Benefits of REIT investing and how to invest in REITs
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REIT investing spreads out your risk over multiple properties and across many regions. Learn about REIT stock, best REITs to invest in, and why are REITs a good investment.
With the real estate market going crazy in many parts of the country, many millennials and GenZers just can’t break into home buying. But there are other ways to invest in real estate — like with REIT stock.
It’s a Real Estate Investment Trust (REIT) is a real estate company that owns and/or operates income-producing properties such as malls, hotels, apartments, and office buildings. REITs distribute most, if not all, of the net income they receive to their unitholders.
That makes REITs an attractive investment for yield-hungry investors, especially in a low-interest-rate environment where high-interest savings accounts, GICs, and bond yields pay next to nothing. It’s a great way of growing your portfolio without taking big risks.
Keep reading for a deep dive into REIT investing, including whether REITs are a good investment, the pros and cons, and how to make a REIT investment in Canada.
Why invest in REIT ETFs
Broadening your real estate exposure is why investing in REIT ETFs makes more sense than holding individual REITs. It’s more efficient and diversified for investors to hold one ETF representing the entire real estate market. Consider the management fee your cost for that diversification and simplicity.
REIT investors can also use ETFs to get exposure to foreign real estate. For instance, Vanguard’s VNQ and iShares’ IYR trade on US stock exchanges and hold specialized, commercial and residential real estate in the U.S.
VNQ holds 174 individual stocks and REITs and comes with a management fee of just 0.12%. IYR has 82 holdings and comes with a management fee of 0.42%.
If you’re going to choose a REIT ETF, then go big and broad. Keep your costs low and diversify beyond Canada’s borders.
Investors can purchase REIT ETFs for free using Wealthsimple Trade or Questrade.
READ MORE: How to buy stock in Canada
Pros of REIT investment
Low cost: Homeownership in Canada is becoming increasingly unaffordable. It can take years to save for a down payment, and even then, the rise in real estate prices may move at a faster pace than savings.
On the other hand, investors can purchase a single unit of a REIT for as little as $10.
Low maintenance: Owning a rental property comes with headaches, like negotiating with tenants, managing and maintaining the property.
Owning units in a REIT or REIT ETF gives you all the benefits of being a landlord (income and capital appreciation) without any of the hassles.
Easy to sell: The single biggest problem with owning an individual property is the lack of liquidity. Selling a home can be expensive and time-consuming.
Selling a REIT, however, is as simple as clicking the sell button on your trading platform. Since REITs trade on public stock exchanges, they avoid the lack of liquidity that plagues the private real estate market.
Diversification: Individual REITs hold multiple properties across the country, never relying solely on one city or region.
REIT ETFs hold multiple REITs, diversifying further across different real estate sectors like commercial and residential. Owning a home is a concentrated bet on real estate in one particular city and even on one particular street.
Cons of REIT investment
Taxes (potentially): Holding REITs inside your registered accounts (RRSP or TFSA) works out just fine because the distributions are sheltered from tax.
But holding REITs inside a non-registered account can be problematic because the distributions are taxed at your full marginal rate. That’s right: unlike dividends from Canadian companies, distributions from REITs don’t enjoy favourable tax treatment. That’s because the REIT flowed the income directly to you without paying tax.
Lack of leverage: The use of leverage is a big draw for real estate investors because you only have to put down 20% of the purchase price when you buy a rental property (and just 5% if it’s your primary residence).
REIT investors don’t have the same advantage because most online brokers will only allow you to use 2:1 leverage to buy securities. Leverage cuts both ways if prices rise or fall, but in general, its use has allowed real estate investors to enjoy generous gains.
Investing in REITs in Canada
The easiest way for investors to add REITs to their investment portfolio is to purchase a REIT ETF through their discount brokerage account.
The top REIT ETFs in Canada are BMO’s ZRE, Vanguard’s VRE, and iShares’ XRE.
A savvy DIY investor may choose to invest directly in a handful of individual REITs rather than pay the ETF management fee. A good way to do this is by “skimming” the top 10 holdings of these REIT ETFs and then purchasing the individual REIT holdings through a discount brokerage account like Questrade.
Or use Wealthsimple Trade — Canada’s only zero-commission discount brokerage. Plus, Wealthsimple Trade will reimburse an outgoing administrative transfer fee of up to $150 on investment account transfers valued at more than $5,000.
If you decide to select your own individual REITs, diversify your holdings to include REITs that invest in malls, apartments, seniors’ residences, hotels and other infrastructure to broaden your real estate exposure.Start investing with Questrade
So, are REITs a good investment?
Yes! Looking at the 25-year period ending May 31, 2017, REITs outperformed stocks, bonds, and commodities as an investment. Here are reasons why REITs are a good investment:
- REITs offer diversification. REITs tend to own a wide variety of properties across the country, whereas most homeowners have their real estate exposure concentrated in a single property in one market.
- REITs also tend to pay healthy distributions. They offer a way for investors to juice their fixed-income returns, particularly in a low-interest-rate environment.
- Keeps up with inflation. While Canadian residential real estate soars in value, REITs have quietly kept pace as an investment over the past year. Canada’s largest REITs, led by BMO’s ZRE, Vanguard’s VRE, and iShares’ XRE, returned between 29% and 35% in the one-year period since May 2020. However, you should temper your expectations, as this year has been atypical. The performance is less exciting over a five-year period, with the top-performing REIT (ZRE) returning 4.83% per year between 2016-2021.
- Favourable during periods of higher inflation and rising interest rates. That’s because a strong economy can lead to higher occupancy rates and higher rent payments for real estate owners.
Are REITs a good long-term investment?+
REITs have an incredibly strong long-term track record as an investment, even outperforming the S&P 500 over long periods of time. They’ve done well in higher inflation, higher interest rate periods (like what we may be heading into soon). That’s because the strong economy allows REITs to charge higher rents and drive up occupancy rates.
While investors do get some real estate exposure by investing passively in a total stock market index, adding REITs to the mix can increase returns thanks to high distributions and the potential for capital appreciation.
Which REIT should you invest in?+
Consider BMO’s ZRE ETF for exposure to Canadian real estate, and Vanguard’s VNQ for cheap exposure to US real estate.
For individual stock pickers, look at Canadian Apartment Properties REIT (CAR.UN). It’s Canada’s largest REIT, owning 57,000 townhomes and manufactured housing sites across the country. CAR.UN has returned a healthy 13.5% per year over the past 5 years.
Are REITs a good investment in 2021?+
Yes. REITs have been a strong investment for the past year and should make a good investment in 2021 and beyond as life returns to normal.
Investors are concerned about inflation and higher interest rates as we emerge from the pandemic. Real estate offers a hedge against traditional stock and bond markets, as real estate investors can benefit from price appreciation and higher rents, while commercial real estate stands to gain from increased occupancy as the economy improves.
The bottom line: REIT Investing vs. direct investment in real estate
Canadians have a love affair with homeownership. Those who have experienced or witnessed outsized housing price gains in Vancouver or Toronto may feel that directly owning real estate is far superior to investing in REITs or even stocks in general.
But outside of a few major markets in Canada, investing directly in real estate has not been as profitable as owning REITs. Owning one home, on one street, in one city, and in one country is a highly concentrated position and can lead to a wide dispersion of returns (both positive and negative).
Real estate returns are also driven by two components: net rental income, and the increase or decrease in property value. If you live in your home, then you’re foregoing half of your potential return.
It’s safe to say that investing directly in real estate means making a leveraged bet on an individual property. REITs allow you to diversify that investment across multiple properties and even multiple types of real estate.
READ MORE: ETF investing