Are REITs a good investment?

Updated June 5, 2024

Owning real estate other than one's residence is an excellent way to have a more balanced portfolio. Any investment portfolio with at least a 5% to up to 20% in real estate has better returns and less risk than a portfolio composed only of say, stocks and bonds. That’s because REITs have a very low correlation with investments like stocks and bonds, making them more stable.

Some clients may not cozy up to the idea of owning real estate. Many of them will say they don’t have the time or patience to deal with the headaches that come with owning real estate property. The good news for them is, even in Canada, there is a way to enjoy the benefits of real estate ownership without the hassles.

The best way to have ownership of real estate is to invest in Real Estate Investment Trusts, or REITs. In this article, Wealth Professional provides answers to questions like are Canadian REITs a good investment? Are REITs a good buy now? Which are the best REITs to invest in?

Read on to find out all about REITs and if they make a good investment.

Introduction to REITs

Unlike its American counterparts, Canadian REITs had their start thanks to the Income Tax Act of 1986. However, the Canadian REIT market didn’t formally develop until the 1990s, with the first Canadian REIT trading on the Toronto Stock Exchange (TSX) in 1993.

So, what is a REIT? A real estate investment trust is an alternative to owning real estate properties.

It's a pool of real estate assets that individual investors can find on the major stock exchanges. REITs are a lot like mutual funds, but instead of buying and selling shares of stock, shares in real estate properties are traded. REITs offer the more attractive features of stock investing, but without the troubles of owning and maintaining real estate property.

What makes REITs a good investment? With a REIT, your clients don’t have to worry about collecting rent, constantly finding tenants, paying for utilities, making repairs or renovations, etc. If you’d like a beginner’s guide on REITs to hand out to your clients, here’s an article on how to invest in REITs.

How does a REIT work?

A REIT works by passively holding interests in real property. Its owners, known as trustees, possess legal title of and manage the trust property on behalf of the REIT’s shareholders or unit holders. REITs are generally overseen by fiduciary duties, such as those that apply to directors of a corporation.

While there is no legislation that directly governs a REIT’s organizational structure, the principles of contract law and trust law apply. Trust income can flow through the trust into the shareholders/unit holders’ hands, so REIT income is not taxed at the trust level.

What are the benefits of investing in a REIT?

A REIT is a good investment for those who want exposure to real estate but don’t have enough capital to invest in a property. As in real estate, REITs allow investing in different types of properties such as:

Find out why CEO Dean Orrico of @MiddlefieldGrp believes in the resurgence of REITs in 2024, despite the shifting dynamics in the real estate sector. Explore his perspective on the strength of non-office markets and their positive outlook. https://t.co/7WNNWfhRuO pic.twitter.com/ovKCjc7ppM

— Wealth Professional Canada (@WealthProCA) February 29, 2024

The variety of real estate properties that investors can have exposure to is just one of the many interesting benefits of a REIT. Here are some reasons why REITs make a good investment:

1. No corporate tax

REITs pay zero corporate tax, regardless of their profitability. This is in stark contrast to most dividend-paying stocks, which are effectively taxed twice: once on the corporate level and again on the individual investor’s dividend payments.

2. Excellent liquidity

To retain its status as a REIT, the company that holds a REIT must invest at least 75% of its assets in real estate and declare at least 90% of its taxable income as dividends to shareholders. REITs must meet these requirements to ensure that the company doesn’t pay tax on the REIT income. The net result for investors is the REIT paying dividends, so shareholders have guaranteed income (and it’s not a scam!).

3. REITs are easily traded

Part of its excellent liquidity is the REIT’s ability to be easily bought and sold on the stock market. Investors who need money don’t have to go through the painful, lengthy process of finding a buyer if they have REIT shares.

4. It’s a passive investment

As a REIT shareholder, your client does not own the property or have mortgages in their portfolio. This means your clients can own income-producing real estate without worrying about maintenance, utilities, collecting rent payments or other tasks associated with owning real estate.

5. Gives high dividend yields

Since a REIT must pay at least 90% of its taxable income to shareholders to keep its tax-free benefit, REITs tend to have above-average dividend yields. REITs can potentially provide a safe dividend yield of 5% or more, while the average stock on the S&P 500 only yields less than 2%.

REITs are an excellent choice for added income. Investors also have the option to reinvest their dividends and buy more shares, compounding gains over time.

6. Total return potential

A REIT has high potential for capital appreciation as the value of its underlying assets grows. Since real estate values tend to increase over time, a REIT can use several strategies to create additional value. A REIT can develop properties from the ground up or sell valuable properties and redeploy the capital. This, combined with dividends, means a REIT can be an excellent total return investment.

What are the different types of REITs?

Rookie investors may think that REITs are exclusively concerned with homes and rental properties, but it is more diverse than that. For starters, REITs are generally classified by how they generate income from real estate:

• equity REITs – REITs that acquire, manage, build, sell and renovate income-producing real estate
• mortgage REITs – REITs that invest in mortgages, mortgage-backed securities (MBS), and related assets, earning income from the interest on their real estate investments
• hybrid REITs – a combination of equity and mortgage REITs

Under equity REITs are other subcategories. Here are some of the more common types of REITs under equity REITs, including:

Residential REITs

These REITs own and operate some of the most common real estate, namely multi-family rental apartment buildings and manufactured housing. While it may seem attractive, investors should take account of a few factors influencing this REIT’s viability.

For starters, the best apartment markets tend to be where home affordability is low relative to the rest of the country. If the apartment supply in a particular market remains low and demand rises, residential REITs should earn well. As with all companies, those with the strongest balance sheets and the most available capital normally do the best. 

