Rent Real EstateREITs Offer Canadians a Tax-Sheltered Income Alternative
Stock market volatility and low interest conditions have made Real Estate Investment Trusts (REITs) appealing to investors looking for income-generating investments.
"REITs are an attractive investment vehicle for the fifty plus investor, first, because there is a predictable stream of cash flow," says Tom Schwartz, President and CEO of Canadian Apartment Properties Real Estate Investment Trust (CAP REIT), who sees REITs as ideal for investors using other criteria, too. "Also, all real estate trusts in Canada are highly tax sheltered -- in our case 70% sheltered. They are liquid and trade on the stock exchange so there is a mechanism for getting out."
A REIT (pronounced "reet") is a security that trades publicly on the Toronto Stock Exchange and other major exchanges, and that is invested in real estate, either directly through income-producing properties or indirectly through mortgages. On a quarterly or monthly basis, REITs pay investors their portion of after-expenses REIT income, drawn largely from rent payments. These expenses include property management costs and an administration fee, but REITs do not pay income tax.
Although sold like stocks, REITs differ significantly from real estate stocks. Income earned by properties held by a real estate corporation flows into the corporation and then is passed on to shareholders as dividends. Investors that buy shares in a REIT have a direct stake in the properties and share income generated by rents or capital gain.
In 2001, CAP REIT distributed a total of $1.05 per unit to its unitholders, which was treated as follows for income tax purposes: 23.34% of distributions were considered taxable income, not dividends or capital gains; 76.66% of distributions were not taxable and were treated for income tax purposes as a return of capital. The non-taxable portion reduced the adjusted cost base of the units owned by each unitholder. If, after deducting the return of capital portion, the adjusted cost base of the units was positive, no portion of the return of capital was taxable in 2001. If the amount was negative, unit holders were deemed to
realize a capital gain in 2001 equal to the negative amount and the resultant adjusted cost base of those units was nil. Obviously, expert income tax advice is important when considering the suitability of this investment vehicle.
REITs are often compared to mutual funds since investor dollars are pooled to finance the purchase of real estate. Like a mutual fund, investors are hedging their bets by using the professional expertise and corporate research resources to get into the real estate market on a scale that should overcome or minimize problems that plague individual investors buying one or more properties on their own.
But REITs are still risky investments. In the mid-80s, REITs suffered significant losses when the commercial properties they held were dramatically devalued by crashing real estate markets. On the up-side, 1997 was considered "the year of the REIT" because the commercial real estate had rebounded and record numbers of Canadian REITs appeared, including CAP REIT.
The first four REITs began as real estate mutual funds, while later trusts have tended to concentrate on one type of property-- hotels, nursing homes, office buildings, shopping malls or apartment buildings. Some REITs invest in and own their own properties and are therefore directly responsible for the value of their portfolio of properties.
"If there is a bad downturn in the real estate market, (CAP REIT) will be affected, but apartments are most stable in major cities which operate at vacancy rates of less than 2%," said Schwartz explaining that his REIT owns 11,656 suites in multi-unit residential properties located in major Canadian urban centers which include the Greater Toronto Area, London, Ottawa, Montreal, Halifax, Saskatoon and Regina, and that the REIT buys an additional 1500 units each year. "There is no new supply and that is the primary reason apartments are the most stable form of real estate."
REITs are as sensitive to stock market conditions as most stocks and respond unfavourably to interest rate increases just as most real estate holdings do, so there is much to research and consider before investing. Examine the portfolio of real estate holdings, property management policies, investment horizons and principals" track records in this and previous ventures. Whether the REIT you"re interested in holds office buildings, apartments or hotels, you may want to personally check out a few properties from a tenant"s or resident"s point of view since ultimately that"s the perspective that will make this investment
successful.