the result of new

speculative development and weakening export markets erode tenant

profitability and demand for space.

The residential rental market will be defined by stable to modestly declining

occupancy rates and below-inflation increases in rental rates. New supply in

the form of rental condominiums and the transition towards single and multi-

family home ownership will continue in 2006.

The housing market will moderate, but continue to support historically high

levels of housing starts (200,000 units+) and resale activity. The affordability

of housing and the appeal of real estate as an investment will support price

increases, albeit at a slower pace.

NOI growth for real estate companies will be supported by incremental

acquisition activity and inflation-like same-property income growth. Operatin

margins are expected to remain relatively flat.

We anticipate that FFO multiples will continue to edge higher from the currenlevel of 13.1 times for 2006. This increase will augment the declining

distribution yield provided by the REITs.

Premiums to NAV, which currently stand at 18%, are forecast to fluctuate in

the 0% to 20% range. This reflects the anticipation of continued volatility in

the equity markets.



REIT yields relative to 10-year Government of Canada bonds yields are likely

to compress further in 2006 as strong investment demand for income willingly

accepts a lower risk spread.

The volume of new development activity will accelerate as excess debt and

equity capital have pushed acquisition costs towards replacement costs. The

economics of new development become increasingly attractive to public and

private market real estate participants. Development will be broad-based

across all property segments.

Vanishing budget surpluses introduce the risk that governments re-address tax

legislation to modify the flow-through status of income trusts, and potentially

REITs.



REALESTATEOUTLOOK

The Economy and Real Estate A Marriage of Convenience

The real estate cycle has historically followed the economic cycle as real estate

services the economy by providing a location to conduct business, warehouse and

produce goods, sell goods to consumers, and provides housing and

accommodations during business and leisure travel. Accordingly, real estatecompanies have significant earnings leverage as the economy and property

fundamentals recover.

Fundamentals for real estate encompass occupancy rates, rental rates, the supply

and demand of commercial space, and contractual lease agreements that suppor

a stable stream of cash flow. Different sectors display distinct property

characteristics and generate differentiating yields based on the underlying asset

class.

Among the five sub-sectors of Canadian REITs, office and industrial are highly

responsive to economic dynamics such as employment growth and corporateearnings and profitability; while sectors such as retail and lodging are more

sensitive to changes in the level of consumer confidence and retail spending.

Other sectors such as apartment rental and senior housing are largely dependent

upon the demographic characteristics of the society (such as household income,

population growth, and peoples lifestyle preference), and are therefore more

defensive and less responsive to economic cycles.

Given that the outlook for the Canadian economy in 2006 remains healthy, we

believe that real estate companies focused on the ownership of retail and office

properties will enjoy positive earnings leverage in the year to come.

Canadian Property Market Pros and Cons

The Canadian real estate property market is attractive to investors for a number

of reasons: 1) Canada is politically stable (until recently) with steady economic

growth outlook; 2) The real estate market is transparent and integrated; 3)

Canadian lenders understand the real estate market and the presence of CMBS i

flourishing; 4) Cap rates for income properties are comparatively higher in

Canada at 6% versus the U.S. at 5%, the U.K. at 4%, Hong Kong at 3% and

Japan at 3.5%, and 5) Property markets are relatively liquid to transact. Recall

as well, that real estate has traditionally been viewed as a hedge against inflation

in addition to the benefit of potential capital gains. Given the recent accelerationin prices, the ability to offer modestly growing income is attractive.

The primary issue with the Canadian property market is that it lacks depth. By

this we mean that the availability of high quality product is limited, the number of

core property markets can be counted on one hand, and real estate is tightly held

largely in the hands of Canadian pension funds. As a point of reference, real

property transactions across Canada totaled $16.6 billion in 2005, this compares

Real estate companies

focused on the

ownership of retail and

office properties willenjoy positive earnings

leverage in the year to

come



to more than $18 billion in the city of Manhattan alone. Domestic players have

become more active in real estate transactions over the past year, as foreign

investors constituted about 9.5% of property transactions versus 20% in 2004.

Canadian pension funds have notably increased their exposure to real estate, with

a 10% weighting in real estate compared to 2% in the early 1990s. Pension fund

are generally disciplined long-term investors that are likely to hold on tightly to

real estate. With deep pockets and lower targeted investment returns, pension

funds have a competitive advantage over Canadian REITs in terms of acquiring

assets. However, joint ventures between the two parties reflect the fact that

REITs are able to provide professional, integrated real estate management.

