The federal government’s new tax on income trust distributions comes into effect just under seven months from now, on January 1, 2011.
This new tax will put trusts on an equal tax footing with regular corporations. Many trusts have already converted to corporations in response, or plan to do so later in 2010 or in 2011. Others will continue to operate as trusts, although they may have to cut distributions to pay the new tax.
Tax exemption sets real estate investment trusts apart from other income trusts
Real estate investment trusts, or REITs, resemble income trusts, but with a key difference: REITs invest in income-producing real estate, such as office buildings and hotels.
REITs were common in Canada long before income trusts became popular enough to become a significant drain on Canadian tax collections. Ottawa feels the income-trust business structure is appropriate for REITs, so it has exempted REITs from the new income-trust tax.
(In the latest Canadian Wealth Advisor, we update our buy/sell/hold advice on a real estate investment trust whose strengths go far beyond the trust-tax exemption. Read on for further details.)
Real estate investment trusts can maintain their exemption as long as they meet the following requirements:
1) REITs must not hold any property other than “qualified REIT properties” at any time during a tax year.
2) 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.
3) 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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This real estate investment trust has high occupancy, rising rents
In a just-published issue of Canadian Wealth Advisor, we update our buy/sell/hold advice on a real estate investment trust that meets these requirements, Allied Properties Real Estate Investment Trust (symbol AP.UN on Toronto). The trust currently pays a monthly distribution of $0.11 a unit. The annual rate of $1.32 yields 6.6%.
Allied owns office buildings in Toronto, Montreal, Quebec City and Winnipeg. These mainly Class I properties contain over 5.7 million square feet of leasable area.
Class I refers to 19th and early 20th-century light industrial buildings that have been restored and converted to office and retail space. These properties usually feature high ceilings, natural light, exposed beams, interior brick and hardwood floors.
The trust has 53 mainly Class I properties in Toronto (these contain 52.7% of Allied’s leasable area). It also has 13 Class I buildings in Montreal (35.8%), seven in Winnipeg (6.7%), five in Quebec City (3.2%) and one in Kitchener-Waterloo (1.5%).
Allied finished the latest quarter with a high 95.0% occupancy rate. During the quarter, it renewed or replaced 35.6% of its leases that expire in 2010, mostly at or above previous rates. That will push up its rental income per square foot by 5.3% in the properties that have extended or signed new leases.
Income trust tax exemption just one advantage of REITs
Aside from the 2011 trust tax exemption, REITs can add to your portfolio in a number of other ways. They can provide a hedge against inflation, for example. And we continue to believe that low interest rates and government-stimulus spending will spur inflation over the next few years.
Many REITs have taken advantage of today’s low interest rates to refinance their mortgage debt. Many, like Allied, have been able to renew leases at high rates. That’s how REITs stand to gain from an ongoing economic recovery, while providing a hedge against inflation.
You can get our full analysis of Allied Properties Real Estate Investment Trust, including our clear buy/sell/hold advice, in the latest issue of Canadian Wealth Advisor. What’s more, you can get this issue absolutely free. Click here to learn how.
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