Hey guys. It is Adrian here, the Canadian in a T-shirt. Today, I will be breaking down the basics
of REITs and how to invest in real estate through the stock market. REITs are an amazing tool to
tap into the real estate market. Even if you do not have a lot of money and it gives you pure
passive income usually through monthly dividends. In this video, I will go over how REITs work, the
advantages of REITs over traditional real estate investing, the different types of REITs, how their
passive income is taxed, and the different REIT investing strategies especially for Canadians.
This is chapter eight of my Millennial Investing Guide. So click the pop-up at the top right to
check out the previous videos in that playlist to learn about the basics of investing and dividends,
what are stocks bonds, and ETFs, and how to invest during a market crash.
So what is a REIT? A REIT is a real estate investment trust. It is a large company that
owns hundreds or thousands of real estate properties and rents them out for a profit.
It is basically a way for everyday people to tap into the real estate market, even if you do not
have the money for a down payment. Instead of saving up for years to buy one property,
you could buy shares of a REIT the same way you buy shares of a stock and now you are a part-owner
of hundreds of properties. And so you get a portion of the monthly rent collected on all of
those properties. Real estate investing is one of the best ways to build wealth because land itself
is limited and people will always need a place to live and work. There is a finite amount of
land available, especially in the big cities and as populations grow, the demand goes up and thus
the value of this real estate increases. But only the owner benefits from this increased value,
the rest of us are paying the owner every month through rent. But it is very expensive
to buy property. Sure, you can partner up with a few people and split it evenly,
which makes it easier. But what if we took it one step further. What if we split these
properties with thousands of people. That is what the US government did when they created the REIT.
This Real Estate Investment Trust allowed thousands of everyday people
to pool their money together to buy real estate. And you did not have to meet each
other and signed contracts and partnerships, you just bought shares of a REIT on the stock market
So if you buy a share of a REIT, you own a small part of that company and so you
own a small part of all of the real estate properties held by that REIT. Even better,
you are entitled to a portion of their profits gained through rent. So now even if you only
have twenty dollars, you can start investing in real estate properties. That is a game-changer.
So why should you invest in REITs? Their two biggest benefits are access to the
real estate market and passive income. Let us break it down. REITs are an affordable
and accessible alternative to physically owning real estate. You can purchase a single share of
a REIT for less than twenty dollars. But buying physical real estate is exceedingly more difficult
and expensive. You need a large amount of money upfront to buy a property. In Canada,
you need to make a down payment of at least twenty percent of the property value for rentals.
So if you are buying a house to rent and the house is selling for five hundred thousand dollars,
you must have a hundred thousand dollars in cash if you want to buy it. Even if you qualify for
a larger mortgage, you need twenty percent of the purchase price upfront in cash. If you don't have it,
too bad, you will have to save up. But with REITs, you just invest as much as you can.
You just buy the shares of the REIT and you could do it instantly through an online broker
like QUESTRADE. You do not have to meet with lawyers, you do not have to sign any paperwork,
you just buy the shares on the stock market with a click of a button.
Buying a physical property is a long process. You have to inspect the property,
meet with lawyers and real estate agents, you have to get approved for a mortgage,
and all of this comes with extra fees. And that is just to become an owner. To actually earn money
as a landlord. You have to find tenants to rent out to. This takes time and money to advertise,
interview, and screen the tenants. And once they move in, you have to deal with maintenance,
repairs, and renovations. You will be getting calls any time of day to deal with plumbing
issues, late rent payments, and worst of all tenant evictions. Being a landlord is
definitely not passive income. It takes a lot of time and effort but you do have a high level of
control. You own the property and you make all the decisions. You can choose your tenants and
you can decide how to deal with repairs. If you want to hire someone or do it yourself.
With REIT investing, you give up this control but it is purely passive income. The REIT,
the company itself owns and operates the rental properties. They have hundreds of
employees and contractors to find tenants and deal with maintenance. You are not
involved and you do not have a say in the matter. But if you own shares of a REIT,
you are a part-owner and so you get a portion of the monthly rent. You do not have to do a thing.
You just sit back, collect those dividends, and make money in your sleep.
Another advantage of REITs is liquidity. Buying a rental property is a huge commitment. If
something goes wrong and you need your money back, you cannot just cash out.
Selling a property takes weeks or months and it comes with huge costs. Usually,
about six percent of the selling price plus it is all or nothing. You cannot sell half of the
house. But with REITs you have the freedom to sell as many shares as you want. If you need
ten thousand dollars back, just sell ten thousand dollars worth of shares. You do not have to sell
the whole thing and you get this money instantly. And if you use an online broker like QUESTRADE,
it will literally cost you only five dollars in commission fees to sell these shares.