Recent examples of the mutually beneficial trend for real estate and institutions to

form joint ventures include:

Glimcher Realty Trust (52%) and Oxford Properties Group (real estate arm o

OMERS, 48%) to acquire anchored retail properties in the U.S. Initial

portfolio purchase was the US$170 million Puente Hills Mall in Los Angeles

for an estimated 7.3% cap rate. Each party intends to commit US$200 millionof equity to the joint venture.

ING Australia and Chartwell Seniors Housing REIT to acquire a portfolio of

U.S. senior housing for $140 million (50% interest) for an estimated 7.5% cap

rate.

RioCan REIT and Canada Pension Plan (CPP) formed a joint venture to

acquire regional shopping centres. This joint venture unsuccessfully bid on th

Marche Central property in Montreal, which sold for $303 million in 2004.

RioCans Retail Value Limited Partnership with TIA-CREFF and OMERS

which committed $200 million in equity. RioCan generates management

income from the partnership, in which it holds a 15% equity interest.

Excess Capital Chases Real Estate

There is no question that global real estate values have benefited from low bond

yields, inconsistent returns provided by stock markets, and the graying of the

population seeking yield investments. Global investors have flocked to real estate

both in the form of real property assets and publicly traded REITs. Hard assets

and real estate stocks both offer higher yields than found in global bond markets.

This has been reflected in the whopping increase of the global market

capitalization of REITs, which has increased six-fold in the past fifteen years. In

1990, the global market capitalization of REITs stood at US$100 billion, which

increased to US$300 billion in 2000, and doubled to US$600 billion in 2005.

Furthermore, an estimated US$700 billion of capital was directed towards real

estate last year, which was 20% higher than 2004. Leading real estate investors

indicate that excess capital directed towards real estate has a remaining shelf life

of two to four years.

Real estate values have

benefited from low bond

yields, inconsistent

returns provided by stock

markets, and the graying

of the population seeking

yield investments



Undoubtedly, Canadian real estate property values and real estate stocks will

benefit from too much capital (debt and equity) seeking to be deployed. On a

comparative basis, the market capitalization of Canadian REITs is small potato,

representing only 3% of the global market capitalization. Meanwhile, our

neighbor to the south represents approximately half (50%) of the global market

capitalization of real estate. Australia, which is a comparative country with

Canada given the size and scope of our economies, represents 11% of the globalmarket capitalization of real estate. This suggests that the public market

capitalization of real estate in Canada has the potential to more than triple! Of

course, the primary difference between the two countries is the fact that

Australians have forced superannuation retirement savings, which has been

funneled towards real estate investment.

We believe that new real estate investment trusts will spring up in Canada, largel

drawn out from family owned real estate business. We have seen this

institutionalization of real estate occur since the correction of the last real

estate cycle in the early 1990s. Two recent examples of this trend include

Iberville Developments (Marcel Adams family) sale of retail assets to RioCan

and to CPP, FirstPros (Goldhar) sale of portfolio of assets to Calloway REIT.

Furthermore, data suggests that real estate held in private hands is approximately

20 times greater than institutionally held real estate market.

Building Growth

So what is the sum of excess capital and high property values? In one word

DEVELOPMENT. We believe that the combination of excess debt and equity

capital chasing real estate, combined with historically high property values that

are quickly approaching replacement costs, will push the real estate industry into

the next stage in the cycle the development stage.

In fact, we believe that we are already witnessing the early stages of the

development cycle blossoming. This is reflected by a rise in the number of

projects under construction and competition among developers to secure large

lead tenants. New construction activity is broad-based across all of the property

sectors.

Consider the following:

Cap rates have declined so precipitously that while still accretive over the cos

of debt, when the cost of equity is factored in for acquisitions of the highest

quality assets, returns are in the low to mid-single digits. Note that theincrease in the debt leverage is a key factor.

Development returns are more attractive ranging in the high single-digits to

low teens. This assumes that demand for the space will be absorbed during

the construction lead time or shortly thereafter.

Debt capital has shown its willingness to accept lower risk spreads and higher

loan-to-value ratios.

Investors are willing to launch projects by lowering their pre-lease level

requirements, which has traditionally been above 50% to 40%.

We believe that new real

estate investment trusts

will spring up in Canada,

largely drawn out from

family owned real estate

business

We are already

witnessing the early

stages of the

development cycle

blossoming



New product is usually able to squeeze out tenants from older buildings

mitigating development risk.

Double digit FFO growth will not be achievable without some form of

development activity.

The question becomes does fundamentals in the real estate sector merit new

construction? For the most part, the industry could support incremental newdevelopment projects. The key of course is discipline on behalf of developers

and lenders.

