Real estate investment trusts (REITs) resemble income trusts, but with a key difference: REITs invest in income-producing real estate, such as office buildings and hotels.

The best REITs have good management and balance sheets strong enough to weather an economic downturn. They also have high-quality tenants, and they carefully match their debt obligations with income from their leases. The best ones are still doing well, despite the weak economy, and are taking advantage of low interest rates to refinance long-term mortgages.

We advise against overindulging in REITs. But high quality REITs can make attractive, low-risk additions to your portfolio.

Tax exemption adds to appeal of real estate investment trusts

Most REITs are exempt from the federal government’s new tax on income-trust distributions, which comes into effect just under two months from now, on January 1, 2011.

This new tax will put income trusts on an equal tax footing with regular corporations. Many trusts have already converted to corporations in response, or plan to do so in late 2010 or in 2011. Others will continue to operate as trusts.

As a result of their exemption, REITs should continue to attract investor interest as the tax prompts more trusts to convert to corporations and cut their distributions.

RioCan is among the real estate investment trusts that are exempt from the new tax

In a just-published issue of Canadian Wealth Advisor, our newsletter for conservative investing, we’ve updated our buy/sell/hold advice on a REIT that’s exempt from the new income-trust tax, RioCan Real Estate Investment Trust (Toronto symbol REI.UN). The trust’s units yield a high 6.0%.

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RioCan is Canada’s largest REIT. It has interests in 289 shopping malls across the country, including 11 under development. In all, these properties contain over 66 million square feet of leasable area. The trust has a 97.1% occupancy rate.

RioCan is Canada’s largest owner of “neighbourhood” shopping centres, which are enclosed malls in smaller cities. But the company’s strongest growth is in its “New Format” malls, in the suburbs of larger cities. The trust is also Canada’s largest owner of these malls, which have lots of parking and room for new building, and mainly consist of big-box stores, or large stores that are usually part of a chain.

U.S. expansion adds growth potential — and risk

RioCan also owns an 80% interest in 28 malls in the U.S. through joint ventures. As well, it owns 14% of Cedar Shopping Centers, a U.S. REIT that focuses on malls anchored by supermarkets and drug stores, mainly in the northeastern U.S.

Despite its vast potential, the U.S. economy remains weak, and unemployment is a high 9.6%. That adds to RioCan’s risk. However, RioCan is mitigating this risk by expanding through a joint venture. Moreover, the anchor tenants of these malls sell staples that consumers must buy no matter what the economy is doing. That further cuts the risk of this investment.

You can get our latest buy/sell/hold advice on RioCan and 20 other lower-risk investments in the latest issue of Canadian Wealth Advisor. Best of all, you can get this issue absolutely free when you subscribe today. Click here to learn how.