Why this real estate investment trust’s U.S. expansion scares investors

Many Canadian firms have tried to expand into the U.S. over the years. Some, like Tim Hortons (symbol THI on Toronto), have had difficulty in the United States. Other companies’ expansion efforts have failed miserably.

Canadian Tire (symbol CTC.A on Toronto) provides a memorable example of a failed U.S. expansion. In 1982, the retailer bought a chain of Whites automotive-retail stores in Texas. By 1985, Canadian Tire had lost $300 million on this purchase. That’s when the company decided to sell the division and retreat to Canada. Its stock price has since gone up more than 600%.

This real estate investment trust’s U.S. expansion adds risk — and potential rewards

RioCan Real Estate Investment Trust (symbol REI.UN on Toronto) one of the real estate investment trusts (REITs) we cover in our Successful Investor newsletter, recently made a big acquisition in the United States.

REITs invest in income-producing real estate, such as shopping centres and office buildings. RioCan is Canada’s largest REIT, with properties in all 10 provinces. It specializes in big-box outdoor malls (these malls feature large stores that are usually part of a chain), and owns 258 shopping centres. Most of these are in suburban areas, where land is generally cheaper than in towns and cities.

RioCan is expanding into the U.S. through a joint venture with Cedar Shopping Centers, Inc. (symbol CDR on New York). RioCan will pay Cedar $181 million U.S. for 80% of this venture, which will hold seven of Cedar’s malls in Massachusetts, Pennsylvania and Connecticut. The deal will close in March 2010.

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This is a big investment for RioCan in relation to its 2009 earnings. To put the purchase price in perspective, the trust earned $113.9 million, or $0.49 a unit, in 2009. Still, this purchase only represents 2.6% of the trust’s $4.3-billion market cap.

Despite its vast potential, the U.S. economy remains weak, and unemployment is a high 9.7%. That adds to RioCan’s risk. However, unlike Canadian Tire in 1982, RioCan is mitigating this risk by expanding through a joint venture. Moreover, the joint venture’s malls are anchored by grocery and drug stores. These retailers sell staples that consumers must buy no matter what the economy is doing.

As well, this new joint venture will help RioCan make further purchases in the U.S. In light of the weak U.S. economy, the trust could be in a good position to buy new properties at bargain prices.

We advise against overindulging in real estate investment trusts. That’s mainly because real estate is a cyclical business, and rental income from the underlying properties can suddenly dry up during economic slowdowns. To cut your risk, you should focus on well-established REITs with long histories of maintaining their distributions during cyclical downturns.

You can get our latest buy/sell/hold advice on RioCan and dozens of other stocks you may be considering buying (or selling) in our Successful Investor newsletter. Click here to learn how you can get one month free when you subscribe today.