A Real Estate Investment Trust, or REIT, is a legal entity that issues units (equivalent to shares) to raise cash from individuals and then uses it to purchase income-producing properties. The resulting gains are then distributed to the investors, who can participate in commercial real estate without having to buy the property all on their own. Investors avoid becoming landlords since professional managers administer the properties.
Regulations for REITs are set by Canadian tax law, which requires the trust to invest only in qualified properties, mostly in Canada. Another key rule is that at least 75% of revenues must come from real estate activities: rents, mortgage interest and/or capital gains.
A REIT is also governed by its own Declaration of Trust. This document establishes the rules of operation such as the type of properties to be purchased and the acceptable levels of debt.
Many REITs are publicly traded in exchanges with the suffix “.UN”. The TSX hosts some well-known corporations such as CAPREIT (CAR.UN) which invests in rental apartments, or RioCan (REI.UN), which owns retail and mixed-used assets. It is also possible to invest in REITs indirectly by purchasing specialized mutual funds or ETFs. Some REITs are private and can only be accessed via the Exempt Market; this option is only available to accredited investors.
REITS will either diversify by purchasing properties in different classes or specialize in just one: apartment buildings, shopping malls, dental offices, hotels, retirement homes, just to name a few.
Investors include these assets in their portfolios for several reasons. Their returns can be very attractive, especially under booming real estate and low interest rate conditions. When compared to owning physical properties, purchasing units in a publicly traded REIT offers higher liquidity.
Income-oriented investors like REITs because they tend to offer a predictable and steady distribution of cash, usually quarterly or monthly. There is also the potential for capital gains when the properties increase their value in the market.
Taxation rules are especially important. REITs do not pay taxes and gains are passed to the investors, who are only taxed at the individual level. Avoiding double taxation is advantageous when developing a fiscal strategy, but this is a very complex subject that requires expert professional advice.
REITs do have a downside. They are highly sensitive to interest rates and real estate market conditions. The sector has taken a major hit due to the economic stress created by the Covid-19 crisis. With non-essential businesses severely limited in their operation, there is a growing concern that many will not be able to pay their rent or even remain open. High unemployment also means more apartment rent defaults and vacancies. Some REITs that own hotels are experiencing dark times. This has all negatively impacted REIT stock prices and projected earnings.
Not all is bad news, however, as some trusts offer relative safety and good returns. For example, Choice Properties (CHP.UN) holds mostly retail space across Canada. This may sound paradoxical, but its main tenant is Loblaw (grocery stores are an essential business) so rental default is not a concern. Northwest Healthcare (NWH.UN) operates hospitals and medical offices in Canada and other countries. Its stable occupancy and recent growth have drawn the market’s attention.
For investors who prefer broader exposure, there are multiple ETFs available. Vanguard’s FTSE Canadian Capped REIT Index ETF (VRE.TO) is a low-cost option that holds Canadian trusts of all sizes. The S&P/TSX Capped REIT Index ETF (XRE.TO) by iShares is very popular and the market leader. It owns properties in multiple sectors and has a good track record of performance.
The current conditions for REITs are challenging. Some investors are leaving in search for safer or more stable options, even if they sacrifice returns. For others, the historical long-term performance of real estate and the current prices represent an opportunity to buy. It all depends on the individual’s investment goals and their short and long-term perspectives on the industry’s future.
Legal Disclaimer: the contents of this article are for information purposes only and are not intended to provide any form of financial or investment advice.