Despite policymakers’ concerns about the Canadian real estate bubble, the smart money likes what it sees when it comes to Canadian real estate investment trusts (REITs).

And since the Canadian Edge Conservative Portfolio currently holds four “buy”-rated REITs, with an average yield of nearly 6%, we’re glad to have their affirmation. Our REIT holdings have invested in properties that include office space, industrial sites, retail hotspots and even apartments.

But it’s not just Canadian REITs’ supersized yields that institutional investors favor. Crude oil’s collapse, which has wreaked havoc on the country’s energy sector, has naturally spilled over into other areas, including real estate, particularly in the resource-rich province of Alberta.

Consequently, Bloomberg says that Canadian REITs currently trade at their cheapest valuations relative to their U.S. peers since the Global Financial Crisis.

To be sure, Canadian REITs have already had an incredible run, delivering a total return of nearly 278% in U.S. dollar terms since the bear market bottom in March 2009, based on the performance of the Bloomberg Canadian REIT Index.

That’s nearly 34 percentage points better than the S&P 500 and more than 102 percentage points better than the S&P/Toronto Stock Exchange Composite Index.

However, U.S. REITs have done even better. Over that same period, the Bloomberg NA REITs Index generated a total return of 417.2%. And now they trade at a premium valuation compared to their Canadian counterparts.

The key metric here is the price-to-funds from operations ratio (P/FFO). That’s because the relevant measure of profits for a REIT is funds from operations (FFO).

On that basis, the 43 constituents of the Bloomberg Canadian REIT Index trade at an average P/FFO of 11.8. By contrast, the 164 members of the Bloomberg NA REITs Index trade at a P/FFO of 20.8. According to Bloomberg, that substantial gulf in valuations is at its widest since 2009.

Meanwhile, Canadian REITs offer an average forward yield of 7.0% versus 4.1% for the average U.S. REIT.

Pennies on the Dollar

And for U.S. income investors with new money to invest, Canadian REITs aren’t just cheaper from a valuation standpoint, they’re also cheaper in currency terms.

During the decade-long global resource boom, the Canadian dollar briefly defied its “Monopoly money” status in the eyes of some U.S. citizens when it traded above parity with the U.S. dollar.

The loonie ultimately peaked at USD1.06 in July 2011, but continued to trade near or above parity with the greenback through the end of 2013.

The Canadian dollar began its long slide to where it trades presently, at USD0.80, as a result of the divergence in monetary policy between the Bank of Canada (BoC) and the U.S. Federal Reserve.

The BoC had abandoned its upward rate bias well in advance of its surprise rate cut in late January, when it lowered its benchmark overnight rate to 0.75%.

Meanwhile, the U.S. dollar began to surge against the loonie as well as other currencies, as the Fed curtailed its extraordinary stimulus, and then began considering when to finally raise short-term rates off the zero bound, which is where the federal funds rate has been stuck since late 2008.

Some key U.S. economic data have disappointed recently, particularly the March employment report, which may force the Fed to defer any rate hike until later this year, or even 2016. Until recently, the Fed had been widely expected to raise rates by mid-year.

Regardless, the normalization of interest rates seems likely to proceed slowly, which means dividend stocks such as REITs should continue to be competitive against Treasuries for some time.

When the Fed finally does raise rates, that will likely cause the loonie to trade lower, while possibly prompting a selloff in dividend stocks akin to the “taper tantrum” that occurred in mid-2013. We believe such a scenario is a buying opportunity.

The Eventual Loonie Liftoff

Of course, the discount for U.S. investors resulting from the depreciation of the Canadian dollar only offers value if the currency starts to rise again, enhancing gains on investments made at current levels.

At some point, the commodity cycle will turn, which should push the loonie higher again. And a resurgent Canadian economy accompanied by the BoC’s normalization of its own interest rate policy will also be key drivers of any currency rebound.

For now, analysts expect the Canadian dollar to bottom this year, around USD0.78, a level which it nearly touched in mid-March. Thereafter, the loonie is expected to rise modestly in 2016, with a more moderate gain, to USD0.87, in 2017.

It’s also important to note that the divergence in each central bank’s monetary policy doesn’t just affect the exchange rate, it also affects REITs’ borrowing costs.

Assuming the BoC cuts rates at least once more this year, a move which the majority of traders clearly expect, then Canadian REITs’ borrowing costs will decline as well.

Additionally, lower rates mean that Canadian REITs will continue to enjoy support from Canadian income investors.

And for value-oriented income investors based in the U.S., that means Canadian REITs offer high yields at a substantial discount with the prospect of further gains ahead.