Office Construction Outlook

The office sector continues to recover as 4Q05 represented the seventh

consecutive quarterly decline in national vacancy rates. For 2006, the nationa

vacancy rate is forecast to decline to 8.5%, down from 9.2% in 2005.

Sub-let space is no longer an issue and should pave the way for a speedy

recovery of the office market.

Selected markets in Calgary, Toronto, and Vancouver have limited availabilityof large, contiguous blocks of office space in the downtown cores.

According to CB Richard Ellis, there is 6.2 million square feet of office space

currently under construction. This is nearly triple the 2.3 million square feet

added in 2005.

CBRE estimates that 16.4 million square feet of space could be under

construction within the next five years, of which 60% will be located in the

downtown markets of Calgary, Toronto and Ottawa. In the last cycle, only

30% was located in the downtown core, with the remainder built in the

suburbs.

The long-lead time of 40 months or more for projects in the downtown core,should provide sufficient time for the office leasing momentum to take off.

Projects under construction are unlikely to come to market until 2007.

New buildings offer better layout and design, including state of the art HVAC

and IT systems, which appeal to larger tenants.

Toronto has 1.1 million sq.ft. under construction with 3.9 million sq.ft.

expected, Calgary has 2 million sq.ft. under construction with 3 million sq.ft.

in the pipeline, and Ottawa has 1 million sq.ft. under construction with an

additional 1 million square feet anticipated to be built.

Winnipeg, Montreal and Vancouver has 1.9 million, 1.4 million, and 1 millionsquare feet, respectively under construction and planned in the near term.

Industrial Market

The development boom has already started in the industry market with

approximately 25 million square feet built in 2005. An estimated 17 million is

slated to be built in 2006, of which approximately 45% is pre-leased.

A number of U.S. industrial property developers have entered the Canadian

scene, who have lower return thresholds, utilize higher debt leverage, build

According to CB

Richard Ellis, there

is 6.2 million square

feet of office space

currently under

construction

The development boom

has already started in

the industry market

with approximately 25

million square feet built

in 2005



speculatively and are less risk adverse confident that new product will steal

occupancy from older industrial buildings.

Short lead time for construction of 6 to 9 months means that new supply can

enter the market rapidly.

Returns on development are attractive high single digit versus transaction

prices in the 6% to 9% range.

New development concentrated in the single-tenant industrial buildings, which

cost approximately $60 per square foot to build.

Much of new demand in the industrial market is for warehouse space to store

imported consumer goods.

There is a scarcity of new, state-of-the-art, industrial warehouse buildings in

the core cities of Vancouver, Calgary and Toronto. This provides support for

net asset values, at least until new supply is available.

Service land costs continue to escalate up 20% to 30% in the past two years,

which should help keep a lid on excessive building.

Retail Market

New construction of retail space has remained relatively low, representing

approximately 2% of total inventory annually since 1987. Considering that

retail sales have increased per annum from 4% to 7%, there is merit to the

idea that additional retail space is warranted.

New supply of retail space has largely been in the form of power centres in

the suburban fringe, approximately 7.5 million square feet annually.

Tenant demand for large format retail space has resulted in redevelopment of

traditional enclosed malls. In many instances, enclosed malls are being turned

inside-out (i.e., access to stores from the parking lot).

Increasing development of neighbourhood and community malls surrounding

new suburban housing communities along major arterial roadways.

Apartment Market

Full pipeline of condominiums already built and unsold and to be built, of whic

a portion will be acquired by investors for rental purposes.

Limited new construction of rental apartment buildings, largely geared to the

extreme end of the market subsidized housing and luxury and business stay

rentals.

Hotel Market

On a national basis, a new supply of hotels is forecast to remain below 2%

over the next few years. This has been consistent over the past five years.

According to Lodging Economics, an estimated 60 new hotels representing

5,900 rooms are forecast for delivery in 2006. An additional 82 hotels with

7,700 rooms are scheduled to open in 2007. There is an estimated 211 hotel

projects that are in the pipeline, representing some 26,300 rooms. It appears

New supply of retail

space has largely been

in the form of power

centres in the suburban

fringe, approximately 7.5million square feet

annually



that the pipeline of new hotels to be constructed is accelerating. Of the 211

proposed hotels, approximately 75% have a nationally recognized brand.

New supply has been concentrated in certain markets including Niagara Falls,

Toronto Airport, Torontos downtown and Vancouver airport. This has

restricted the ability of hoteliers to increase average daily rates.

