Globe & Mail Article Sizing up a REIT: the key factor that's often overlooked
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Real estate investment trusts come in all sorts of flavours, from apartments to offices, medical buildings to senior living, and, of course, retail.
Those differences are plain. It's a little bit harder, however, to distinguish which REITs make payments to investors that are most advantageous, tax-wise, and which might have payouts that are a bit more aggressive than they might seem. Analyst Howard Leung at Veritas Investment Research recently made an attempt, however, and his findings are of interest to income-oriented investors in the space.
Mr. Leung's first observation is on what he calls the "tax efficiency" of the Canadian REITs. These trusts are tax-exempt as long as they distribute their taxable income to shareholders. In doing so, they pass that tax obligation to the unitholders, who pay based on whether it's business income, capital gains and what's called a return of capital.
Mr. Leung says - and most would agree - that a return of capital is preferable from a tax basis, because unitholders pay no tax in the year it's received. Instead, the unitholder's cost base is reduced by the amount of the payment, and is only taxable as a capital gain when the units are sold. Long-time unitholders can defer taxes for the long term via this method.
How does a REIT create a return of capital? Here's the primary way: Canada Revenue Agency allows REITs to use something called a capital cost allowance as a deduction against its taxable income. More CCAs means less taxable income, and more return of capital in the REIT's payout to investors. And the newer the trust, and the newer its properties, the greater value of the CCAs. As a trust and its properties age, CCA deductions decrease.
Mr. Leung says this means Milestone Apartments REIT, which did its initial public offering in 2013, and Chartwell Retirement Residences are two of the most "tax-efficient" REITs it looked at. On the other end of the spectrum, Canadian REIT and Boardwalk REIT are among the least tax-efficient.