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Usually, real estate investing is all about buying, holding, and selling properties. However, for many this process is too time-consuming or too complex to fit into their already-busy lives. That is why there are hands-off alternatives.
Known for their high returns on investment and lower overall risk, real estate investment trusts (REITs) are a popular means of hands-free investing. REITs also provide a reliable option for people looking to expand their portfolio without increasing their workload to an unmanageable size.
Before we get started, if you would like to learn how you can sell your investment portfolio to one of these trusts, click the link below and we can explain the process over a free strategy call.
Now, if you are ready to try a unique method of real estate investing and earning passive income, let’s take a look at real estate investment trusts.
What is an REIT
A real estate investment trust or REIT, is a company that owns, operates or finances income properties. These are modelled similarly to mutual funds where investors who buy into the trust have the opportunity to earn dividends from the properties managed by the trust. This is a powerful option for investors looking to enter the market and benefit from its growth without needing to buy, manage or finance any of their own investment properties.
How Do They Work?
In Canada, there is no legislation regulating the exact structure of one of these trusts, however they are liable to the principles of contract law and trust law. Also, in order for REITs to become properly qualified, the trust needs to be a publicly or privately traded unit that satisfies the rules and regulations set out in the Income Tax Act. (Privately traded trusts are usually exclusively available to accredited or eligible investors.) As a result, most real estate investment trusts follow a similar operating structure, only varying in their specific investment methods.
Essentially, investors looking to invest in an REIT need to begin by buying shares in the trust. (In Canada, most trusts are traded on the Toronto Stock Exchange.) By doing so, they become entitled to a certain percentage of the trust’s profits. These profits are paid out in the form of dividends. The frequency that the trusts pay out varies on the structure of the particular trust – usually ranging between annual, quarterly, or monthly payments.
Profits generated by an trust are not subject to corporate income tax, however, they are subject to capital gains tax after they are paid to their shareholders. Sometimes, this can be avoided if the investment is routed through a tax-exempt account such as a TFSA.
Meanwhile, the trust uses the funds received from its shareholders to buy and manage real estate investments. The types of properties and their strategies will vary between companies.
Five Types of Investment Trusts
Real estate investment trusts come in many shapes and forms, but frequently they appear in one of the following forms.
A residential real estate investment trust is a company that owns residential real estate such as apartment buildings, multi-family properties and single-family rental properties. These properties are rented out to tenants in order to generate cash flow, which is later divided between the trust’s shareholders.
Commercial real estate investment trusts are trusts that invest in a variety of commercial real estate ventures. This can include offices, retail stores, hotels, warehouses and more. Unlike other trusts which attempt to stick to a single niche, commercial real estate investment trusts are often more diversified across different types of properties.
Retail REITs are essentially commercial real estate investment trusts that strictly invest in retail properties. This can include single-tenant storefronts, plazas, big box stores and shopping malls. These trusts can invest in any sort of retail property or can prioritize specific tenants such as certain grocery brands or chain stores.
Healthcare real estate investment trusts are incredibly uncommon – at the time of writing this there are only two in Canada. These trusts focus on buying and operating certain medical buildings such as private medical offices, health centers, pharmacies, and retirement/long-term care homes
Industrial real estate investment trusts are companies that invest in industrial real estate such as factories, manufacturing facilities and more.
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Advantages and Disadvantages of Real Estate Investment Trusts
Real estate investment trusts have plenty of unique advantages and disadvantages that make them into unique investment opportunities.
Lower Barrier for Entry
Unlike traditional real estate investing, the financial barrier for entry is much lower for an REIT. Instead of requiring large sums of money saved for down payments and going through the process of qualifying for financing, most real estate investment trusts allow you to buy in at a much lower cost per share, allowing you to enter the market much sooner than you would have been able to by simply buying property.
When investing in an real estate investment trust, you are buying into an investment company as opposed to buying a particular property. This means that your funds are being dispersed across multiple properties owned by the trust as opposed to a single self-owned investment. This diversifies your portfolio and makes a much more stable investment.
Stable Cash Flow
With a real estate investment trust, the trust is responsible for managing and maintaining all their properties, so renovations and property maintenance are much less likely to have an impact on your cash flow – which is paid out in dividends. Instead, the risk is split across multiple shareholders and properties, meaning individual calls for repairs or renovations have less of an effect on your portfolio.
Low Potential to Scale
Unlike traditional real estate investing, there is much less potential for you to scale your investments with an real estate investment trust. Aside from buying more shares or buying into multiple trusts, you do not have many options to grow your portfolio with this method.
Also, due to 90 per cent of their profits being paid in the form of dividends, the trust has limited funds to expand its portfolio for its shareholders as well.
Potential for High Management or Transaction Fees
Depending on how you purchase your shares and where you structure your investment, your real estate investment trust investment may be subject to hefty management or transaction fees. Always make sure you inquire about any fees before you decide to buy.
To Learn More
If you are interested in learning more about real estate investment trusts and real estate investment, give us a call at LendCity. Our team is constantly available for you to reach out with any real estate investing questions you may have. To get started you can visit us at LendCity.ca or give us a call at 519-960-0370. Alternatively, you can click the link below to book a free strategy call today.