New hotel supply generally focused on limited service hotels, which has had a

historic tendency to over-build given lower capital required and low barriers to

entry.

Potential future risks to this development cycle include: 1) Speculative

development as result of excess capital; 2) A slow down of the Canadian

economy, which is a major growth driver for demand of commercial space; 3)

Corporate consolidation reducing demand (i.e., bank mergers impacting financial

office core in Toronto, oil and gas merger activity impacting office demand in

Calgary); 4) Displacing the balance of supply and demand, resulting in flat rents;

and 5) Escalating land and construction costs, which erode proforma developmen

returns.Looking forward, we believe that the real estate companies, public and private,

will look to augment their FFO growth via development opportunities. Among the

REITs that we cover, a growing number are undertaking development, either in-

house or through a third party developer including: Cominar, Chartwell, CREIT,

Dundee, First Capital, Morguard, Primaris, Retirement REIT, RioCan, and

Summit. Given a tight acquisition market, we believe that REITs with exposure to

development will be able to generate above-average FFO growth. Of course, we

view REITs as conservative investment vehicles given that they pay out monthly

distributions. Accordingly, we believe that development should remain a small

part of their business.

New hotel supplygenerally focused on

limited service hotels,

which has had a historic

tendency to over-build

given lower capital

required and low

barriers to entry

We believe that the real

estate companies, public

and private, will look to

augment their FFO

growth via development

opportunities



REALESTATEEQUITYMARKETPERFORMANCE

Consistent with the strong performance over the past five years, the Bloomberg

Canadian REIT Index posted a strong 24% return over the year. This return

followed significant returns of 17% in 2004 and 28% in 2003. This return far

exceeded our expectations of returns in the 8% to 12% range. However, we

were correct in our view that the REIT sector would not outperform the broader

market index for the sixth consecutive year, as the S&P/TSX 60 Index posted an

even stronger 26% return in 2005. Since 2000, the Canadian REIT sector has

delivered more than a 20% average return annually and greater than 200% total

return over the period. Wow!

The U.S. REIT industry also beat expectations achieving an 8% return (12% for

equity REITs only) compared to a paltry 5% for the S&P 500 Index, 1% for the

NASDAQ, and a 0.6% decline for the Dow Jones. More importantly, the U.S.

REIT industry did outperform the other market industries for the sixth

consecutive year. So far in 2006, the U.S. REIT industry is on track to

outperform for the seventh straight year as the NAREIT index is up 6.7%. Evenmore telling, the average dividend yield for U.S. Equity REITs of 4.4% is 20 basi

points lower than the 10-year Treasury yield of 4.6%. This negative spread

compares to a historical average positive risk spread of 100 to 200 basis points

over the past decade.

Since 2000, the Canadian

REIT sector has

delivered more than a

20% average return

annually and greater than

200% total return

TABLE2: COMPARATIVETOTALRETURNOFSELECTEDINDICES

1999 2000 2001 2002 2003 2004 200Bloomberg Canadian REIT Index 8.0% 17.9% 27.9% 8.3% 27.9% 17.0% 24.0%S&PTSX 60 Index 34.1% 7.9% -11.6% -13.9% 24.4% 13.8% 25.9%

NAREIT Composite Index -6.5% 25.9% 15.9% 5.2% 38.5% 30.4% 8.3%

S&P 500 Index 21.0% -9.1% -11.9% -22.7% 28.7% 10.9% 4.9%Dow Jones Industrials 25.2% -6.2% -7.1% -16.8% 25.3% 3.2% -0.6%NASDAQ Composite Index 85.6% -39.3% -21.1% -31.5% 50.1% 8.6% 1.4%

Data as of December 30, 2005

Source: Bloomberg Inc. and RJ Research estimates and analysis

Considering that real estate fundamentals were relatively weak over this period,

we believe that strong demand for yield-investments (and capital preservation)

spurred stock performance. The compression in the yield spread amongst the

REITs also suggests that differentiation of REITs on a risk-basis was limited. In

reviewing the ranked returns performance below, selected senior REITs (CREIT

RioCan, Summit) posted very strong stock performance. This can largely beexplained by the managements long track record, stability of income portfolios

and the liquidity of the stocks. Relatively new REITs including Calloway,

Primaris, Chartwell, and Sunrise also recorded double-digit total returns. These

stocks have exhibited tremendous growth in their portfolios since their IPOs.



