Real estate investment trusts fall into the income trust category. More specifically, these trusts hold assets that generate income and then redistribute it.
In the case of REITs, the trusts own buildings that generate rental income. RioCan, the owner of shopping malls, is the largest REIT in Canada, while Cominar, which holds office, commercial and industrial properties, is the largest Quebec-based REIT. But there are many others.
REITs to suit all needs
There are different types of REITs. Some specialize in the hotel industry, others in retirement homes, shopping malls, residential properties or office buildings.
Some REITS also diversify by investing in various real estate sectors. For investors, buying units in these trusts can be a good way to spread out the risk.
An affordable financial plan
Units in most REITs are sold on the stock market, just like shares. All you have to do is contact your financial advisor to purchase them. And you don’t need to invest a large sum of money, as you would if you were buying a building. Over time, you receive income without having to handle building maintenance and management or assuming the other usual responsibilities of a building owner. If you’re thinking of investing in real estate, there’s no denying that this is a much simpler and quicker way than actually buying a bricks-and-mortar building.
When you own units in a REIT, you receive a portion of the profits it generates. These distributions are often monthly or quarterly. You therefore receive income on a regular basis.
Another advantage is that the dividends are usually higher than those paid out by publicly traded companies. According to Quebec’s Autorité des marchés financiers, REITs distribute between 70% and 95% of their profits to shareholders. These high returns are due to the fact that, aside from building maintenance and the acquisition of new buildings, REITs can grow without having to significantly reinvest funds. Furthermore, unlike publicly traded companies, they do not pay tax on the profits they distribute to investors, but only on those profits that they keep.
Tax treatment of distributions
How does this affect you? You will have to pay tax on the payments you receive from a REIT. Also, keep in mind that the tax treatment of distributions varies according to how they are derived. In the case of rental revenues, you will be taxed as though this is income you’ve earned.
In the case of return on capital, the base price of your units will be reduced for tax purposes. When you sell your units, you will therefore have to pay tax on capital gains. The capital gain is the difference between the price you receive for your units and their adjusted base price.
Know the risks
There aren’t many investments that don’t involve some element of risk. In the case of REITs, there’s no guarantee that you will receive regular dividends. The amounts paid out may be reduced or even suspended.
If mortgage rates rise and a REIT has to renegotiate its mortgages that are coming to term, its profits may slip. Or, for instance, occupancy rates might decline in tough economic times. In either case, both the amount and the frequency of dividends may be affected. And the unit price of REITs fluctuates according to supply and demand as well as market conditions.
Look before you leap
To reduce risk, be sure to do your homework on the REITs you’re considering investing in.
Since the shares are not fixed-income titles, avoid relying exclusively on the previous dividend amounts when you make your choice. Management quality is a critical factor. One basic rule is to opt for REITs that are managed by one of its major shareholders, since this person or entity will be inclined to act responsibly. Also look for the following features:
- quality buildings with good tenants;
- long-term leases;
- high occupancy rates;
- reasonable debt loads.
It’s also wise to consult online the annual information form, the prospectus and other information related to the REITs you are interested in. Your investment advisor or portfolio management advisor can also provide valuable advice.
In terms of diversifying, REITs can play a useful role in your financial portfolio. They provide an alternative way to invest in real estate and turn a profit, without ever having to worry about leaky roofs or bad tenants.