REITs Are Worth a Look for Retirees Seeking Income
When you’re no longer earning employment income, you have to start relying on your investments to generate cash flow to live on. One type of income-oriented investment is Real Estate Income Trusts.
One of the main attractions is they pass along most of their cash flow to the investor.
What is a REIT?
Real Estate Income Trusts own real estate like shopping malls, apartment buildings, office buildings, retirement homes, hotels, and even public storage. REITs make it easy for small investors to own real estate and takes away the headache of being a landlord or being a partner in an investment group.
In addition to the income aspect of REITs, real estate also provides diversification to a portfolio that already holds stocks and bonds.
REITs are interest rate sensitive since real estate is often financed by debt. If interest rates rise, the yields of bonds may become more attractive and REIT holders may sell and buy bonds instead, driving the REIT prices down. This is what happened in 2018, but they have since rebounded.
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Individual REITs vs REIT ETFs
Here’s a list of individual Canadian REITS. You could choose three or four top Canadian REITs – such as RioCan, Canadian Apartment Properties, H&R, and First Capital – and own over 55% of the REIT index.
Or, instead of owning separate REITs you could buy a basket of them with a REIT ETF and spread out the risk.
While individual REITs usually focus on similar properties, REIT ETFs may combine various properties. So, you can quickly achieve low-cost diversification across different classes of real estate and geography with just one purchase.
If you’re looking for non-Canadian exposure your only choice in Canadian-listed ETFs is iShares Global Real Estate Index ETF (CGR). It is globally diversified (58% in US real estate companies) which makes it a good choice if you already have Canadian real estate investments.
Otherwise, you can hold US REITs in a US dollar account. There are many more providers on US sites giving you many more options than what you would find available in Canada.
Taxation of REITs
Income distribution is usually made up of some combination of capital gains, return of capital and other income.
Some funds distribute a portion of your capital with your income. This is called “return of capital”. While return of capital is not taxable – it’s just your money being returned to you – it reduces the Adjusted Cost Base (ACB). It will increase your capital gains (or reduce your losses) when your shares are eventually sold.
Some payouts are considered “other income,” which is fully taxable and not eligible for the dividend tax credit.
Your T3 slip will indicate the exact income breakdown.
If you invest in non-Canadian REITs through ETFs, the income is subject to foreign withholding taxes – you can claim a credit when you file your income tax return. All the rest is fully taxable at your top rate.
Unfortunately, REITs are not very tax-efficient because they throw off a lot of taxable income. They should be kept in a tax-sheltered account whenever possible.
The bottom line
Real Estate Investment Trusts have traditionally been attractive for the income potential provided by real estate combined with the liquidity of stocks.
You can include real estate into your investment portfolio without the obligations of owning actual rental properties with individual REITs or a REIT ETF.