If you are a Canadian citizen there is probably no better income-producing investment option on the market today than Canadian Real Estate Investment Trusts. They are more commonly referred to as Canadian REITs and have gained a lot of traction over the last decade or so. There are now so many REIT options on the Toronto Stock Exchange (TSX), that you can actually buy indexes that will track the entire Canadian REIT market!
What are Canadian REITs?
But what is a REIT? And why are they such effective investment vehicles? The short answer is that they are pools of money that are used to purchase revenue-producing real estate properties, and then transfer the earnings back to unit holders of the trust, but there are a few other specific reasons why Canadian REITs are so effective.
Canadian REITs – To Good To Be True?
Investment gurus, like most individuals, have commonly espoused the cliché, “If something looks too good to be true it usually is,” for years. This logic was applied specifically to companies who offered very high dividend rates. Most investors believed that if companies were paying out that much money to shareholders, then their long-term growth and competitiveness would be hampered by a lack of capital re-investment.
This thinking is what has driven people away from real estate investment trusts, as they offer outstanding annual dividend yields of 5-10%, and sometimes even higher. If these companies were operating under traditional corporate structures, then the “too good to be true” argument would probably apply, but what many people don’t realize is that the reason these investment vehicles are able to consistently return so much money to unit holders (because there is no company to buy shares in, investors are called unit holders because they purchase units of the trust) is because they hold several advantages over the traditional corporation model.
Canadian REITs Tax Structure
The main advantage of Canadian REITs is the fact that they distribute profits before taxes, whereas all other corporations are forced to pay the business tax rate before distributing their profits. This results in an automatic 20%-ish profit margin for REITs that are not available to other business models.
In fact the Canadian investment trust model was not limited to the real estate sector until January 1st, 2011. Up until this point many different companies had switched over to an income trust structure in order to take advantage of the Canadian tax rules. While the Canadian government decided to stop the bleeding of tax revenues, they ruled in favour of keeping the tax-advantaged structure for real estate in order to encourage growth in the all-important sector.
An Addition to your Canadian Dividend Stocks
Canadian Real Estate Investment Trusts offer a particularly great deal for Canadians who wish to generate income outside of their tax-advantage accounts. Dividend income is only taxed at 25% of your marginal tax rate for most Canadians (there is a little more to the calculation than this, but this is the gist of it), as opposed to 50% of capital gains income, and 100% of interest income off of say bonds or GICs. This advantage alone makes the investment vehicles very attractive. When you factor in the consideration that real estate investments are not traditionally pegged to equities performance, and you have a very effective way of diversifying your portfolio without having to purchase a rental property, or try to raise capital to buy a commercial retail building. American Real Estate Invest Funds do not have many of the tax advantages of their Canadian brethren, and with a depressed real estate market, their yields are often a third of their Canadian counterparts’. While you may take some capital gains profits as a REIT rises in value, the true gains will be seen in your bank account every month as your solid dividends just keep adding up in an extremely tax efficient way. At the end of the year, whether you keep an accountant or just pull up some free tax software, you’ll be happy to see these hints turn into numbers.
There is some risk in Canadian REITs (as there is in any investment). Some speculators believe that the Canadian market is poised for the same downturn as the one that has recently shook the USA. I personally don’t agree with this logic because of the much tighter and better regulated Canadian real estate market. Canada has also maintained the healthiest economy of developed countries (save for possibly Australia) and consumer confidence has remained fairly high. While I might stay away from trusts that are heavily dependant on volatile urban areas such as Vancouver and possibly Toronto, I believe the Canadian market as a whole will remain very healthy in the decades to come. Our solid base in energy, commodities, and stable banks is a very strong indicator a future healthy real estate sector. Because of this, I believe REITs represent a great investing opportunity for the next few years as world markets remain range-bound and investors search for elusive income-producing investments.
Here’s the list of Canadian REITs we have covered at Canadian Dividend Stock:
Chartwell Seniors Housing Real Estate Investment Trust (CSH)