FIGURE5: RANKEDRETURNSFORREITSIN2005 (IN%)

Note: Total returns as of December 31, 2005

Source: Bloomberg Inc

At December 31, 2005

Note: First Capital Realty is not a REIT

119.51

36.35

28.39

26.93

26.61

22.83

22.12

21.44

16.85

16.83

16.64

7.19

7.19

7.1

6.8

5.98

5.38

0.39

0

-4.55

10.6

9.53

10.8

12.03

14.85

13.48

Westfield REIT

Summit REIT

RioCan REIT

CREIT

Calloway REIT

Allied Properties REIT

Primaris REIT

First Capital Realty

Northern Property REIT

Royal Host REIT

Sunrise Senior REIT

Boardwalk REIT

Chartwell Senior Housing REIT

Cominar REIT

Legacy Hotels

CHIP REIT

H&R REIT

IPC US REIT (C$)

IPC US REIT (US$)

CAP REIT

Morguard REIT

Alexis Nihon REIT

Innvest REIT

Dundee REIT

Whiterock REIT

Lanesborough REIT

Source: Bloomberg and RJ Research estimates and analysis

Outlook for 2006

We forecast that Canadian Bloomberg REIT Index will slightly underperform the

broader market index in 2006. This reflects the above-average returns the REITsector has achieved since 2000. Our target total returns for the REIT sector

range from 6% to 16%, which implies that the industry will provide the current

going-in yield with modest capital appreciation. Our target prices assume a

price-to-FFO multiple of 14 to 15 times based on our 2006 FFO estimates.

We believe that the stock market will continue to exhibit volatility and heightened

sensitivity to financial and political news including the direction of inflation,

bond yields, economic growth and government instability and potential tax

changes. We believe that any correction in the stock market performance will

provide an attractive opportunity to establish or increase market positions of

senior REITs, which have typically been expensive. This is particularly relevantgiven the private market pricing of real estate, as a prolonged correction would

create merger and acquisition opportunities. High-quality REITs with a long

track record of performance include Cominar, CREIT, H&R and RioCan.

We anticipate that FFO growth per unit will remain modest in the 0% to 5%

range on average with the mid-point on par with inflation. The bulk of this FFO

growth will continue to be driven from acquisitions, although we expect the pace

of acquisition growth to moderate over the year. Internal growth in the form of



same-property operating income will range from 0% to 3% across the sector.

The sectors that will experience above-average FFO growth include office and

retail oriented REITs. We believe that fundamentals for the apartment sectors

will continue to improve over the course of the year and expect relatively flat

FFO performance. The impact of a higher Canadian dollar will constrain the

earnings growth of the lodging REITs and industrial-focused REITs.

We anticipate that an increase in short-term interest rates will have minimal

impact on the REITs as exposure to current and floating rate debt remains

limited. We believe that long-term interest rates will remain relative flat as

inflation concerns ease. As a result, we expect cap rates to remain relatively low

over the course of the year. These low cap rates will continue to provide suppor

for REIT valuations. We anticipate REIT management teams will increase debt

leverage ratios to drive FFO returns. For maturing debt, we anticipate that

REITs will continue to extend the average mortgage term of debt.

Given the lopsided nature of Canadas economic growth, we believe that

companies with a location bias of properties in Western Canada will benefit in thnear-term. This includes REITs such as CHIP REIT, Primaris Retail REIT and

Boardwalk REIT.

On a sector basis, we believe that investment portfolios should remain biased

toward retail-oriented REITs given the healthy retail spending trends as consume

confidence remains high due to strong employment levels and real wage growth.

Retail REITs have outperformed over the past few years, reflecting strong

acquisition activity, incremental development activity and same-property operatin

income growth as a result of rental increases on leasing activity. Retailers

continue to seek new retailing formats and remain in expansion mode. Figures

on the level of new supply indicate there is opportunity to support new retaildevelopment. The top names we like in this retail space include First Capital

Realty and Primaris. We would be a buyer of RioCan in the event of a stock

market correction.

Given strong job growth, we believe that investors should also weight their

portfolio towards office-oriented REITs. Fundamentals in the office market

continue to improve and the sector is poised to experience earnings leverage as

occupancy and rents trend higher. While office projects under development are

increasing, the construction lag until delivery should provide enough of a lead tim

to keep the office market fundamentals in balance. The names we recommend i

this space include IPC US REIT and H&R REIT.

We also favour diversified names such as CREIT and Cominar REIT, which hav

solid track records for above-average returns, and an attractive portfolio exposed

to both the office and retail property segments.



