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The ins and outs of REITs

Real estate is a classic alternative investment. It has typically been an integral part of a well...

Real estate is a classic alternative investment. It has typically been an integral part of a well-diversified investment portfolio, helping to lessen risk and enhance returns through consistent cash-flows and the potential for capital appreciation.

Real estate is a tangible asset that cannot be traded by a click of a mouse or bounced around by machine-based trading algorithms. As such, real estate is not subject to the same level of volatility as the stock market, where things can happen in a blink of an eye.

Like any asset class, the value of real estate can fluctuate over time. For the most part, history has shown us that real estate is best characterized by the old adage, “Slow and steady wins the race.”

By staying on top of what’s happening in the real estate market, and knowing what to look for, we can foresee trends that lead to market deviations well before they happen. With this knowledge, we can devise an investment plan on how to alter operations or dispose of the investment.

In doing so, we can enhance our cash-on-cash return or return on investment.

Investing in a REIT is a prudent way to diversify a portfolio and establish a consistent cash flow – without sacrificing the potential of growth.

What is a REIT?

Modelled after mutual funds, a REIT is an investment vehicle that pools money from individual investors to buy income-producing real estate. Each investor is given the appropriate number of REIT shares based on the amount they invest.

REITs offer an investor the opportunity to diversify their portfolio, receive a regular income stream and potentially see their investment appreciate over time.

REITs were introduced to provide individual investors with the opportunity to participate in various sectors of the real estate market.

Like purchasing stock, anyone can invest in REITs. In doing so, they can invest in a portfolio of large-scale properties in most segments of the economy, including apartments, student housing, industrial facilities, storage centres, infrastructure, offices, shopping malls, hospitals, hotels, nursing homes and timberlands.

Stockholders of a REIT earn a share of the income generated via real estate investments – without actually having to purchase the properties themselves. This is similar to the way shareholders benefit by owning stocks in other corporations.

Generally speaking, REITs disburse all of their taxable income as distributions to shareholders. Shareholders then pay the income taxes on those distributions.

Investors receive the benefit of a “stream of income” like direct owners of commercial property, as the income earned by a REIT goes to its unitholders without being taxed at the REIT level.

Similar to a mutual fund, REIT investors reap the rewards from diversification, enhanced buying power, liquidity and professional management. Unlike a gas royalty or oil trust, the assets of a REIT do not deplete.

That is, REITs are a viable investment structure, provided they are income-producing properties.

Why invest in a REIT?

REITs provide investors with exposure to real estate investments that offer consistent, tax-advantaged income and capital appreciation potential.

It is widely accepted that the most important factor to building wealth for individual investors is effective diversification across different investment classes.

Because real estate is a distinct asset class with limited correlation to most other investments, it is a key contributor to portfolio diversification and should contribute to maximizing portfolio returns and reducing volatility over the long term.

Most individual investors, however, do not have the capital or the management skills to achieve direct ownership of a shopping mall, hotel, retirement home, office building, apartment complex or industrial property.

REITs can do just about everything an individual stock, bond or mutual fund can do.

The beauty of this type of investment is that, since real property has limited correlation to most other stocks and bonds, REITs offer an additional layer of diversification. This, in turn, enhances optimum building of wealth for individual investors.

Benefits of a REIT include:

* Total expected returns from two sources: regular monthly income stream and potential price appreciation;

* A lower historical volatility than equities when investing through private real estate vehicles;

* Negligible correlation to traditional equity and fixed-income asset classes;

* A potential strategy for protecting assets from the impacts of high and rising inflation;

* An oversight framework that includes documentation of managers’ responsibilities and reporting requirements, audited financial statements, and additional reporting that provides transparency into diversification, leverage, occupancy rates and sources of returns.

Greg Placidi, MBA, CFA, is the Chief Investment Officer and Portfolio Manager at Equiton Capital: Greg is an accomplished investment professional with significant experience managing a wide array of investment portfolios. Over the last 30 years, Greg’s career has centred around global financial services and he has held senior roles in investment management, strategy consulting, insurance, real estate and financial services regulation.

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