Another great benefit of REITs, is the inherent diversification. When you buy a rental property,
you are making a huge commitment. You are basically putting all your eggs in one basket.
You spent years saving up this down payment and you poured all this money into this property,
but you could lose it all. Even if it is a perfect property, there can always be a flood,
a fire, destructive tenants, and these will disrupt your income and hurt your investment.
With REITs however, your investment is spread out over hundreds of properties, so you take on far
less risk. This inherent diversification is the exact same benefit of owning ETFs
rather than individual stocks. I talked about this in detail in my ETF video. So click the
pop-up at the top right to check that out. You can think of REITs like an ETF of real
estate. Instead of putting all your money into one stock or one property, you can buy a REIT
and diversify across hundreds of properties. Even if one property tanks in value,
your REIT as a whole will still be okay and so will your investment.
I am not saying that REITs are always better than owning real estate directly.
You should try to invest in both approaches and that is what I do. I own a rental property
and I am looking to buy another one in the next few years. But I also invest heavily in REITs.
I will be breaking down the pros and cons in further detail between REITs and physical
real estate in an upcoming video. And I will be making more videos on how to get started
in real estate investing. So stay tuned for that. The main investing strategy of REITs
is to generate steady passive income through dividends. In fact, REITs generally pay higher
dividend yields than regular stocks. In a lot of cases, these dividends are paid out every month.
This is because the income that REITs earn comes from the rent paid by their tenants.
This rent is paid out every month. And so most REITs pay out their dividends every month as well.
In the US, the government actually requires REITs to pay out at least ninety percent of their
taxable income to shareholders through dividends. If they do this then REITs do not have to pay
any corporate taxes on their earnings. That is why REITs pay such strong and reliable dividends.
They want to maintain the special tax treatment even during hard times. In Canada,
the government does not force this ninety percent dividend payout. But it is still
in the REIT's best interest to pay out the majority of their taxable income to shareholders
to reduce their corporate tax bill. In this way, the tax on the rental income
gets passed down to the shareholders. REITs pay out the majority of their earnings to shareholders
who are happy to earn that strong passive income. But that does not leave a lot of money inside the
REIT to grow as a company. So do not expect too much capital appreciation with REITs.
Sure the underlying properties inside the REIT will likely increase in value over time.
And that might cause a share price to go up. But the main benefit of REIT investing
is the passive income earned through dividends. Any capital gains you get is just a bonus.
I will talk more about REIT strategies and the taxation rules later in the video.
But now let us talk about the different types of REITs. There are two fundamental types of REITs,
mortgage REITs and equity REITs. Mortgage REITs are far less common, and they do not
actually own property. Mortgage REITs invest in mortgages and mortgage-backed securities.
And they make their money from the interest paid on these loans. Because of this mortgage REITs are
very dependent on interest rates. Equity REITs are much more popular than mortgage REITs. When
most people including myself say REITs, they are almost always talking about equity REITs. Equity
REITs are the companies that actually own and operate real estate properties. They earn their
income through rent. Equity REITs usually focus on one or two real estate sectors, residential REITs
own houses, condos, and apartments and rent them out to people to live in usually with year-long
leases. Commercial REITs rent out to businesses and usually with longer leases of five to ten
years. This includes retail REITs which own shopping malls and plazas usually anchored by a
grocery store or a big chain like Walmart. There is also industrial REITs which owned factories,
warehouses, and distribution centers. Then there are more specialized REITs, like office REITs,
hotel REITs, and healthcare REITs which own medical buildings and retirement homes.
With any type of investment, it is important to diversify across multiple sectors. Again,
do not put all your eggs in one basket. You want to get exposure to all sectors of Real Estate.
You can do that by only different types of REITs or by investing in REIT ETFs,
which are a collection of REITs bundled together.
Click the pop-up at the top right to check out my stock picks recommendation playlist where I
go over some of my favorite REITs and ETFs that I personally invest in. I will also be making
a whole video dedicated to my favorite Canadian REITs for passive income. So stay tuned for that.
REITs are an excellent source of passive income but how should you invest in them?
Like any high yield dividends stock, you should hold them in your tax-sheltered accounts.
Mainly your TFSA and RRSP. I have gone into detail on the tax advantages of this
in my past tax videos. So click the pop-up at the top right to check those out. Holding high yield
dividends in your TFSA and RRSP maximizes your tax efficiency. But this is especially important
when it comes to REITs. That is because in Canada, REITs do not pay regular dividends.
They pay distributions, and distributions are taxed heavier than regular dividends. That is
because of the corporate tax benefits that REITs receive. When a regular company earns income,
they pay corporate taxes on that. With the remaining after-tax money they can pay out
dividends. And now the shareholders will have to pay taxes on the dividends that they receive.
