Investing in REITs can give you a hedge against inflation—as well as let you defer taxation

Investing in REITs is a great way to save yourself the trouble of owning real estate

A REIT is also known as real estate investment trust. Investing in REITs lets you hold income-producing real estate such as office buildings, shopping malls and hotels.

REITs can save you the cost, work and risk of owning investment property yourself.

Investing in REITs can kick start your real estate investing in Canada

We continue to believe that ownership of a primary residence is all the real estate exposure most investors need. However, if you want to add to your real estate holdings, one good way to do it is through REITs.

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The best real estate investment trusts have good management and balance sheets strong enough to weather an economic downturn. They also have high-quality tenants, and they carefully match their debt obligations with income from their leases. The best ones are still doing well, despite the slow economy, and are taking advantage of low interest rates to refinance long-term mortgages.

If you’re investing in real estate yourself, you should look at multiple-unit rental housing or commercial properties, especially those with big parking lots or extra land. Investments like these can give you current income, plus long-term development possibilities. That’s a potent combination for patient investors. And of course, location is the most crucial part when it comes to real estate investing in Canada and in any country.

If you’re interested in real estate investing in Canada through a REIT, you should look into the RioCan Real Estate Investment Trust (symbol REI.UN on Toronto). RioCan is Canada’s largest real estate investment trust and owns hundreds of shopping centres located across Canada. It specializes in big-box outdoor malls (these malls feature large stores that are usually part of a chain).

Beware of private REITs

Conventional REITs are publicly traded on a stock exchange. Private REITs calculate the value of their own units (often just once a year), and don’t need to reveal all the information that’s available to the public from publicly traded investments. Private REITs portray this feature as a benefit—since it avoids the volatility and speculation of public markets!

However, staying private also cuts the likelihood that nosy outsiders and analysts will find out about and draw attention to hidden risks and problems that the REIT happens to suffer from.

Even at the best of times, private REITs holding small-town real estate is harder and more expensive to finance than city properties. Because of the higher risk of cut-offs in rental income, lenders demand bigger down payments and higher mortgage rates. This makes small-town property harder and more expensive to sell.

Small-town real estate has to provide high returns in good times to offset the higher risk of loss when the market turns downward.

The combination of these two “benefits”—a small-town focus plus a once-a-year valuation by the REIT’s insiders—would be enough to make us advise against small-town, private REIT investing.

Tax exemption sets real estate investment trusts apart from other income trusts

REITs resemble income trusts, but with a key difference: REITs invest in income-producing real estate, such as office buildings and hotels.

REITs were common in Canada long before income trusts became popular enough to become a significant drain on Canadian tax collections. Ottawa felt the income-trust business structure was appropriate for REITs, so it exempted REITs from the new income-trust tax.

Real estate investment trusts can maintain their exemption as long as they meet the following requirements:

  • REITs must not hold any property other than “qualified REIT properties” at any time during a tax year.
  • At least 75% of the trust’s revenue for a tax year must come from rent or mortgage interest from real or immovable properties in Canada, and capital gains from the sale of such properties.
  • At least 75% of the total fair market value of all trust properties that the REIT holds must be in Canada.

Income trust tax exemption just one advantage of investing in REITs

REITs can add to your portfolio in a number of other ways. They can provide a hedge against inflation, for example. And we continue to believe that low interest rates and government-stimulus spending will spur inflation over the next few years.

Many REITs have taken advantage of today’s low interest rates to refinance their mortgage debt. Many have been able to renew leases at high rates. That’s how REITs stand to gain from an ongoing economic recovery, while providing a hedge against inflation.

Is investing in REITs already part of your investment strategy? If so, how has it performed for you? Share your story with us in the comments.


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