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When you think of real estate investing, you’re probably imagining being a landlord to earn passive income. You find the right property, go through the purchase process and add it to your portfolio. Then you find a tenant and have to deal with all that comes with being a landlord – the good, the bad and the ugly.
What if being a landlord doesn’t sound appealing? What if you can’t yet afford to buy an investment property? Fortunately, there’s a way for you to still invest in real estate without actually buying any: real estate investment trusts.
What is a REIT?
A real estate investment trust (REIT) is a company that owns, operates and/or finances income-generating real estate. A REIT owns the property, leases the property, then distributes the profits from the rent as dividends to shareholders.
REITs often focus on one property type, such as commercial real estate or student housing. There are also diversified portfolios spanning different real estate sectors. Some of the properties you’ll see in REITs include apartment complexes, hotels, office buildings, retail space, health care facilities and farmland. The portfolio administrators are well-versed in how to grow and build wealth in that particular sector.
The government offers special tax incentives for REITs. These companies pay hardly any corporate taxes because virtually all of their profits flow to shareholders, who then pay taxes on that income. To qualify for this exemption, the company must meet certain requirements. REITs can only hold qualifying properties at any time during the tax year. At least 75 percent of the REIT’s gross income must come from property rents, interest on the mortgages financing the property or capital gains from property sales. At least 75 percent of the total value of all of the REIT’s properties must be in Canada.
The government established REITs in 1993 in response to the collapsed real estate market. Large numbers of investors in real estate mutual funds were cashing in their shares during the economic downtown. Mutual fund administrators were then forced to sell their properties below value. The government created closed-ended real estate funds that could be publicly traded so that investors had another source of liquidity.
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Types of REITs
There are several types of REITs trading on the Toronto Stock Exchange that you can purchase:
Residential REITs are usually invested in apartment buildings. Rental properties are generally stable.
Retail REITs currently comprise about 25 percent of all Canadian REITs and are the most popular type. They include properties like retail outlets and malls.
Health care REITs
The nation’s ageing population has made the healthcare real estate asset an interesting one to watch. The success of these REITs is connected to the country’s health care system and its ability to fund hospitals, nursing homes and retirement homes.
Office buildings are an attractive option because they have a high-quality and stable tenancy.
Industrial property is the largest real estate asset class in the country. The tenant base is stable, and the properties are less costly to maintain.
Also known as mREITs, these trusts lend money to real estate owners. These REITs represent 10 percent of REITs in Canada. They are best when interest rates are low so that investors get a better return.
Many REITs have portfolios representing more than one real estate types. They may focus on one sector like commercial and include a mix of office, retail and hotels.
What investors can expect from a REIT
REITs are a great investment option for many reasons. One of the biggest is that you can still invest in real estate without the risk of being an owner. You also don’t have to handle finding tenants and managing a property yourself. If you’re unable to afford an investment property, REITs have a lower point of entry.
Shares of a REIT are easy to buy and sell. They are publicly traded on the TSX. This allows you to pull your cash out quickly if needed. Instead of having your investment tied up in one property, which can take months to sell, you can simply sell your shares.
REITs offer investors stable dividends and help to mitigate risk. They are a great way to diversify your other investments. When you own one property, your profitability is linked to how well that one property performs in the market. With a REIT, you are less exposed to market fluctuations. Publicly traded REITs are regulated, and information about their portfolio and performance is transparent. With a little research, you can have a good idea of what to expect from your investment.
There are some downsides to investing in REITs. Because REITs must redistribute virtually all of their income back to shareholders, they don’t have much room for capital appreciation. Growth is incremental because they have little to put towards purchasing new holdings.
As with any investment, REITs do not guarantee a profit or protect you from losses. Any dividends you earn from your investment will be taxed as income. Getting started with some REITs may come with high fees.
Selecting the right REIT
When choosing a REIT, you need to do your research before buying. Some questions you’ll want to ask about the trust include:
- When did the REIT buy its assets? If it bought during a boom, the value may not be strong for long. Look for REITs who have longer relationships with their properties.
- How much debt does the REIT have? If the company has a lot of debt to its assets, your share of the dividends will plummet if a business isn’t performing well.
- What does the market for that real estate sector look like? For example, if you’re considering a REIT with retail properties, do your research on how the retail sector is performing overall to see if any downturns might be coming.
REITs help you start growing your real estate investing career in a way that is both stable and profitable. With a little research, you can find a REIT that fits your investment goals and earns you strong passive income.