What is a REIT?

Real Estate Investment Trusts are much like a mutual fund that invests in a portfolio of real estate of specific types of properties such as apartments, office, retail or hotels. Unit holders get a proportional share of profits and losses. Investing in REITs is generally more predictable than playing the stock market or investing in individual property, plus REIT investments are a lot less work.

Canadian REITs are expected to show good returns in the low teens for the next few years as a total return (distributions plus capital appreciation) given growth and an improved global economy.

In addition, Real Estate Investment Trusts were excluded from the Halloween 2007 decision by the Harper Government which taxed income trusts, making REITs one of the only tax-efficient savings or investment vehicles left for Canadians.

Another reason why REITs are gaining popularity is because real estate is one of the few places where investors can put their money to accrue interest and get tax-efficient cash flow.

Here’s a guide to the benefits and what to look for:

Tax benefits
The tax benefit of REITs relates to distribution. A portion of the distribution from Canadian REITs is classified as return of capital, which is not taxed. It actually goes to reduce your adjusted cost base, so that when you go to sell the unit later, you realize more of a capital gain than you normally would have.

For example, if you buy a unit at $10 and the distribution is $1, and half of that is return of capital, then after one year, your adjusted cost base would go from $10 to $9.50, because that $0.50 return of capital reduces your cost base and you don’t pay taxes on it right away. The other $0.50 is generally business income which his taxable.

If you were to sell the unit a year later, and it’s gone up to $11, you’d pay a capital gains tax on $11 minus the $9.50 cost base, so you’d have a $1.50 in capital gains as opposed to $1 in capital gains.”

The tax treatment benefits both the REIT and the investor. Because the REIT operates as a trust it doesn’t have to pay any corporate income tax on revenue that is generated in the portfolio, so the profits essentially become 100% tax deferred until the investor draws them out of the portfolio.

So if you’re accruing gains and your dividend is in a registered account, you’re not paying any personal income tax until you decide to discharge the capital from the registered account. The opportunity to grow this capital tax free gives investors a tremendous edge in terms of building their portfolio.

That paves the way for strong growth. One private Canadian REIT, for example, boasts 8 per cent annual distribution for investors, with monthly payouts. Each unit costs $10, with a minimum investment of $5,000. Investors can also borrow to boost their overall stake.

With an overall investment of $10,000 at a 8 per cent distribution, monthly payments would be just under $670, and the annual total would equal $8,000. As long as your REIT has a portfolio of steady rental income, those can be reliable expectations.

Of course any real estate property requires management and repair costs, but these can be minimal in a REIT when it’s all handled under one roof for a large number of properties.

REIT investments vs Individual property investments
When investing in REITs, you’re essentially buying into the real estate market. But it’s a much different type of investment than buying a singular property and managing it yourself.

An apartment REIT, for example, buys multiple complexes and properties throughout the country, manages them and handles the portfolio. Unlike amateur investors, the purchases for any new properties are made by professionals with experience and heavy research.

Buying an investment property also often entails managing it yourself, essentially becoming a landlord.

Another advantage to REITs is that the real estate industry is heavily regulated, and following all the laws can often be a bit intimidating as well.

And most importantly for some with limited funds, REITs allow you the chance to invest with a smaller share of cash needed to buy a house or apartment. Just $5,000, for example, can get you started at some private REITs.

Choosing a REIT
Just like finding a property, you do need to do some research into REITs to find which ones are the best canadian REITs for you. In addition to the countless REIT companies, there are also various REIT options, such as retail, office or apartments.

Almost all REITs offer diversity of multiple locations and properties, which is a major advantage to an investor who wants to spread out their money.

Multi-family residential is one of the safest REITs, while higher risk REITS are hotels or single-tenant REITs. There are different rates of returns, but investors have to decide what their risk profile is to determine which REIT is appropriate for them.

Investors should also look at where their REIT has properties. For example, Integrity Wealth Group plans to operate mostly in Western Canada, while Skyline has stuck to mostly secondary and tertiary markets outside Toronto.

Many funds stick near company headquarters – following the age-old rule of sticking to what you know best. Investors looking at US REITs should consider the currency risk. Those who get into the U.S. REIT market now are essentially taking the risk that a recovery is on the horizon.

No matter where you choose to buy, be sure to put as much time into choosing your REIT as you would any piece of property. You may even decide to buy more than one REIT to diversify your holdings there even more, but each one should be carefully researched. Many REITs post examples and private returns on their Websites. Past history often can give you the best gauge of future performance.

Public REITs versus Private REITs
Investors can choose between a private or public REIT, and there are advantages and disadvantages to both.

Private REITs are less subject to movements in the markets, while investors in public REITs have to deal with shifts in sentiments, which can be hard to predict. Private REITS allow investors to eliminate some of the volatility.

But there are advantages to public REITs: they have strict reporting rules, and are therefore required to be more open. Private companies, due to their nature, aren’t required to report in the same manner to their investors.

There’s also more liquidity in the public sector. You can just put in a sell order and trade it immediately to whoever is willing to match the bid price on an exchange.

Public REITs will also have a lesser investment cost, as private REITs can have a minimum of at least $10,000.

Whatever you choose, make sure you’re comfortable with the style of management and portfolio in your REIT. Look for management that has a good track record, has some experience and a long-standing history of transparency.

All REITs investors need to consider how they will manage their debt: Leveraging your equity can increase yields, however it can also put your fund at risk if you leverage too much. Don’t leverage enough and you‘ll end up wasting potential future growth.
 

Public REITs vs Private REITs