To conclude, REITs today provide a stable to modestly growing source of income

for unitholders. Fundamentals in the real estate industry are stable to improving,

which will foster operating income growth as we enter the next stage of the real

estate cycle. The underlying value of real estate is supported by a universal

demand for income and the recognition that REITs provide a hedge against

inflation and offer potential capital gains. The longer-term value of real estate is

also supported by economic growth.

2006 Investment Performance Recommendations

Our recommendation for 2006 is based on the following economic and industry-

specific factors:

The Canadian economy continues to exhibit good GDP growth rate as demand

for our commodities and services excels.

With little threat of real inflation on the near-term horizon, bond yields are

likely to remain relatively low (although on an upward trend on a long-term

basis).

Property fundamentals for the office and lodging sector are expected to

continue to improve over the year and remain relatively stable for the retail,

industrial and apartment sector.

REITs still provide an attractive risk-adjusted 250 to 300 basis-point spread

over long-term bond yields. We believe that this spread will narrow in 2006.

FFO per diluted unit is expected to accelerate in 2006 as the impact of last

years acquisitions surfaces.

Acquisition activity is anticipated to moderate and will be partially offset by

improving operating margins as occupancy and rental rates improve in

selected property sectors.

Cap rates are showing indications of stabilizing and are likely to increase as

we look ahead.

Acquisitions remain accretive, albeit at a narrower spread.

Debt leverage remains conservative by historical standards and the firms have

abundant acquisition capacity.

Balance sheets are sound and management teams are expected to exercise

control in taking advantage of opportunistic equity capital.

Interest and rental income coverage ratios are very strong, indicating that the

sector is able to withstand higher interest expense.

Near term debt exposure is low on a percentage of total debt basis, which

means little refinancing risk is evident.

Bank loans, current debt and floating rate debt levels are very low, insulating

the companies from a sudden spike in financing rates or increase in spreads.



Operating margin on rental portfolios are expected to be stable and may

increase for selected companies.

General and administrative and trust expenses are expected to stabilize as the

auditing and legal expenses and administrative staff handle increased

compliance and regulatory matters subsidies.

Lease rollover for the commercial REITs remains at or below typical roll-ove

levels for all property sectors. As a result, we do not anticipate significant

gyrations in occupancy rates.

Payout ratios are inversely related to debt leverage. On the whole, we

believe that management teams are committed to reducing payout ratios.

Capital markets will remain favourable to the REITs, in terms of new IPOs

and secondary debt and equity offerings.

An increasing proportion of the sectors FFO will be derived from other

streams of income including asset and property management fees,

development fees, mezzanine interest, and investment income. It largely

reflects the goal to diversify and enhance income as the result of a highlycompetitive acquisition market.

The weighted average cost of mortgage debt may decline further as there is

approximately 60 basis-point difference from current commercial mortgage

rates of 5.5% and REIT mortgage debt cost of 6.1%..

The underlying quality of property assets of the REITs has improved over the

years, providing income stability and generally requiring less capital investmen

on leasing and capital expenditures as lease rollover and vacancy are typically

lower.

Abundant debt capital means that the spreads on financing should remain low

which is favourable for the REITs.

Excess private and institutional equity capital should translate into continued

demand for real property assets and REIT stocks. We are likely to see

merger and acquisition activity heat up in 2006.

The combination of limited liability protection and indexing has fostered

greater acceptance of REITs as an investment class.



Top Picks for 2006

CREIT (REF.UN)

A long track record of excellence including asset growth, operating income

growth, and FFO growth.

A well diversified portfolio both geographically and by asset class provides

income stability. Over the past five years, management has stepped up thenotch in terms of portfolio quality.

The REITs conservative operating strategy designed to ensure income

stability will benefit unitholders during an expected economic slowdown.

Internal growth opportunities via its office portfolio; retail portfolio expected to

continue its positive contribution to revenue growth; industrial portfolio will

remain stable.

Selective development opportunities with partners will augment FFO growth.

Cominar REIT (CUF.UN)

A consistent track record of superior FFO growth, conservative leverage andoperational excellence.

Core competency is sourcing underperforming properties (at higher yields)

and re-developing and re-leasing the properties, resulting in significant income

and value enhancement.

Geographically focused on the Montreal and Quebec City markets expertise

in these markets and familiarity with tenants provide a competitive edge.

In-house development program that will construct $30 to $50 million in new

projects will augment FFO growth.

Disciplined management team will not stretch to acquire assets.

Major stakeholders have a vested interest in maintaining the income stability

of the REIT.

First Capital Realty (FCR)

Over the past five years, management has successfully de-levered the

balance sheet, while simultaneously growing FFO and enhancing shareholder

liquidity.

