Monday, October 19, 2015

Real Estate Investment Trusts

Real Estate Investment Trusts (REITs) purchase real estate properties and pass the rental incomes through to investors.

Defined as a type of asset-backed security, they are also referred to as equitized income products or high-yield securities. The disparity in names highlights the controversy as to whether these securities are equities or fixed-income. They are most often compared to bonds because of the income they generate, but they do not have guaranteed payouts.

Income trusts react to changing interest rates, similar to fixed-income securities, but trade on an exchange, like equities.

Because they are backed by the specific revenue-generating properties or assets held in the trust, they face the same risks as common equities.

For income trust investors, the tax treatment will
be more like that of corporations – investors will be taxed on their distributions as though the distributions were dividends.
For investors, distributions from an income trust will now be taxed in the same way as dividends received from taxable Canadian corporations.


Real Estate Investment Trusts (REITs) consolidate the capital of a large number of investors to invest in and manage a diversified real estate portfolio. Investors participate by buying “units” in
the trust. REITs allow small investors to invest in commercial real estate previously available only to corporate or more affluent and sophisticated investors.


Canadian tax laws offer REITs significant tax deductions. For this reason, REITs pay out a high percentage of their income, typically 95%, to their unitholders.


REITs may be structured as either open-end or closed-end funds. If they meet the stringent standards set out under the Income Tax Act, REITs may qualify as registered investments for RRSPs and RRIFs.


REITs face many of the risks typical of real estate investments related to the quality of properties, rental markets, tenant leases, debt financing, natural disasters and liquidity. 

REIT managers generally minimize risk by avoiding real estate development and investing primarily in established income producing properties. 

To reduce the danger of incurring too much debt, most REITs limit the extent of leverage to 50% to 60%. Leverage ratios tend to be significantly higher in the real estate industry.

Liquidity is a major benefit of REIT ownership. REIT units are much more liquid than real estate. However, investors should determine the liquidity of any particular REIT before investing,
since some, especially the more specialized REITs, have thin trading volumes, despite being exchange traded. 


As publicly traded instruments, REITs are also subject to full disclosure rules giving the investor access to more complete information for decision-making purposes.

When interest rates rise, REIT trading values may fall. On the other hand, REITs represent a good hedge against inflation since, in an inflationary environment; the value of the underlying real estate owned by REITs may appreciate.


Because rental income is fairly stable, REITs generally yield high levels of income but usually lack the potential for large capital gains or losses possible with equities. As with any investment, it may be necessary to accept lower yields to ensure a high-quality portfolio underlying the yield.


Buying REITs gives investors access to professional management. REITs, however, are just as susceptible to ineptitude on the part of management as any other company. The keys to minimizing risk lie in sound research before purchase and in diversification.

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