When interest rates on fixed income securities like GICs and T-bills dropped, many people living off their investment income had to look for other ways to generate money. Income trusts became a popular new investment. Then came Jim Flaherty’s “Hallowe’en Horror” and the elimination of many income trusts because of changes to Canadian tax laws. Real Estate investment Trusts, REITs, were one of the few types on income trusts that were exempt from the most damaging of the tax changes. So REITs became very popular investments for people, especially retired persons, seeking income.
What Are REITs?
A real estate income trust is a type of company that invests either directly in property by buying and owning it, or indirectly by buying and owning mortgages, or both. Different REITs tend to prefer to invest in different types of properties. For example, some REITs hold mostly apartment buildings; others shopping malls; others industrial parks.
An investor can buy a share in a publicly traded REIT on the stock exchange. Like other shares, the price for a unit can go up or down dramatically.
The investor usually receives distributions from the REIT either monthly, quarterly or annually.
The distributions are NOT dividends. They are usually income and/or a return of capital. They can be very messy to keep track of taxes properly for in an unregistered investment account, like a regular cash brokerage account. Keeping them in a registered investment account reduces the need for some types of paperwork. (For example keeping them in a RRSP, RRIF or TFSA.)
The idea of an investment trust is to reduce taxes. In a common situation, a company makes money, pays taxes on it, and distributes some of the after tax growth to its investors as dividends. An income trust turns this around. Instead, it makes money, distributes it to the investors and has them pay the taxes on it. If those investors pay lower tax rates than the corporate tax rates, there is less tax being paid and, at least in theory, the investors can get a higher return.
Why Do Investors Like REITs?
Investors like high income investments. REITs appear to give them a high yield, often 5% or better on a pre-tax basis.
Investors also like the idea of investing in real estate but being able to sell it off quickly and easily at any time. If they buy an apartment building with several friends, it would be difficult to sell their position immediately. But if they buy units in a REIT that holds apartment buildings, they can sell their position with a few quick keystrokes on their brokerage website. (Whether they can sell it for a profit is another story.)
Many investors have convinced themselves that the value of real estate can only go up so to them REITs seem like very safe investments. As safe as, say, houses. (I don’t count myself among those investors.)
Many REITs are also legally obligated to keep paying out a high percentage of their profits. They can’t suddenly suspend payments like a dividend paying stock can, simply at the discretion or whim of management. That appeals to some types of investors as well.
REITS Are Vulnerable
So far it seems like REITs are a great investment and it sounds like we should all sink huge amounts of our savings into them. Unfortunately, no investment is invulnerable and no investment is simple. REITS are susceptible to increases in interest rates. In Part Two, I’ll explore Why Do Rising Interest Rates Affect Real Estate Investment Trusts, REITs? And try to answer the selfish question: should I sell my small REIT holding now or not?
- Flaherty imposes new tax on income trusts
- Why Do Rising Interest Rates Affect Real Estate Investment Trusts, REITs?
- Stocks that Pay Monthly Dividends are Useful for Retirement Income
Do you have some REITs in your portfolio? Did the dip in prices this spring send any shockwaves through you? Please share your experiences and insights with a comment.