Continuing the discussion from our last post how to use RRSP to buy investment property, here we’ll share everything about REITs.
Intelligent investors know how to make their money work for them. Allowing money to sit in a RRSP untouched for years may generate a safe income, but there are more options for investors looking for a better return for their money. One of these options is using a RRSP account to invest into a REIT.
Registered Retirement Savings Plans (RRSPs) are investment accounts, created to help Canadians hold savings and investment assets. They offer more tax benefits in comparison to other saving accounts.
According to a census conducted in 2016, 35% of Canadian households have chosen to use RRSPs to save for retirement.
While investments are taxed upon withdrawal, a RRSP account generally generates better investment outcomes. This is due to the fact that funds deposited into RRSPs are not subjected to the same taxes other saving accounts are subjected towards. This allows the account to remain tax free until the investor decides to withdraw funds from the account. Withdrawn funds are taxed, but there are investment opportunities within the RRSP rules and guidelines that allow an investor to circumvent the taxes while generating a higher investment return than if they had left the RRSP alone. One of these methods is investing RRSP savings into REITs.
What is a REIT
REITs, or Real Estate Investment trusts, are corporations that own and manage a range of investments in mortgages and real estate properties. A certain number of requirements are needed for a company to be considered a REIT, such as it being managed by a board of directors or trustees, or the company invests at least 75% of their assets into real estate assets or cash.
A REIT essentially works as a stock, with 90% of their annual income being redistributed to their shareholders. REITs are open to the public and currently there are 50 Canadian REITS listed in the TSX (Toronto Stock Exchange) and hundreds located globally.
The income from a REIT is reported and the tax is paid by the investor, not the trust holder. This differs from other types of investments that are RRSP approved as most of the time the returned investment is also taxed.
There are 2 Main Types of REITs: Equity REITs and Mortgage REITs.
90% of REITs fall under the umbrella of Equity REITs. Equity REITs (or eREITs) produce their incomes from the sale of long-term property investments and through the collection of rents. They own and operate income-producing properties, such as retail spaces, resorts, and offices. Tenants lease these spaces for their places of business and the monthly rent is redistributed among shareholders.
Mortgage REITs (or mREITs) loan money for mortgages to real estate investors/owners. They also purchase existing mortgages or mortgage-backed securities (or asset-backed securities). They are the ones who lend money directly to landlords for purchasing rental properties. Despite their ties to real estate, they do not invest directly into properties themselves. While Equity REITs generate their income though the collection of rents, Mortgage REITs earn theirs from the interest rates that are tacked onto mortgage loans. Factors that affect the earnings from these loans are changes in mortgage rates, clients prepaying loans before their agreed upon due date, foreclosure, and bankruptcy. You can read more about the advantages and disadvantages of REITs here
While there are two main types of REITs, there is also a third type of REIT called a Hybrid REIT that combines the two. They can make their earnings through interest from mortgages and collecting rents. However, these are uncommon in today’s society.
There are many benefits in choosing REITs as an investment opportunity.
Here are a few benefits to consider:
- Liquidity– One of the benefits of a REIT is that it can be bought or sold in the market without it having a negative impact on the initial pricing. This can give investors freedom to pull out of their investment, should it not live up to their expectations.
- Diversification– In the past, REITs have allowed investors to invest in physical assets, such as properties, and are not reliant on stock prices. They can either work together or not at all while offering a diverse investment for investors.
- Transparency– REITs are audited by the government, and as a result, are able to provide audited financial reports that investors are able to inspect. They are also required to disclose information regularly.
- Dividends– With regular incomes coming from rent and monthly payments from mortgages, investors have historically seen better returns from their investments. Registered REITs are required to redistribute 90% of their earnings back to investors.
- Performance– REITs are managed by skilled and professional managers. They have the skills necessary to generate higher income properties than their inexperienced counterparts.
REITs work by allowing investors to purchase multiple rental properties without the risk of relying on a single investments successes. It’s a great way for both new and experienced investors to be involved in real estate, while allowing a team of experts to manage the properties themselves. As in every investment, there are risks when choosing Real Estate Investment Trusts, such as sudden skyrocketing interest rates or investing in a REIT that is not suitable to the area. Allowing professional consultants to help guide your investments can lower this risk.
Using your RRSP to invest in REITs can help boost your investment portfolio without the financial risks seen in options such as stocks. They allow smart investors to dip their toe in the real estate market without the commitment or work that comes with owning and maintaining the property itself.