Here are a few things to think about before adding a REIT, or any other themed investment
REITs allow an investor to hold shares in a trust that owns and manages a collection of real estate properties or mortgages, while stock investors purchase shares in the ownership of a public company. Photo by Illustration by Chloe Cushman/National Post files By Julie Cazzin with Allan Norman
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Access articles from across Canada with one account Share your thoughts and join the conversation in the comments Enjoy additional articles per month Get email updates from your favourite authors Q: I’ve read a lot of articles lately recommending investing in real estate investment trusts (REITs). What are they exactly and how do you invest in them? How do I know if they are a good investment for me and how are they taxed? Finally, I have always had a balanced portfolio of 60 per cent equities and 40 per cent fixed income. How would REITs fit into my portfolio mix? — Josh
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FP Answers: Josh, if you’ve always had a balanced 60/40 portfolio, it’s quite possible you already have exposure to the REIT sector, which includes companies that own or finance income-producing real estate. To help you decide, I’ll give you a few things to think about before adding a REIT, or any other themed investment such as oil, tech, bitcoin, etc., to your portfolio.
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Start by recognizing that adding a new position to an investment portfolio potentially changes your future expected returns and risk profile. How do you feel about your existing portfolio? If you’re comfortable with its risk profile, and the expected returns are sufficient to meet your goals, why add a REIT? If not, is there something you’re more familiar with that you could add to your portfolio, or would switching the mix to 70 per cent equities and 30 per cent fixed income make sense?
In my view, investors add themed investments such as REITs to their portfolios in hopes of increasing returns, and there is a familiar path these investments take to get into their investment portfolios. First, that sector of the market awakens and provides strong returns followed by increasing press coverage. This is followed by the convincing stories we hear about — and, ultimately, tell ourselves — why this is a good investment. Finally, the investment is made. Think of bitcoin over the past two years as a recent example.
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Themed investments tend to be more volatile than broad-based investment portfolios. But it is possible that the addition of a themed investment will sometimes reduce overall portfolio volatility. Themed investments may also appeal to market timers. Before investing in a themed investment, you should have a strong belief in the underlying investments. This should be backed by evidence — not stories. Otherwise, you may find it very difficult to stay invested through the rough times.
In your case, Josh, you have an interest in real estate investing and there is plenty of evidence showing that sector has been a good long-term investment for many people. However, to be fair, there have been many reports of new participants to the world of real estate having underwater portfolios.
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Real estate is not immune from risk. The challenges of real estate investing on your own is that it takes a lot of money, time and knowledge to do it properly and there is also a lack of diversification and liquidity. Exchange-traded REITs overcome these challenges and make real estate investing accessible to almost everyone.
In simple terms, REITs allow an investor to hold shares in a trust that owns and manages a collection of real estate properties or mortgages, while stock investors purchase shares in the ownership of a public company. Generally, REITs are required to annually distribute 90 per cent of their taxable income to shareholders in the form of dividends. REITs can also be specialized or broadly based in the properties they own, such as apartments, shopping centres, office buildings, long-term care homes and other types of properties.
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Although REITs pay dividends, they’re different from stock dividends, and they don’t qualify for the dividend tax credit. The distributions from REITs can be a mix of capital gains, foreign non-business income, return of capital and other income. The taxation characteristics don’t matter in registered accounts, but they do in non-registered or corporate accounts, so you’ll want to confirm the distribution makeup and history of REITs that you’re interested in.
REITs can be bought in a variety of ways, including as individual stocks, exchange-traded funds and mutual funds, which makes purchasing a REIT simple. In addition to the publicly offered REITs listed above, qualified investors can also purchase private REITs, which seem to be getting a lot of media attention lately. One reason for this may be that many issuers have been able to provide smooth positive returns while public REITs have been subject to the usual volatility associated with the public markets.
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Recommended from Editorial FP Answers: What should I do if I’ve missed three years of repayments to my RRSP Home Buyers’ Plan? FP Answers: What are the pros and cons of using a DRIP account for your investments? FP Answers: Is there any advantage to continuing CPP contributions after age 60? FP Answers: We’re in our 50s, but do we have enough to retire next year on $70,000 per year? But don’t confuse smooth positive returns with safety. Private REITs have their own set of potential risks. They may invest in the same type of real estate as public REITs, but private REITs are not listed on public stock exchanges and their units are purchased through the exempt market, which is subject to a different reporting structure. Private REITs also require the purchaser to meet certain income or asset tests to qualify a purchase.
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Article content Josh, if you decide to add REITs to your portfolio, determine if it acts more like an equity or a bond. If it acts more like an equity, add the REIT to the equity side of your portfolio.
Finally, REITs or other themed investments generally make up a smaller portion of an investor’s portfolio. Remember to ask yourself if your portfolio is aligned with your goals. Do you believe in the investment and is that belief based on long-term evidence? Do you understand the risks? Is there an option you’re more comfortable with?
After answering these questions, does it still make sense to add a REIT? If you’re not sure, talk to a qualified adviser.
Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Investment Industry Regulatory Organization of Canada. Allan can be reached at alnorman@atlantisfinancial.ca.