Multi-residential family REITs are considered a stable, profitable investment option - find out why in this article.

Healthcare REITs

The success of this sort of real estate depends mainly on the healthcare system. Most of the operators of these facilities rely on occupancy fees, healthcare reimbursements and private payments. Healthcare REITs don't invest in the facilities themselves, but in the real estate of hospitals, medical centres, nursing facilities, and retirement homes.  

When investing in a healthcare REIT, make sure its customers and investments are diversified.

A healthcare REIT focused on one specific type of facility is good to an extent but so is spreading risk. Generally, an increase in the demand for healthcare services (as in an aging population) is good for healthcare real estate, and therefore profitable for healthcare REITs.

Office REITs

Office REITs invest in office buildings and receive rental income from tenants who take on long-term leases. This type of REIT can be a good investment but can be quite risky as it depends on the economy and employment rate. The lower the employment, the fewer the offices, the less income for this REIT.

Office REITs can provide diversification for REIT investments but it’s best to invest in those that have interests in economic strongholds like Toronto or Vancouver.

Retail REITs

This type of REIT deals in supermarkets, grocery stores, pharmacies, shopping centres, and malls. With the rise of online shopping and the recent pandemic, this REIT took a hit. However, pharmacies and groceries are still a necessity, so this can still be a viable part of a diversified portfolio.

Industry REITs

These REITs own and manage industrial facilities and rent out space to industrial tenants. Some industrial REITs focus on specific types of properties, such as warehouses, data centres, and distribution centres. Since 2018, demand for warehouses and data centres has spiked, driving more growth for industrial REIT revenues.

Thanks in part to the pandemic, these properties will remain crucial for online stores, data management, logistics, and other e-commerce needs. In our 2023 interview with two asset managers, they said that industry REITs are well positioned in Canada.

What are private REITs?

There are real estate funds or companies that are not registered with the SEC. As this REIT is “private,” their shares are not traded on national stock exchanges. Typically, private REITs are sold only to institutional investors.

Speaking of private REITs, American investment guru Dave Ramsey had this to say of this sort of REIT: “They run the spectrum of really, really bad to awesome”. Private REITs are not advisable for beginners in investing, according to Ramsey. Watch his video to know more about why private REITs may not be for your clients, unless they’re the type who have money to burn.

Here are some guidelines on how advisors can establish if a private REIT is actively managed.

What are the risks of investing in REITs?

No investment is without risk or drawbacks. Here are some of the risks:

Dividends can be taxed

While REITs don’t have to pay a corporate tax, REIT dividends are typically taxed at a higher rate than other investments. In many cases, dividends are taxed at the same rate as long-term capital gains, which is generally lower than the tax rate of their regular income.

Dividends paid from REITs don’t always qualify for the capital gains rate. It’s more common for REIT dividends to be taxed at the same rate as ordinary income.

REITs are sensitive to interest rates

REITs can be hypersensitive to changes in interest rates. Rising interest rates can hurt the price of REIT shares. In general, the value of REITs is inversely tied to the Treasury yield. This means when the Treasury yield rises, the value of REITs is likely to decline.

REITs’ value is influenced by trends

Unlike other investments, REITs can be very much affected by risks associated with the property. For instance, if a person invests in a REIT that’s a portfolio of candy stores in strip malls, they could see their investment take a hit if candy or strip malls fall out of favour.

The Best REITs in Canada now

Depending on the economic climate, employment rates, interest rates, customer preferences, and other factors, the top REITs for any given year can vary widely. For example, the top Canadian REITs in 2023 featured a list of REITs in sectors that were different from 2022 or 2024.

Here’s what industry analysts say are the best REITs to invest in Canada for this year:

1. SmartCentres

This is Canada’s largest retail REIT by market cap. SmartCentres has 283 properties in its portfolio, 178 of which are for rent and the other 105 are currently on the market. What makes SmartCentres an impressive and viable REIT is its biggest client: Walmart.

SmartCentres makes 25% of its revenue from Walmart alone. SmartCentres is looking to expand into mixed-use commercial and residential properties soon, which will only increase the value further of its current retailers.

Since 2003, this retail REIT has been paying regular dividends. This REIT holds the distinction of being highly resilient, not cutting its dividends during the 2008 financial crisis nor the 2020 pandemic. 

2. Morguard North American Residential

One of the largest residential REITs in Canada, Morguard owns 43 multi-suite residential properties across North America, including 16 in Ontario and Alberta, plus another 27 properties spread across nine US states.

This REIT has an outstanding occupancy rate in its properties, way above the industry standard. Morguard North American Residential also provides high yields, if not the highest, among residential REITs in Canada. That number is likely to climb higher, as this REIT has made an impressive increase of 10% in the last four years.

3. Allied Properties

This is an office and data REIT that owns 195 rental properties in many Canadian markets. When companies were no longer renting space during the pandemic, Allied Properties took advantage of low prices and made 14 acquisitions in Toronto.

It has continued to expand its reach since then, with the acquisition of six high-quality offices in Toronto, Montreal, and Vancouver in March 2022. Its current property portfolio now stands at around $8 billion.

This could be a good time to buy Allied Properties, since this REIT pays a solid dividend right now, since the start of the year, more companies have required their employees to return to the office.

Let’s go back to the question we started out with: are REITs a good investment? While most Canadians say they prefer real estate and stocks as investments, it’s still worth recommending REITs. These types of investments can be good for portfolio diversification and to provide more liquidity. They also have the potential for long-term capital gains if managed well. How much of your client’s investment portfolio will be allocated to REITs of course depends on their financial goals, risk tolerance, and time horizon.

Do you think REITs are a good investment for your clients? Let us know in the comments!