Investing in REITs (Canada) can help you minimize the risk of owning investment property
REITs (Canada), as essentially the one remaining category of income trusts, continue to pay distributions before they pay tax—and that’s good for unitholders. The 2011 law that put an end to tax privileges for other income trusts made an exception for these real estate firms. They remain popular with Canadian investors seeking steady income and good growth prospects.
Investing in Canadian REITs lets you hold income-producing real estate such as office buildings, shopping malls and hotels. They can save you the cost, work and risk of owning investment property yourself.
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REITs and income trusts
Real estate investment trusts resemble Canadian income trusts, but with a key difference: REITs (Canada) invest in income-producing real estate.
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).
More about REITs (Canada)
Canada offers special tax treatment for Canadian income trusts. When they flow their income through to their unitholders, the REITs don’t pay much if any corporate tax. Investors pay tax on most of the distributions as ordinary income (although part of some distributions qualify as a tax-free return of capital).
Ottawa feels the income-trust business structure is appropriate for real estate investment trusts, or REITs, so it exempted REITs from the income trust tax.
As mentioned, real estate investment trusts resemble Canadian income trusts, but with a key difference: REITs invest in income-producing real estate, such as apartments, shopping malls and hotels. (We cover a number of carefully selected REITs in our Canadian Wealth Advisor newsletter.)
Regardless, the basic tests we use to ferret out good investments and reject bad ones still apply to REITs, and not just Canadian ones.
Keep “investment inputs” in mind when judging REITs (Canada)
Here’s a list of investment inputs that we look at before recommending an income trust:
Did the Canadian REIT buy its assets in the midst of a recent boom, or has it owned them for some time? Bidding for assets in the midst of a boom tends to be risky, since it can lead to unpleasant investment surprises.
How much debt is the Canadian real estate income trust, or REIT, carrying? You need to gauge the debt in relation to all assets, including hidden assets and those that appear on the balance sheet. Too much debt in relation to assets can lead to a downturn in distributions when the business hits a snag.
Are there any special factors worth considering? With REITs, you need to look at the quality of tenants, length of leases and the possibility of improving the use or expanding the occupancy of existing properties.
Is the Canadian REIT’s focus area the subject of a lot of favourable broker and media attention? If so, investor expectations may be excessively high, and that leaves the trust vulnerable to a steep downturn on any hint of bad news.
Income trust tax exemption just one advantage of investing in REITs (Canada)
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 may 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 even despite COVID-19 challenges for some of its tenants. That’s how REITs stand to gain from an ongoing economic recovery while providing a hedge against inflation.
Are REITs (Canada) part of your investment portfolio? If so, how have they performed for you? Share your experience with us in the comments.
This post was originally published in 2017 and is regularly updated.
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