Investing in publicly traded real estate is going to get even harder now that one of Canada’s largest shopping mall operators is going private.

A $9.4 billion deal, including debt, will see Toronto-based First Capital Real Estate Investment Trust, a retail landlord with about 136 shopping centres in urban areas, be sold to privately held KingSett Capital and Choice Properties REIT. The pair plan to carve up the portfolio.

It’s the latest REIT takeover in a sector in which stock prices have been battered since the pandemic, with private entities often scooping up assets at a discount. In this case, Canada’s largest REIT,

Choice Properties , controlled by the Weston family, is in on the deal. The $24.40 per unit offer is a 17 per cent premium to First Capital’s 20-day volume-weighted average price and a premium of eight per cent to the REIT’s net asset value of $22.57 per unit. But consider the REIT traded at almost $22 before the pandemic for context.

One of the ongoing themes in post-pandemic real estate has been that private assets have traded at higher prices than their public counterparts, with many arguing about that gap and who is right.

If you were an investor, you would have been left wondering how much you should have in tepid real estate holdings given a five-year total return of just over two percent based on something like the iShares S&P/TSX Capped REIT Index ETF.

That’s just ugly when the overall TSX Composite is up more than 75 per cent in the same span.

But there has been money to be made in REITs. Just ask Jeffrey Olin, president and chief executive of Vision Capital Corp., which has a large position in First Capital.

“The big picture context is that the difference between real estate and any other asset class is that the size of the private property market is much bigger than the $2 trillion publicly traded REIT sector in North America, and there is an arbitrage between the two.” said Olin. “We don’t want to compete with a Blackstone or a Brookfield, we’d rather sell to them.”

In 18 years of buying REITs, his fund has now witnessed 25 of its holdings taken over, and the average premium has been close to 30 per cent.

The list of REITs being taken private is long, and while retail hasn’t dominated the conversation, apartment REITs struggling with low valuations have been prime targets. InterRent has already disappeared from public markets and Ottawa-based Minto Apartment REIT will soon, with private investors backing both moves.

Bank of Nova Scotia analyst Mario Saric issued a note lamenting “another quality REIT saying goodbye,” but said the First Capital deal is a reason to be overweight on the retail trust sector. There are still other retail REITs, such as RioCan and Primaris, but this takes a major one off the board.

Olin said none of the valuations added up and points to a time in the fourth quarter of 2022 when there was 42 per cent delta between U.S. public and private REITs

“Did that make any sense?” he said. “It was ridiculous. The question was who was right, and we said both. In some sectors, the stock market got it right, like the office. In other sectors, the market got it wrong.”

Olin likes grocery-anchored retail space because the anchor tenant across the continent is usually a major chain such as Loblaws, and cautions that not all REITs are cut from the same cloth. “It’s defensive space, and it has growth,” he said of neighbourhood malls, which have more necessity-based tenants, such as grocers.

So what’s next? “No question, the names in Canada are dwindling. But you know this can be cyclical,” said Olin, who points to Go Residential REIT, which is listed on the

Toronto Stock Exchange but holds apartment assets in New York City and started trading last year, as a sign of growth.

Adam Jacobs, head of research in Canada for real estate company Colliers, said he remembers attending a REIT conference less than two years ago, when everyone was complaining that no big deals were happening.

“Now every week one of the deals happens. I guess the dam has broken,” he said. “There is this argument that the public REITs are undervalued and inherently worth more if you look at rent growth and value of assets, and people are ready to act on that.”

But like Olin, he says asset class matters. And grocery-anchored retail is just something everybody wants right now.

“This is just a portfolio that would be hard to transact one at a time,” said Jacobs, who compares the deal to a decision by Blackstone Group to buy Pure Industrial REIT, a 2018 deal that was based on the premise of rent growth.

“Grocery-anchored retail might be at the same point in the cycle,” he said. “Really in demand, not much in development, and it’s really hard to buy.”

The research head said there is a lot of what people call “dry powder” in the private market, looking to buy real estate and access to debt, which is critical for any transaction, has settled down, and interest rates have stabilized.

“People are able to pull the trigger now. The debt component is significant,” said Jacobs.

Carl Gomez, chief economist at Centurion Asset Management, which operates a private investment REIT, said publicly traded REITs will remain a target because of depressed prices.

“They are trading below their intrinsic value, and that’s opportunity to scoop them up, especially those REITs with high-quality scalable portfolios,” said Gomez. “It’s just a great acquisition target.”

Gomez said REITs are really just real estate wrapped up as a stock.

”But the problem with the stock market is it just doesn’t trade on stock fundamentals, it trades on noise, rumour and a lot of stuff that amps up the volatility,” he said. “That’s the problem for some of the REITs now. I will say the public REIT market has (less desirable) product there too.”

Another problem with the Canadian REIT sector is that it’s always been very small relative to its U.S.

“You just can’t take the same type of sector bets,” said Gomez.

Once First Capital disappears, there will be even less to bet or invest in the sector. But is it the end of the world?

Certified financial planner Jason Heath noted income trusts were really popular in Canada, with about 260 trading publicly in 2006, but those numbers are down to 19 remaining in the S&P/TSX Income Trust Index, and they are mostly REITs.

“For most investors, REITs should not play a meaningful role in portfolio construction. As a good yardstick, the S&P 500 in the U.S. has only a two per cent real estate weighting. The S&P/TSX has even less,” he said.

An even better point he makes is that most of Canadians’ net worth is in real estate, a factor driven by high home-ownership rates.

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“Adding more real estate, especially Canadian real estate, is poor diversification,” said Heath.

So, goodbye to another REIT. For long-suffering investors, getting out at a premium might not be such a bad thing.