Aggressive growth plans to double the size of the portfolio in the next few

years. Management has acquired more than $1 billion in assets in the last

couple of years. In-house development expertise, including more than 2 million of potential

gross leaseable area, paves the way for continued FFO growth.

Major shareholders with a commitment to grow this REIT.

Primaris Retail REIT (PMZ.UN)

A conservative balance sheet and prudent payout ratio provide income stability

and opportunity for future distribution growth.



This rapidly growing REIT has enhanced its geographic diversity and the

caliber of its portfolio through accretive acquisitions.

A strategic relationship with Oxford, the asset manager of the REIT, enables

the trust to realize operating synergies and rely on expertise management.

Growth opportunities via strategic acquisitions will continue to be a driver of

FFO growth.

Operationally, the trusts portfolio has generated strong increases in rental

rates on lease renewals, high portfolio occupancy rate and above-average

sales productivity.

InnVest REIT (INN.UN)

With a portfolio of limited service hotels concentrated in Ontario and Quebec,

the REIT has significant leverage to the continued recovery in the lodging

sector.

Over the past year, the firm has invested in portfolio enhancements including

re-branding initiatives, property upgrades, and customer loyalty programs.

These initiatives should lead to above-average room revenue growth.

A skilled management team with extensive experience in the lodging sector

and a track record for executing acquisitions.

Good growth potential via external acquisitions, including a potential foray into

the U.S. lodging market.

Runners Up in 2006

IPC U.S. REIT (IUR.U-US$, IUR.UN- C$)

A perennial favourite, IPC US REIT continues to be a value name in the

REIT space today.

A highly skilled and experienced management team with a knack for creative

deal-making and real estate investments.

The operating portfolio has earnings leverage as the U.S. office market

continues to improve. Near-term portfolio vacancy will provide future rental

income growth.

A solid balance sheet and the benefit of higher leverage should produce

above-average FFO growth and distributions to unitholders.

H&R REIT (HR.UN)

A management team adverse to risk, effectively in the business of leasesecuritization, creates a rock solid income stream.

A record of above-average portfolio asset growth that continues to meet the

strict financial and risk parameters.

Relatively new portfolio of assets has lower capex requirements. Limited

lease roll-over also translates into lower costs for the REIT to maintain

income stream.

Track record of strong FFO growth.


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TABLE3B:REALESTAT

EINDUSTRYREPORTCARD

S

tock

Company

S

ymbol

High

Moderate

Low

Aggressive

Moderate

Conservativ

AggressiveConservativ

BoardwalkREIT

BEI.UN

CAPREIT

CA

R.UN

ChartwellREIT

CS

H.UN

RetirementREIT

RR

R.UN

CominarREIT

CU

F.UN

CREIT

REF.UN

DundeeREIT

D

.UN

H&RREIT

H

R.UN

MorguardREIT

MRT.UN

IPCUSREIT

IU

R.UN

SummitREIT

SM

U.UN

FirstCapitalRealty

FCR

PrimarisRetailREIT

PM

Z.UN

RioCanREIT

REI.UN

CHIPREIT

HO

T.UN

InnVestREIT

IN

N.UN

LegacyREIT

LG

Y.UN

RoyalHostREIT

RYL.UN

*Anticipated1yearrelativeperfo

rmance-1=Highest,5=Lowest

GrowthRatePotential

Management

FinancialStructure

Relative

Income

Appreciation

Both

High

Moderate

Low

Value*

3

3

3

2

1

1

3

2

4

2

4

1

1

3

2

1

3

4

OverallIn

vestmentRisk

InvestmentPotential

Source:RJResearchestimatesandanalysis



PropertyInvestment and

Market Review


38/268



PROPERTYINVESTMENTANDMARKETREVIEW

The Canadian property investment market during 2005 was notable for a number

of factors including the following:

The second half of the year witnessed an across-the-board decline of cap

rates driven by investor demand for yield in a low-interest rate environment.

Cap rates for Canadian assets remain attractive on a global property marketbasis.

Strong demand by foreign investors including Australians, Germans and

Isrealis remained a market factor. Although it was domestic players, pension

funds and REITs that were most active.

Risk differentiation evident in 2001-2003, in which foreign buyers opted for

the security of long-term leases and core markets seemed less evident.

Senior real estate executives indicated that aggressive buyers and abundant

capital have led to property prices approaching replacement cost, most notably

in the industrial market.

A number of experienced real estate management teams characterized the

acquisition market as challenging and competitive with limited high quality

product available to purchase and very high prices paid.

Geographical diversity became an important theme for real estate

management teams either into the U.S., British Columbia, or a flight to core

urban markets.

