But beware! Real estate comes with real risks
With Canadian interest rates once again at rock bottom, income investors are hard-pressed to find any good income-producing assets without incurring a high degree of extra risk. Some advisors like to tout investment funds that hold real estate investment trusts (REITs) as a good choice for more conservative investors (say, retirees) looking for a steady stream of income, because they are diversified and have a better risk profile than, say, common shares of big blue-chip companies. But this may not paint the whole picture about REITs.
Strong REIT performance
Real Estate Investment Trusts, or REITs, have performed well in the past few years, and their higher yields have attracted a lot of investor interest. To illustrate, the S&P/TSX Capped REIT Index has returned 19.22% over the past year to Jan. 31, 2015, compared with 12.33% for the S&P/TSX 60 Index. Longer-term, REITs have also held up, delivering 8.75% over three years (9.81% for the S&P/TSX 60), and 13.55% over five years (8.82% for the S&P/TSX 60).
REITs are specially-structured trust securities that trade on stock exchanges like any other stock. REITs acquire full or part ownership of commercial or residential real estate properties that produce a steady revenue stream. These include properties like shopping centres, office buildings, hotels, apartments, and retirement residences. REITs generally are liquid investments, meaning you can buy and sell units without difficulty.
REITs must distribute their income to unitholders, so they pay a regular dividend. Compared with other high-yield income-producing securities, REITs can be quite attractive. However, in Canada the REIT market is small and choices are limited. Recently, REITs have performed well, mostly because the commercial and residential rental real estate markets are quite strong in most regions. But remember that because REITs are so closely tied to the real estate market, they’ll be subject to the same ups and downs as the market. What goes up eventually must come down.
Where to find REIT fund investments
REITs can be a useful part of a larger income portfolio, because they can provide income, liquidity, along with some growth potential. You can trade REITs individually or invest in a mutual fund or exchange-traded fund that holds a variety of REITs in its portfolio. Many mutual funds in the Real Estate Equity category hold REITs, as do funds in the Miscellaneous – Income and Real Property category. More broadly, funds in the larger Canadian Dividend and Income Equity category may hold REITs as part of their portfolios, but do not necessarily focus on them.
In addition, a number of pure REIT ETFs are available, including (in alphabetical order) BMO Equal Weight REITs Index ETF (TSX: ZRE), First Asset Active Canadian REIT ETF (TSX: FRF), iShares S&P/TSX Capped REIT Index ETF (TSX: XRE), and Vanguard FTSE Canadian Capped REIT Index ETF (TSX: VRE).
This does not mean that these funds are necessarily desirable or useful in any given portfolio. That depends on your personal risk tolerance and financial objectives. But with a proper allocation in the right context, REITs could be a valuable addition to the income component of your portfolio. As always, diversification within the asset class and within your broader portfolio remains a paramount consideration.
REIT fund volatility
For example, as of Jan. 31, the pure REIT ETF, iShares S&P/TSX Capped REIT Index ETF had a 3-year standard deviation (a measure of risk) of 10.57%, and a volatility ranking of 8/10, which is near the top. So REIT funds don’t necessarily have a better risk profile than, say, a quality dividend fund, such as iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (TSX: CDZ), which has a 3-year standard deviation of 6.97% and a volatility ranking of 5/10.
In looking for income, then, you wouldn’t exclusively hold REITs or REIT funds. Instead, you’d look to diversify among other types of income-producing assets and funds as well, including dividend funds. As always, your risk tolerance and investment objectives should give you some guidance here, and with the help of a qualified financial planner, you should be able to build a suitable income-producing portfolio.
© 2015 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice. Securities mentioned are not guaranteed and carry risk of loss. No guarantee of performance is made or implied.