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What is meant by Real Estate Investment Trusts(REITs)? Are they safe investments?

The term Real Estate Investment Trusts (REITs) is a bit of a misnomer. A REIT is actually a company that buys, develops, manages and sells real estate assets. REITs are a way to invest in a professionally managed portfolio of real estate properties. These real estate assets can range anywhere from apartment buildings, to commercial real estate, to big-block shopping malls such as Wal-Mart.

REITs enable small investors to directly participate in the real estate sector without the responsibilities of owning and managing a property on their own. REITs are sold as small units on the stock exchanges, purchased through licensed brokers, or are now available as mutual funds.

The typical Canadian REIT distributes about 85% to 95% of its income (rental income from properties), usually quarterly. The taxable income earned by the trust flows through the REIT and is taxed when it reaches the Canadian holder. REIT holders are also entitled to a deduction for the pro-rated share of capital cost allowance (depreciation on the properties). As a result about 75% to 85% of the distributions are normally tax-deferred.

It should be noted however that the value of the tax-deferred receipts reduces the adjusted cost base of the shares.

REITs today

Recently, interest in REITs is gaining momentum, especially given the volatility of the technology sector when investors look for more stable investments.

Although REITs have been around for 35 years, they fall in and out of favour like many other sectors in the stock market. Economic conditions, interest rate changes, and investor trends all affect the popularity of REITs. For example, REITs fell out of favour a decade ago when high-risk debt was taken on by real estate developers.

Advantages of REITs

  • the key advantage is that REITs is the tax deferral feature
  • relative low volatility and stability compared to other stocks
  • good track record for long-term capital growth
  • liquidity: REITs trade reasonably quickly on major exchanges
  • provide generous dividend yields compared to other similar securities
  • lower-risk securities: real estate tenants don't tend to move out of buildings quickly
  • performance returns are readily available through the financial media

How to avoid risk

  • review the REIT's financial statements and a prospectus, which offer investors a wealth of financial information
  • calculate at the debt ratio to see if it is high or low: if the debts are high and the interest-rate environment is high, the cash flow will be reduced and may affect performance returns
  • evaluate the management behind the REIT: do they have experience and a good track record?
  • examine the properties the REIT holds: are they in a good location, are they quality properties, are they fairly new, do they need rehabilitation? All these factors will affect cash flow and returns.
  • check with your financial advisor or accountant to see if these investments are suitable for your needs, goals and time horizon

Obtaining further information on REITs

  • on the first Saturday of every month, The National Post publishes The REIT report
  • usually, the weekend newspapers list REITs under the trust section
  • two very useful web sites: www.ciprec.com; www.nareit.com
  • Read: Common Sense Investing in Real Estate Investment Trusts, by Andrew Dagys