Despite an erosion of fundamentals in the apartment sector and a lagging

recovery in the lodging sector, cap rates for both of these asset classes

continued to decline.

A number of real estate companies took advantage of market strength to sellnon-strategic properties.

As a result of narrowing acquisition spreads, a number of real estate

companies pursued third party and in-house development.

Several real estate companies have partnered with capital partners to source

acquisitions and benefit from a lower cost of capital. In exchange, real estate

companies earned asset and property management fees.

2005 was undoubtedly a sellers market; a trend that we do not expect to shift

this year as cap rates across all property sectors are forecast to remain low.

Moreover, there remains excessive capital that is seeking to be deployed in realestate.

2005 was a sellers

market. We expect this

trend to continue as caprates will remain low



TABLE4: GOING-INCAPITALIZATIONRATEBYASSETCLASSES

Source: Colliers International

Montreal Ottawa Toronto Calgary Vancouver VictoIndustrial 9.0% 8.8% 7.8% 7.8% 7.0% 9.0%Multi-family 7.0% 6.5% 7.3% 6.5% 5.5% 6.6%

Neighbourhood Mall 9.0% 9.5% 9.5% 7.5% 8.1% 9.0%

Office 8.3% 6.3% 6.8% 7.0% 7.0% 9.0%

Note: Cap rates as of the third quarter of 2005.

High Levels of Acquisition Activity Continues

With bond yields at all-time lows, the demand for real estate as an investment

product accelerated in 2005. With an estimated $16.6 billion in Canadian real

estate transactions posted during the year, 2005 marked the sixth consecutive

year of more than $10 billion in properties transacted. Foreign investors

accounted for approximately 9% domestic Canadian real estate investment, down

from 20% in 2004. Institutional investors, in particular pension funds, picked up

the slack competitively bidding for property portfolios including the Brookfield/

CPP/Alberta Treasury purchase of the $2 billion O&Y portfolio, CPPs purchase

of a $1 billion stake in Oxford office properties and B.C pension funds purchase

of the Menkes industrial portfolio for $400 million.

This competitive bidding resulted in lower going-in capitalization rates across all

property types. Transaction activity increased across each asset type and across

every major city. For the first half of the year, transactions amounted to $9.2

billion, up 13% from $8.1 billion in the six-month period in 2004. For the year,

transactions increased by 18% over the prior year.

Geographically, Toronto accounted for the bulk of activity at $3.8 billion or 41%

of all transactions posted in the six-month period. Vancouver and Montreal tiedfor second place at $1.4 billion each during the half-year. Transaction activity in

Montreal was effectively double the pace in the first half of 2004. Calgary and

Ottawa followed at $0.6 billion each during the half-year. These five cities

combined accounted for 86% of all transactions in the first six months of the

year. Transactions in Edmonton and Winnipeg were well ahead of the same pace

last year.

With bond yields at all-

time lows, the demand

for real estate as an

investment product

accelerated in 2005



TABLE5: MAJOR INVESTMENTTRANSACTIONSBYCITY, 1995, 2000-1H05

(in $mlns) 1995 2000 2001 2002 2003 2004 1H04 1H05Victoria 24 80 92 210 185 267 52 197Vancouver 480 911 1,240 2,054 2,331 3,329 1,332 1,418Calgary 364 1,464 1,289 1,735 1,548 2,456 1,030 601Edmonton 128 434 430 954 974 919 369 407Regina n.a 52 66 97 76 152 n.a n.a

Saskatoon n.a 24 26 25 40 230 276 61Winnipeg 188 223 76 146 302 195 80 181Toronto 1,430 3,924 3,695 4,400 4,373 6,851 3,423 3,772Kitchener/Waterloo n.a 560 269 246 351 331 255 282Ottawa 82 725 758 984 1,072 841 335 604Montreal 319 2,553 1,202 1,821 1,564 2,814 755 1,463Halifax n.a 63 148 99 70 367 165 158Rest of Canada n.a 301 n.a 0 31 48 n.a n.aTotal 3,015 11,314 9,291 12,771 12,917 18,800 8,075 9,155

Notes:

1) 2000-1H05 major transactions are those over $1 mill ion for all cities.

Source: Colliers International, 1995-2005 publications

By asset type, demand for office properties remained strong at $2.6 billion for thehalf-year, up 44% from the same period last year. This reflected two major

portfolio transactions (O&Y and Oxford) completed during the period. For the

2002 to 2004 p

2006 Cdn Real Estate Industry 020806 REV2

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