Special Free Report From The Motley Fool
Dear Fellow Fools,
I’m a home owner and I’d wager a fair sum that the same goes for most of you reading this.
And as a home owner, I know that it involves a pile of work. Even though I’ve heard my fair share of stories on the wonders of owning a rental property or two and growing rich through real estate, the potential headaches involved in following this pursuit far outweigh the potential gains available, in my opinion. Not only do I have zero interest in filling a rental property with quality tenants (over and over again), I’ve also no interest (or time) in dealing with the plethora of maintenance that goes hand-in-hand with this obligation.
With that said, I fully acknowledge the wealth that can accumulate over the long-term by investing in this asset class. If you’re like me and have no interest in the headaches of a primary investment but do have an interest in real estate exposure, there could be a relatively straight forward solution available.
What follows is a head-to-toe description of how you can gain as much real estate exposure as you’d like via publicly traded entities known as Real Estate Investment Trusts (REITs). In a well-diversified portfolio, these securities can provide a generous income stream and historically, performance in this asset class has contributed to considerable capital gains for its investors..
It’s our opinion that an allocation to REITs makes a pile of sense for some portfolios and we look forward to helping you gain a foothold in this corner of the Canadian market.
Enjoy the report!
Iain Butler, CFA
Chief Investment Adviser, Motley Fool Canada
Are you interested in earning rental income? You could, of course, buy a residential property and rent it out. However, in addition to investing a huge amount of capital up front–say, $200,000 or more–you’ll also need to deal with the tenant, pay the property tax, do required maintenance, and deal with all of the other aspects of owning an investment property.
But there’s a more relaxed way to receive rental income, and that is becoming a passive landlord. Instead of buying properties and managing them yourself, you purchase shares in publicly traded real estate investment trusts (REITs), which are liquid and trade on the stock exchange.
The benefits of buying REITs
There are other benefits to buying shares of REITs.
First, you can invest as little or as much as you want without having to incur debt as you would if you got a mortgage for your investment property. So, instead of investing $200,000 in a property, you could invest $50,000 in a group of quality REITs, allowing you to diversify the remainder of your available capital.
In addition, REITs have professional management teams that take care of the properties and tenants, so you can sit back and relax.
Another benefit is that REITs typically own and manage a portfolio of properties, so you can get immediate diversification across different regions if you select one with geographic diversity. By buying multiple types of REITs, you can gain additional diversification across industries as well. For example, you can buy residential REITs, retail REITs, and/or office REITs.
And, if you don’t mind crunching numbers, it can actually be advantageous to hold REITs in a non-registered account. You see, REITs pay out distributions that are unlike Canadian-eligible dividends. REIT 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.
By buying and holding REIT units in a TFSA or an RRSP, investors can avoid any headaches when reporting taxes. However, the return of capital portion of the distribution is tax deferred. So, it may be worth the hassle to buy REITs with a high return of capital in a non-registered account. Of course, each investor will need to look at his or her own situation and consult with a tax professional.
It may sound complicated, but we think investing in REITs is certainly less work than buying an investment property and provides more flexibility. Assuming you receive a 4.5% return from rental income on an apartment you paid $200,000 for, you would receive $9,000 over the course of a year. That equates to $750 per month.
On the other hand, by investing in REITs, you can choose to invest any amount that you want, and you can in many circumstances earn a similar yield (or better) on your investment. And, perhaps best of all, you can follow this path without accumulating debt (assuming you’d need a mortgage for the physical purchase of property) and without having to do any work such as rent collection or property maintenance.
So, if you think you may be ready to start investing in REITs, here are a few things to look for…
Our 3 characteristics of top REITs
- Consistently high occupancy rate. A consistently high occupancy rate implies that there’s a high demand for the REIT’s properties and helps ensure it will enjoy stable rental income. Its properties must be high quality, competitively priced, and offer great service. Otherwise, tenants could just go elsewhere.
- Consistent distributions (even better if they’ve been growing). A REIT paying consistent distributions over time can imply that the business is well run. It’s rare to find Canadian REITs that consistently increase distributions to shareholders, but the ones that do could be deserving of a bit more of your portfolio’s attention.
- Conservative payout ratio. By maintaining a conservative payout ratio, a REIT will be able to pay shareholders distributions even if the funds from operations (FFO) dip on occasion.
Possessing all of the above characteristics helps ensure the REIT is able to pay the declared distributions. After all, anyone buying REITs will expect income, whether that’s a primary goal or not.
A top Canadian REIT
Canadian REIT (TSX:REF.UN)
Company Snapshot: (data as of April 2, 2016)
- Market cap: $3.3 billion
- Share price: $44.99
- Yield: 4.00%
- P/FFO: 14.8
- Number of properties: 198
- Gross leasable area: 25 million square feet
- Debt/Capital: 32%
Canadian REIT (TSX:REF.UN) is the first publicly listed REIT in Canada and was first traded in September 1993.
The REIT is diversified, with roughly 50% of rental income coming from retail properties, 25% from office properties, and 25% from industrial properties. It has also consistently beaten the returns of the S&P/TSX Composite Index and the S&P/TSX Capped REIT Index in the previous three-year, five-year, and 10-year periods.
