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Originally coined in the U.S., a Real Estate Investment Trust was adopted by Canada to describe a security selling just like an exchanged-traded stock but investing in properties or mortgages directly (real estate).
REITs are not taxed if they distribute their taxable income to investors and usually provide favorably high yields for these investors. In Canada it is not uncommon to see them distribute between 75%-95% of income to share holders and producing yields upwards of 7%-13%.
There are three types of Investments: Equity, Mortgage, and Hybrid.
Equity REITs have underlying tangible properties that it invests into and owns. Revenues from this type of REIT are directly linked to rental income earned from these properties.
Mortgage REITs are all about property mortgages. By owning and investing into mortgages this REIT loans money to real estate owners for mortgages or go about purchasing existing mortgages. Revenues come from interest earned on those mortgage loans.
Hybrid REITs are a mix of both equity and mortgage REITs.
Because these types of securities’ revenues are contractual-based and by law must pay out almost all of their taxable income to shareholders they are able to consistently hold and distribute high yields. Dividends from this type of instrument tend to be about four times higher on average than regular stocks.
Studies show that they can boost returns and/or reduce risk when combined into a diversified portfolio — helping to build a more stable long-term wealth future. It has also been shown to offer a good risk/reward trade off.
REITs are not without their risks. Because they are traded on the stock market they are at the mercy of market conditions. And because they are invested in physical property they are affected by real estate prices. So although this type of investment instrument does demonstrate impressive long-term gains there have been periods in history when it has severely underperformed. They also tend to take a beating during periods when interest rates rise.