Investing in REITs (Canada) can help you minimize the risk of owning investment property
REITs (Canada) are the one remaining large category of income trusts; as such, they continue to pay distributions before they pay tax—and that’s good for unitholders of RioCan REIT and others. The 2011 law that put an end to tax privileges for other income trusts made an exception for these real estate firms. A quality REIT in Canada remains popular with Canadian investors seeking steady income and good growth prospects. Canadian REIT taxation plays a significant role in their appeal.
Investing in Canadian REITs and homing in on the best canadian REITs let you hold income-producing real estate such as office buildings, shopping malls and hotels. They can save you the cost, work and risk of owning investment property yourself.
REITs and income trusts
A REIT in Canada, or real estate investment trust, like RioCan REIT, resembles a Canadian income trust, but with a key difference: REITs (Canada) invest in income-producing real estate. Canadian REIT taxation rules make them an attractive investment option.
A REIT in Canada can maintain its exemption as long as it meet the following requirements:
REITs must not hold any property other than “qualified REIT properties” at any time during a tax year.
At least 75% of the trust’s revenue for a tax year must come from rent or mortgage interest from real or immovable properties in Canada, and capital gains from the sale of such properties.
At least 75% of the total fair market value of all trust properties that the REIT holds must be in (Canada).
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More about REITs (Canada)
Canada offers special tax treatment for Canadian income trusts. When it flows its income through to unitholders, a REIT in Canada, like RioCan REIT, doesn’t pay much if any corporate tax. Investors pay tax on most of the distributions as ordinary income (although part of some distributions qualify as a tax-free return of capital). Understanding canadian reit taxation is crucial for investors.
Ottawa feels the income-trust business structure is appropriate for a real estate investment trust, or REIT in Canada, so it exempted REITs from the income trust tax.
As mentioned, real estate investment trusts resemble Canadian income trusts, but with a key difference: REITs invest in income-producing real estate, such as apartments, shopping malls and hotels. (We cover a number of carefully selected REITs in our Canadian Wealth Advisor newsletter.)
Regardless, the basic tests we use to ferret out good investments and reject bad ones, including looking closely at cash flow, still apply to REITs, and not just Canadian ones.
Keep “investment inputs” in mind when judging REITs (Canada)
Here’s a list of investment inputs that we look at before recommending income trusts, including a REIT in Canada like RioCan REIT, and before we consider it among the best canadian REITs:
Did the Canadian REIT buy its assets in the midst of a recent boom, or has it owned them for some time? Bidding for assets in the midst of a boom tends to be risky, since it can lead to unpleasant investment surprises.
How much debt is the Canadian real estate income trust, or REIT, carrying? You need to gauge the debt in relation to all assets, including hidden assets and those that appear on the balance sheet. Too much debt in relation to assets can lead to a downturn in distributions when the business hits a snag.
Are there any special factors worth considering? With REITs, you need to look at the quality of tenants, length of leases and the possibility of improving the use or expanding the occupancy of existing properties.
Is the Canadian REIT’s focus area the subject of a lot of favourable broker and media attention? If so, investor expectations may be excessively high, and that leaves the trust vulnerable to a steep downturn on any hint of bad news.
Income trust tax exemption just one advantage of investing in REITs (Canada)
REITs–especially a REIT in Canada like RioCan REIT–can add to your portfolio in a number of other ways. The best canadian REITs can provide a hedge against inflation, for example. Canadian REIT taxation benefits are an additional advantage for investors.
Many REITs took advantage of the past period of low interest rates to refinance their mortgage debt. Many have been able to renew leases at high rates, increasing cash flow, despite COVID-19 challenges. Even as interest rates continue to move higher, the best Canadian REITs stand to gain from an ongoing economic recovery to increase cash flow while providing a hedge against inflation.
In summary, Canadian REITs offer unique investment opportunities in income-producing real estate, benefiting from favorable tax treatment. Unlike other income trusts, REITs in Canada maintain their tax-exempt status, allowing them to distribute income to unitholders before paying corporate taxes. This structure makes them attractive to investors seeking steady income and growth potential.
To qualify for tax exemption, Canadian REITs must meet specific criteria, including holding qualified REIT properties and deriving at least 75% of their revenue from Canadian real estate. Investors should consider factors such as asset acquisition timing, debt levels, tenant quality, and market sentiment when evaluating REITs.
The advantages of investing in Canadian REITs extend beyond tax benefits. They provide a hedge against inflation, offer exposure to diverse real estate sectors, and have demonstrated resilience during economic challenges. Many REITs have capitalized on low interest rates to refinance debt and improve cash flow through lease renewals.
As the economy recovers, Canadian REITs are well-positioned to benefit from increased cash flow while offering inflation protection. However, investors should conduct thorough research and consider their investment goals before adding REITs to their portfolios. Understanding the nuances of Canadian REIT taxation and market dynamics is crucial for making informed investment decisions in this sector.
Are REITs (Canada) part of your investment portfolio? If so, what has been the top performing REIT in Canada for you? Share your experience with us in the comments.
This post was originally published in 2017 and is regularly updated.
Comments
Ronald
Are shareholders of a REIT subject to the liabilities of the REIT. i.e. Could I lose more than what I have invested?
Thanks for your question. The chances of a Canadian retail investor in a Canadian REIT being liable for the liabilities of the REIT is considered not material. So, we still see our REIT recommendations as buys.
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Are shareholders of a REIT subject to the liabilities of the REIT. i.e. Could I lose more than what I have invested?
Thanks for your question. The chances of a Canadian retail investor in a Canadian REIT being liable for the liabilities of the REIT is considered not material. So, we still see our REIT recommendations as buys.