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Here are a few things to think about before adding a REIT or other themed asset
REITs allow an investor to own shares in a trust that owns and manages a collection of real estate or mortgages, while stock investors purchase shares in a public company. Photo by Illustration by Chloe Cushman/National Post files
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By Julie Cazzin with Allan Norman
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Q: I’ve read a lot of articles lately that recommend 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? After all, I’ve always had a balanced portfolio of 60 percent stocks and 40 percent fixed income. How would REITs fit into my portfolio mix? — Josch
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FP responses: Josh, if you’ve always had a 60/40 balanced portfolio, chances are you’re already involved in the REIT sector, which includes companies that own or finance income-generating real estate. To help you decide, I’ll give you a few things to think about before adding a REIT or any other themed asset like oil, tech, bitcoin, etc. to your portfolio.
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Start by realizing that adding a new position to an investment portfolio may change your future expected returns and risk profile. How do you rate your existing portfolio? If you’re happy with its risk profile and the expected returns are sufficient to meet your goals, why add a REIT? If not, is there something you are more familiar with that you could add to your portfolio, or would it make sense to switch the mix to 70 percent equities and 30 percent fixed income?
In my view, investors are adding themed investments like REITs to their portfolios in hopes of increasing returns, and there’s a well-known path these investments take to get into their investment portfolios. First, this market sector is waking up and delivering strong returns, followed by increased press coverage. Then come the compelling stories we hear about—and ultimately tell ourselves—about why this is a good investment. Finally, the investment is made. As a recent example, think of Bitcoin over the last two years.
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Thematic investments tend to be more volatile than broad investment portfolios. However, it is possible that the addition of a thematic investment will sometimes reduce the overall volatility of the portfolio. Thematic investing can also appeal to market timers. Before investing in a thematic investment, you should have a firm belief in the underlying investments. This should be backed by evidence – not stories. Otherwise, you may find it very difficult to stay invested during tough times.
In your case, Josh, you’re interested in real estate investing, and there’s ample evidence that this sector has been a good long-term investment for many people. However, to be fair, there have been many reports of new entrants into the real estate world with underwater portfolios.
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Real estate is not risk free. The challenges of investing in real estate on your own are that it takes a lot of money, time and knowledge to do it right and also lacks diversification and liquidity. Exchange-traded REITs overcome these challenges and make real estate investing accessible to almost everyone.
Simply put, REITs allow an investor to own shares in a trust that owns and manages a collection of real estate or mortgages, while stock investors purchase shares in the property of a public company. Generally, REITs are required to return 90 percent of their taxable income annually to shareholders in the form of dividends. REITs can also be specialized or broad based in the properties they own, such as apartments, malls, office buildings, nursing homes, and other types of properties.
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Although REITs pay dividends, they are distinct from stock dividends and do not qualify for the dividend tax credit. REITs’ distributions can be a mix of capital gains, foreign non-business income, returns of capital, and other income. The taxation features do not matter for registered accounts, but they do for unregistered accounts or corporate accounts, so you should confirm the distribution structure and history of REITs you are interested in.
REITs can be bought in a variety of ways, including as individual stocks, exchange-traded funds, and mutual funds, making buying a REIT easy. 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 might be that many issuers have been able to generate smooth positive returns, while public REITs have faced the usual volatility associated with public markets.
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FP Responses: What should I do if I have missed three years of my RRSP homebuyer plan repayment?
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FP Responses: What are the pros and cons of using a DRIP account for your investments?
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FP Responses: Is there a benefit to continuing CPP contributions after age 60?
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FP Responses: We’re in our 50s, but do we have enough to retire next year at $70,000 a year?
But don’t confuse smooth positive returns with security. Private REITs have their own potential risks. They can invest in the same type of real estate as public REITs, but private REITs are not listed on public exchanges and their shares are purchased through the exempt market, which has a different reporting structure. Private REITs also require the buyer to meet certain income or wealth tests in order to qualify for a purchase.
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Josh, when you decide to add REITs to your portfolio, determine whether it’s more of a stock or a bond. If it behaves more like a stock, add the REIT to the stock side of your portfolio.
After all, 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?
With these questions answered, does it still make sense to add a REIT? If you are unsure, speak to a qualified advisor.
Allan Norman provides fee-based certified financial planning services through Atlantis Financial Inc. and investment advisory services through Aligned Capital Partners Inc., which is regulated by the Investment Industry Regulatory Organization of Canada. Allan can be reached at [email protected].
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Source: financialpost.com
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