REITs and SIFT Legislation

I was looking at the stats for this site, which I almost never do. I’m always surprised when I find out that more than half a dozen people read this. Again, it’s really meant as a way for me to clarify my thinking through writing. Anyway, I am interested in the Google searches that bring people here. One that stood out was “REITs that convert in 2011”. I’m not sure what page someone landed on as a result of that search, but I’d like to clarify.

REITs are Real Estate Investment Trusts. They are companies that own physical real estate and pass all of the income along to unitholders. They trade on the stock exchange and are subject to similar volatility to stocks. Sometimes, such as during the recent market crash, units of a REIT can be purchased at a discount to the real estate owned. That’s one reason I like them.

REITs were given an exemption from the SIFT legislation that makes income trusts taxable starting in 2011. The official reason given was that REITs exist in other countries, so there’s no unfair advantage. I have owned a couple REITs over the last two years, and I have found another reason. The income paid from the REITs I have owned has been classified as 100% return of capital. This means it is not taxable on receipt (although it reduces the Adjusted Cost Base of the units). Even if the government taxed the income of REITs, they have enough depreciation and other costs from their operations that they do not have any tax liability.

For this reason, REITs are great to own in a taxable (non-registered) account. An 8% tax-deferred yield is roughly equivalent to a 12% taxable yield on a bond. It’s not guaranteed, but it’s juicy! On the other hand, tracking the ACB, in the case that any units are sold, can be a nightmare. REITs will continue to exist through 2011 and beyond. In the current low interest rate environment, they are attractive for their yield, but also for the spread they can earn buying real estate with a cap rate higher than the cost of debt. This is not guaranteed to last.