REIT Tax Rule Changes: Should You Still Buy Them?

REITs are popular with income investors, although the asset class could lose its appeal if the government makes tax rule changes soon.

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Real estate investors can turn to real estate investment trusts (REITs) instead of purchasing properties when the market is frothy or filled with uncertainties, like it is today. However, REITs might be under federal government scrutiny in 2022, particularly on taxation.

Among the campaign pledges of the re-elected Liberals was to make homes affordable to Canadians. While nothing is definite yet, there are concerns a review could lead to policy or tax rule changes that could negatively impact REITs. Moreover, the appeal of this asset class as an alternative to owning investment properties could lessen.  

Rationale for policy changes

Market observers note Prime Minister Justin Trudeau’s mandate letter to Housing Minister Ahmed Hussen. It appears the marching order is to cut profits, deter speculation, and limit the leverage on Canadian real estate. Reforms could include imposing investor taxes to reduce excessive rent surplus.

A possible amendment to the Income Tax Act is to require full disclosure by landlords on rents pre- and post-renovation. Lessors that charge higher rent due to minimal renovation will be subject to additional taxes to reduce profits. Those who purchase properties for flipping purposes (fewer than 12 months) will pay taxes to lessen liquidity.

More hurdles, like increasing a down payment for real estate investors, might be forthcoming to limit leverage. Another government action is to implement a temporary ban on foreign buyers. It should prevent window dressing, especially if beneficial ownership is in doubt.

REIT in the limelight

NorthWest Healthcare Properties (TSX:NWH.UN) became a popular with income investors during the health crisis. The $2.93 billion REIT is the lone real estate stock in the cure sector. It owns and operates a portfolio of healthcare real estate infrastructure such as medical office buildings, hospitals, and clinics.

Although the total return (+16.37%) in 2021 isn’t comparable to high flyers, this REIT pays a high 5.79% dividend. The share price is $13.68 if you invest today. Currently, NorthWest has192 income-producing properties in Canada, Australia, Brazil, New Zealand, and Europe.

The competitive advantages are long-term indexed leases and stable occupancies. After the first three quarters in 2021, the weighted average lease term is 14.1 years, while the occupancy rate is 96.9%. In Q3 2021, NorthWest’s net income rose 552.56% to $173.29 million versus Q3 2020.

High-quality tenant base

True North Commercial (TSX:TNT.UN) trades at less than $10 ($7.44 per share) but pays an ultra-high 8.02% dividend. This $638.99 million REIT owns and operates 45 commercial properties (45) in urban areas. The attributes of True North are its high-quality tenant base, including the federal government of Canada.

Government (35%) and credit-tenants (41%) form the tenant base that produce stable, contractual cash flows. The federal government is the highest contributor (14.6%) to gross revenue. After Q3 2021, the weighted average remaining lease term was 96%, and the occupancy rate was 96%.

Management is confident that its portfolio of high-quality tenants can overcome the uncertain market environment. NorthWest’s strength lies in high rent collections, stable operating results, and consistent tenant engagement.  

Wait and see

The tax rule change on REITs isn’t immediate, but it could come sooner than later with the mandate letter issued by the prime minister himself. Meanwhile, investors will have to wait and see if REITs are worth buying and keeping.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Christopher Liew has no position in any of the stocks mentioned. The Motley Fool recommends NORTHWEST HEALTHCARE PPTYS REIT UNITS.

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