We just turned the corner into 2011 and something big happened on the Canadian market; most income trusts have disappeared. On Halloween of 2006 (you talk about scary news, huh?), the Canadian Finance minister, Jim Flaherty, announced that most income trusts will have to convert into corporations by January 1st 2011. This was in reaction of the growing interest for corporations to switch over to an Income Trust structure for taxation purposes. It all started with the famous Oil Sands Income Trust companies (paying crazy dividends, even to foreign investors) but it ended with the rumors of BCE and Telus converting into income trusts.
Real Estate Income Trusts (REITs) Are Some of the Survivors
A few structures have been saved from the 2011 Canadian Income Trust Tsunami. One of them is the Canadian REIT. I don’t want to go back to the reasons why REITs are able to keep their income trust structure but I want to discuss the benefits of it.
Canadian REIT Advantages
Here’s a brief explanation of how Canadian REITs work:
As established in their trust constitution, REIT profit distribution represents the net income generated from rents. This means that Canadian REITs distribute their profit before paying taxes. Since REITs profits are based on rents, they are able to manage a stable distribution for investors. We usually see high distribution of earnings from Canadian REITs and this is why their dividend yields are so high (between 5 to 10%). Wait! There is more! REITs can also provide investors with capital gain as the REIT units can rise in value (according to property values and rental management). Therefore, on top of having a tax optimized structure to pay a maximum dividend, the investors can also expect capital gains (deferred taxation) in the future. In a realm of low interest rates, Canadian REITs represent a good option for fixed income investors.
When filing individual tax returns, the dividend payments from REITs are filed as ordinary income unless they are considered to be “qualified dividends” which are filed under capital gains. An up-to-date tax software program such as TurboTax Canada is an affordable alternative that allows individuals to file complicated tax returns themselves therefore saving time and money
Canadian Housing Bubble Burst Could Hit REITs Unit Values
There are obviously some concerns about a potential Canadian Housing Bubble. If it ever happens (as it did in the US), most REITs would suffer an important hit (and so do investors!). This may be why you should be cautious when selecting Canadian REITs as a replacement for (low interest) GICs and Bonds. The REITs unit values will more likely fluctuate over time.
Personally, I don’t believe in a Canadian Housing Bubble. We might see a slide in a few overheated markets such as Vancouver, Calgary and Toronto, but in general, I think the Canadian housing market is doing fine.
Why Should You Consider Canadian REITs In Your Portfolio?
This is a simple question with a simple answer. Here are my observations about the Canadian Housing Market and you’ll figure out the answer by yourself;
#1 Very low mortgage rate environment (and interest rates are not ready to surge)
#2 Stricter lending policies (imposed by the Canadian government)
Based on these 2 observations, I’ll make 2 assumptions:
#1 Low rates = higher profits for REITs
#2 Stricter lending policies = Lower risk of default = Lower risk of Canadian Housing Bubble Bursting
Does this sound like a great time to invest in REITs? I believe so!
So if current Canadian REIT distributions are not threatened and the value of their holdings seem to be stable, I think that adding REITs to your portfolio could be a great way to diversify your asset allocation while boosting your overall dividend yield, don’t you think?
Monday Afternoon Edit: I’m not the only one thinking Canadian REITs are a good investment, check out The Globe & Mail Article here.
Disclaimer: While I am not currently holding any REITs in my portfolio, I am considering the addition of one to while I am restructuring my portfolio at the moment.