But now those dividends have been taxed twice. The company has already paid corporate taxes on
that income. And now the investor has paid personal taxes on that dividend.
To avoid this double taxation, the government offers a dividend tax credit to the investors
to reduce their tax bill. Because of this tax credit income earned through eligible dividends
are taxed far more favorably than regular income you earn at a job.
Unfortunately, distributions paid by REITs are not considered eligible dividends. And so they do not
get these dividend tax credits. Remember REITs, as a company, avoid paying corporate taxes by paying
out the majority of their income out to investors. Since the company never pays taxes on this income,
there is no double taxation. And so you do not get that tax credits. The income you earn from REITs
will basically be taxed at your full marginal tax rate. That is why it is best to hold your
REITs in your TFSA and RRSP to avoid this tax bill. In Canada, REITs taxation actually gets
even more complicated. The distribution that you receive mostly comes from rental income,
but it also contains capital gains that the company earned when they sold properties.
And these are taxed differently in your hands. You can see the breakdown of the distribution
that you receive on the REIT's website. To make it worse, the distribution you receive
could also contain a return of capital. I do not want to get into those details right now.
I will save that for a future video. But if the distribution you receive contains
a return of capital, you do not pay any taxes on that amount right now,
but it will increase the taxes you do pay when you finally sell your shares.
The real challenge is that you have to keep track of these adjustments to your Cost Base
every single year until you finally sell. It can be a huge headache and that is why I suggest
to hold your REITs in a tax-sheltered account to avoid all of this. If you hold your REITs
in a TFSA or an RRSP, you would not be taxed on this income. That saves you a ton of money
plus you do not have to keep track of these details. You can just sit back,
collect that monthly income, and watch your investments grow tax-free.
One final note on taxes. Remember, US dividends including from US REITs, are subject to a
fifteen percent US withholding tax unless you hold them in your RRSP. I have talked about this
in detail in my past tax videos. But here is the bottom line, your Canadian REITs should be
held in your TFSA and RESP accounts. Your US REITs should only be held in your RRSP account to avoid
this withholding tax. If you follow this rule, you would not pay any taxes on your investment income
from REITs. I am going to be making a whole video on how to research and evaluate stocks before you
choose to invest in them. But when it comes to REITs, there are a few special metrics to look at.
One of the most important numbers to evaluate any stock is its earnings or net income. It is very
simple. Just the revenue minus their expenses. Are they gaining money or are they losing money?
When it comes to REITs however, this does not tell the whole story. That is because of depreciation.
Remember, a REIT wants to minimize their taxable income so they would not pay any corporate taxes.
They reduce their taxable income by claiming depreciation on their properties. They can claim
that their properties are decreasing in value by let us say three percent every year. They can
deduct this amount from their taxable income. But this depreciation is not real. In reality,
real estate properties are generally increasing in value year after year. So a better metric to
evaluate a REITs cash flow is the FFO, funds from operations. To get the FFO, they basically
add the depreciation back into the net income equation. This is definitely a simplification.
I will be making a whole video on how to evaluate stocks and REITs in an upcoming video. But
overall, when you are comparing two different REITs do not focus on their earnings. The FFO
is a much better representation of their cash flow when it comes to REITs. If you would like to get
started with investing in REITs, I recommend QUESTRADE which is my favorite online broker.
If you click my referral link in the box below, you will get fifty dollars in commission-free
trade rebates for the first thirty days when you sign up. That basically means that your
first ten stock trades would be commission-free. That saves you fifty dollars plus I will get a
small referral bonus as well. If you like to see exactly which REITs I am invested in and to help
support my channel, hit that join button down below to gain access to my exclusive videos like
my TFSA portfolio reveal and to see which stocks I am buying every week. But remember do not just
blindly follow a random guy on YouTube. Everyone has their own financial goals and circumstances.
It is your money. So make your own decisions. Do not just copy what I do. But I hope that
seeing my portfolio might offer some guidance, especially if you are just getting started.
So there you have it. That is everything you need to know about REITs. REITs are a great way to tap
into the real estate market even if you do not have a lot of money. They are a fantastic source
of passive income. REITs own and manage hundreds of real estate properties and they pay you from
the rent they earn. It is important to diversify across multiple types of real estate including
retail, industrial, office, and residential REITs. REIT distributions are taxed more heavily
than regular dividends. So make sure you hold your REITs in your TFSA or RRSP to avoid these
taxes. When evaluating REITs focus on the FFO, Funds From Operations, instead of the earnings.
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everyone. I will see you guys on the next episode of the Canadian in a T-shirt. Bye guys