Canadian REIT’s top 10 tenants–which include Canadian Tire, Suncor Energy and Loblaw Companies–contribute roughly 22% to its revenue. Over 90% of Canadian REIT’s employees own units in the REIT, keeping their interests aligned with those of non-employee unitholders.
How does it stack up?
Consistently high occupancy rate. Since being listed in 1993, Canadian REIT has been accumulating high-quality property assets. This business objective helps the REIT maintain high occupancy levels and high rental rates. Since 2000, it has maintained its occupancy level between 94% and 97%.
Consistent distribution growth. Canadian REIT has increased distributions for 14 years in a row. Its last increase occurred in June 2015 at a growth rate of 2.9%.
Conservative payout ratio. Its most recent payout ratio was under 60%, which is very conservative compared with peers. This leaves room for growing the business and the distribution during good times and to maintain the payout should the economy stall for any meaningful period of time.
A growing retail REIT
Plaza Retail REIT (TSX:PLZ.UN)
Company Snapshot: (data as of April 2, 2016)
- Market cap: $458.21 million
- Recent share price: $4.69
- Yield: 5.54%
- P/FFO: 14.1
- Number of properties: 302
- Gross leasable area: 7.1 million square feet
- Debt/Capital: 47%
Plaza Retail REIT (TSX:PLZ.UN) owns retail properties across eight provinces. Qualities that set Plaza Retail apart include the fact that it can develop new retail properties in-house, and it relies on its entrepreneurial abilities to adapt to changing market conditions. Because it is a small-cap company, it can be argued that there’s a higher ceiling for overall growth.
How does it stack up?
Consistently high occupancy rate. Over the past two years, Plaza Retail has maintained occupancy levels above 94%. Recently, its occupancy rate was even higher at 96%. This indicates that Plaza Retail continues to strive for the better.
Consistent distribution growth. Plaza Retail has increased distributions for 13 years in a row. In the last three years it increased distributions at a rate of 4.0-6.7%. Its last increase occurred in January 2016 for 4% growth.
Conservative payout ratio. Its recent payout ratio was about 75%, which we see as acceptable for a company in growth mode.
A solid residential REIT
Boardwalk REIT (TSX:BEI.UN)
Company Snapshot: (data as of April 2, 2016)
- Market cap: $2.43 billion
- Recent share price: $51.73
- Yield: 4.35%
- P/FFO: 14.6
- Number of residential units: More than 32,000
- Gross leasable area: 28 million square feet
- Debt/Capital: 35%
Boardwalk REIT (TSX:BEI.UN) has a portfolio of quality residential properties across four provinces. Boardwalk management owns roughly 25% of the trust, so we believe management’s interests are highly likely to be aligned with long-term unitholders.
How does it stack up?
Consistently high occupancy rate. Due to a continued focus on quality and service, Boardwalk REIT has both decreased the turnover rate and increased occupancy levels since 2009. It also commands a premium to market-average rents. Since 2012, the REIT has maintained occupancy rates of 96% or higher.
Consistent distribution. Since 2005, Boardwalk REIT has paid a regular, monthly distribution. However, Boardwalk isn’t known for consistently increasing distributions every year. Still, it has increased its distribution six times since 2005, and it has occasionally compensated unitholders for not increasing distributions regularly with juicy special distributions. In February 2016, Boardwalk increased its regularly monthly distribution by 10.3% to 18.75 cents per share.
The REIT paid out a special distribution of $1.00 per unit in January 2016. The special distribution was funded by an ongoing program of selling non-core properties. If Boardwalk ends up selling more non-core properties, unitholders could be in for another treat. Based on its history, it pays, at most, one special distribution in a year.
Conservative payout ratio. Its recent payout ratio is under 64%, which, like Canadian REIT, is a conservative level. It leaves room for error in case something goes wrong, such as the occurrence of a recession or a weakened Alberta economy.
How to earn $6,000 in annual income
Earning $6,000 in annual income is equivalent to earning $500 per month. Here’s a sample portfolio that shows how you can earn $500 a month from these top Canadian REITs. Since Canadian REIT and Plaza Retail REIT have higher yields than Boardwalk, the sample portfolio allocates more investment dollars to them.
|REIT||Price||# Shares||Investment||Yield||Annual Income|
Notice that the higher the yield for a REIT, the less investment is required to earn the same amount of income. The average yield of the portfolio is 4.6%.
You can start building your rental empire one quality REIT at a time. Look for REITs with consistently high occupancy rates, histories of maintaining distributions, and conservative payout ratios. Canadian REIT, Plaza Retail, and Boardwalk all form a good list for your consideration. The sooner you start, the sooner you can begin passively earning monthly rental income.
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All figures as of April 2, 2016.
Fool.ca contributor Katherine Ng prepared this report. At the time of publication, Katherine owned shares of Canadian REIT, Plaza Retail REIT and Boardwalk REIT.
This report is: (a) for general information purposes only and not intended as investing advice; and (b) not to be used or construed as an offer to sell, a solicitation of an offer to buy, or an endorsement, recommendation, or sponsorship of any entity or security by The Motley Fool Canada, ULC, its employees and affiliates (collectively, “TMF”). This report represents the opinion of the individual author and does not attempt to give you professional financial advice or advice that relates to your personal circumstances.
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