Real estate investment funds or REITs are publicly traded organizations that invest in income-producing real estate assets.
As an equity investment, they offer investor yields in hand with medium risk capital appreciation.
They are a real estate investment option for those who really don’t want to contend with the headaches of being a landlord – a very stressful and even expensive aspect of real estate investment properties.
Instead, the REIT is a low maintenance investment where investors purchase shares and watch the dividends come in. Sounds pretty good right? Considering that in the past decade REITs dollar value grew 215 percent, they offer an alternative to out and out real estate investment properties. Here’s everything you need to know about investing in REITs.
REIT trust units are pretty much shares and therefore are purchased like any other stock you see on the stock market.
REITs consist of different types of residential and commercial real estate properties from industrial buildings to residential apartment towers and office buildings to malls. You can choose to invest in Canadian properties or go the international holdings route.
When compared to the money required to invest in a Canadian home to generate rental income, you can own units for far less as they start as low as $10.
An investment property in Canada requires a 20 percent down payment which means you need about $100,000 upfront. Add to that your legal fees, taxes and other incidentals and you’re looking at a substantial investment.
Many Canadians dream of the ultimate house flip as opposed to becoming a landlord. However, unless you are an expert in home renovations, this too will not only cost a fortune but also be a headache to complete with no guarantees you will make a profit.
How do REITS Make Money?
Essentially the REIT lives off the rental income of the properties, which will cover expenses. You then receive a share of the remaining income that is about 85 to 95 percent of the rent collected. Your dividend yields will vary based on many factors from market trends to rental rates and interest rates to expenses.
What are the Different Types of REITs?
There are several types of publicly-traded REITs for you to consider including:
- Retail REITs, which include retail outlets and shopping malls.
- Residential REITs which would be apartment buildings and some forms of manufactured housing.
- Healthcare REITs that is becoming very lucrative as baby boomers age and require new types of healthcare services and housing facilities.
- Office REITs, which are multi-tenant office buildings.
- Mortgage REITs which are tied to the mortgages of properties.
Each investment that qualifies as a REIT comes with its own risks and benefits.
How are REITs Taxed?
Because of the way the earnings are paid out to unit holders, you avoid paying tax inside the trust.
Instead, you are taxed at the time of the distribution. It is an attractive option to investors looking to make money from real estate with improved earnings and the benefits of property appreciation. Just be aware you have to hold units in a registered account, or taxes become more complicated.
Distributions that come from capital gains and income will require tax payments. The full marginal tax rate must be paid on your REIT income distributions as long as you receive them in a non-registered account as your payouts have not yet been taxed.
There are also tax advantages including expenses and depreciation, which are shown on your T3 form.
For real estate property investments, you’re required to report your profits which usually means you will be charged capital gains tax.
What are the Risks of REITs?
As with any investment, there are some risks associated with REITs. Real estate can be volatile so the market where the properties are located will have an impact on potential earnings and possible losses. If the property is purchased in an area where real estate prices are tanking, this will have a negative effect on the value of trust units. While REITs provide the advantage of leverage, although someone else is, in essence covering the debt, this not only can increase returns but also increase the potential for losses. Although you can use leverage to purchase REITs through investment loans or even a line of credit, banks aren’t as fond of lending investors’ money at the same low rates they do for landlords.
REITs the Low Maintenance Option
Being a landlord is not easy. Although you might think it’s just about collecting the rent, there are many very stressful aspects to owning a rental property. First, you have to find trustworthy tenants who won’t destroy your property and will be responsible to pay their rent on time every month.
Next, you have to put up with complaints about your property from backed-up plumbing to faulty heat and appliances. You will not only have to arrange for repairs but also foot the bill without compensation. With REITs, you simply invest and let them do all the work.
Why Choose REITs Over Buying Investment Property?
There are many reasons to choose to invest in REITs instead of buying an investment property:
- Accessible Liquidity: When you own trust units you can choose to sell them when you need cash. You can sell all of them or just a few, based on how much cash you need to get your hands on. With an investment property, it’s an all or nothing scenario. If you need money, you have to sell the entire property and that will be based on the current fair market value. Depending on how much equity you have in the home, this might not be enough. You also have to go through the hassle of evicting your tenants and finding a buyer not to mention paying commission for your real estate agent. And let’s not forget about those capital gains tax. You get immediate cash with REITs while you have to wait to sell your home before you see any equity from your property sale.
- No Work: A REIT is a low maintenance investment that requires no effort on your part. We’ve already pointed out the woes of being a landlord, one of which includes collecting rent. With a registered REIT account, you have no worries, including taxes.
- Diversification: By investing in diverse REITs you help mitigate risk and continue to earn even of some of the properties aren’t doing as well. You can even diversify across real estate sectors so you can earn from multiple businesses.
Who Should Invest in a REIT?
If you are looking for a way to invest in Canadian real estate and are comfortable with the idea of medium-risk, REITS will earn you passive income in a low maintenance investment. Canadian real estate might experience its ups and downs, but for the most part, if you are ready to stay the course in the long term for about five years, investing in REITs is an alternative way to get into real estate investment.