The Motley Fool

Retirees: Read This Before Buying a Rental Property

Investment real estate has been a terrific place to park money over the last two decades.

Real estate was distinctly out of favour in 1997. You could buy a reasonable home in Calgary for $100,000. The average price in Toronto was $211,000. If you were willing to invest in a small town, it was very possible to buy rental property for the price of a new car.

We all know the prices of houses have gone up big time in the last 20 years. But we neglect to think about the cash flow yields that were available back then. Yes, mortgage rates were higher, but investors buying in the 1990s were getting cap rates of above 10% with some even as high as 20%.

Add capital appreciation to the cap rate, and you get an investment that did exceptionally well.

Things are much different today, however. Cap rates of under 5% are common, especially in places like Toronto or Vancouver. There are thousands of investors who don’t care one iota about cash flow; all they want are those sweet capital gains.

There’s just one problem: what happens when the party ends?

Besides, the last thing somebody wants to do in their golden years is deal with real estate. You’d rather be out golfing or spending time with the grandkids. This is exactly what a retiree should be doing. You’ve earned these golden years. Take advantage of them.

Fortunately, there’s a solution that allows a retiree (or anyone, really) to get similar — or in many cases, better — yields than physical real estate, all without having to screen tenants or deal with plumbing emergencies.

Here’s how.

Enter REITs

A real estate investment trust (REIT) allows an investor to easily buy a small portion of a diversified real estate portfolio. Some REITs own only office buildings. Others might only own retail space or industrial warehouses or apartments. And some own a little of each kind of asset.

Take Artis Real Estate Investment Trust (TSX:AX.UN) as an example. The Winnipeg-based company owns retail, office, and industrial properties across western Canada and Ontario as well as in the United States. Approximately 55% of its income comes from office buildings.

Artis shares are down nearly 20% — excluding dividends — over the last five years as the market has grown concerned with its Alberta-heavy portfolio. Results have been just fine, however. Artis recently reported that 2016’s funds from operations hit $1.55 per share, a slight improvement over last year’s results of $1.53 per share.

Artis pays an annual dividend of $1.08 per unit, giving it a payout ratio of under 70% of funds from operations. You won’t find many payout ratios that low, especially for a REIT that yields 8.3%.

Another solid REIT is Crombie Real Estate Investment Trust (TSX:CRR.UN). It’s the owner of 251 different properties — mostly grocery-anchored retail spaces featuring a Sobeys or Safeway — spanning nearly 17 million square feet in gross leasable area. Empire Company first spun off the REIT in 2005, and it is still the largest shareholder today.

Yes, Empire Company is struggling, but that doesn’t mean its stores can’t pay the rent. Many investors worry about the future of retail, but, at this point, it looks like grocery will be spared the pain other retailers have suffered. And if grocers do embrace an online-focused business model, it’s likely products will be delivered from existing stores, rather than a warehouse somewhere.

Crombie pays a distribution of 7.41 cents per share each month, which translates into a 6.5% yield. It has a payout ratio under 80% of funds from operations, which means investors can count on the payout.

The bottom line

Your golden years are no time to struggle with uncooperative tenants or frustrating condo boards. Buy a great REIT like Artis or Crombie, collect your truly passive rent cheques, and enjoy your retirement. It’s a far better option than trying to manage a property yourself.

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Fool contributor Nelson Smith owns shares of ARTIS REAL ESTATE INVESTMENT TRUST.

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