Real estate investment trusts (REITs) primarily own properties to receive rent. Since their underlying assets are properties, you’re really looking at long-term investing. REITs look for quality properties that they expect to appreciate over the long term. In the meantime, they generate stable rental income from them.
Individuals investing in real estate properties probably have the same kind of expectations. These individuals want to receive rental income, while the properties they own rise in value over time.
Benefits of REIT investing
REITs make the process of investing in real estate much easier for investors who may not want to maintain properties or screen tenants. REITs have professional teams to do that. Further, as soon as you buy shares in a REIT, you’re immediately geographically diversified because REITs own many units or properties.
Where I live, one can get roughly 3.2-5% rental income for a $300,000 apartment. That equates to $800-1,250 a month. Don’t forget that there’s maintenance and management costs that come with it, along with the mortgage that you need to pay interest on.
REIT example
Instead of investing in an apartment, consider buying a residential REIT. Northern Property REIT (TSX:NPR.UN) will become the third-largest publicly traded multi-family REIT in Canada after merging with True North Apartment REIT Trust. The transaction is expected to close around October 30, 2015.
After the merger, Northern Property REIT will be renamed Northview Apartment Real Estate Investment Trust. Its portfolio will consist of over 24,300 multi-family suites across eight provinces and two territories.
Not only do you get diversification immediately, but you also get a yield of 8.5% at today’s price of $19.2 per share. Northern Property REIT is near a 52-week low of $19 and is over 33% below its 52-week high of $29. The price has fallen because most of its properties are located in resource-rich areas. That’s why the REIT decided to merge with True North to diversify into Ontario, New Brunswick, and Nova Scotia.
Northern Property REIT’s payout ratio is around 70%, which makes its 8.5% yield pretty safe.
Tax on the income
REITs pay out distributions that are unlike dividends. Distributions can consist of other income, capital gains, foreign non-business income, and return of capital. Other income and foreign non-business income are taxed at your marginal tax rate, while capital gains are taxed at half your marginal tax rate.
So, to avoid any headaches when reporting taxes, buy and hold REIT units in a TFSA or an RRSP. However, the return of capital portion of the distribution is tax deferred. So, it may be worth the hassle to hold REITs with a high return of capital in a non-registered account.
Of course, each investor will need to look at their own situation. For instance, if you have room in your TFSA, it doesn’t make sense to hold investments in a non-registered account to be exposed to taxation.
In conclusion
Investing in REITs is like investing in real estate, except you can sit back and let the rent come in every month without having to manage properties or having to take on any debt. The only downside is that publicly traded REITs act just like stocks. Their prices go up and down, and you must prepare for that.
