# Partial To REITs



## tygrus (Mar 13, 2012)

I like these stocks too much I think. I know its advisable to keep these about 25% of your portfolio, but they are attractive to me for a number of reasons, regardless of their leverage and dependence on interest rates.

There is no product to worry about like Apple or Blackberry or commodity prices flucuations or regulatory hurdles. These things own land, buildings and charge rent. Thats it. As long as they have a renter, they have cash flow and even if they do not, the value on commercial property is unlikely to go down. The renters are taking the actual business risk trying to make and sell products.

I would also argue that REITs are a broad snapshot of the entire economy anyway because they have tenets involved in everything and well diversified too.

Some people argue that interest rates could affect them or a housing correction. I beg to differ. These are business loans, not mortgages and unlikely to rise much in rates. many REITs have locked in long term rates anyway. Secondly, if there is a housing bust, REITs with apartments will benefit.

And leverage or debt, many companies have debt and they still operate fine.


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## HaroldCrump (Jun 10, 2009)

In general, they are alright for the _income_ part of your portfolio, but let's be clear what they are not - they are not a replacement for bonds, and they are not growth based equities.

In other words, you won't get any significant capital appreciation out of them over time.
There have been brief periods of time when REITs have been oversold and went on to subsequently outperform their historical returns, such as between 2009 and 2012.

But whether they can outperform after the taper-driven sell off last spring is anyone's guess.

I think it's fine to go a little overweight on REITs _as long as_ you are not reaching for yield by swapping bonds for REITs.


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## tygrus (Mar 13, 2012)

HaroldCrump said:


> I think it's fine to go a little overweight on REITs _as long as_ you are not reaching for yield by swapping bonds for REITs.


Well I don`t own any bonds and probably never will, so I guess over weighting a bit is fine.

And as far as capital appreciation goes, I consider that already built in as an extra premium in the dividend which is 3% higher than most other dividend payers.


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## Just a Guy (Mar 27, 2012)

What you may not know about with REITs, is how they are spending the money. Being highly leveraged, there is a lot of room for abuse while still maintaining cash flow...

Just look at some of the postings here where "investors" show cash flowing properties... There was one a while back which that had numbers something like a worth about $350k, rented for $1800 and claimed a cash flow of $1000/month. Turned out to be mostly interest only payments, leaving huge exposure to a rate increase...

Having been in real estate a long time, I know there is a lot of money to be made in it, a lot more than REITs pay out...I also know that, it's easy to cook the books to show profits/losses very easily. If you look at a lot of scams, real estate is often used because of these aspects...

I wouldn't trust others to manage my real estate, it's too tempting and easy to abuse the system...


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## tygrus (Mar 13, 2012)

Just a Guy said:


> What you may not know about with REITs, is how they are spending the money. Being highly leveraged, there is a lot of room for abuse while still maintaining cash flow...


The REITs I own are widely followed by analysts at all the major banks and also make up the largest holdings in XRE and ZRE ETFs so that gives me some confidence that they aren`t a scam.

I like real estate, but I certainly do not want to manage renters and tenants and thats where the REITs come in. The management team do all that for you.


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## Just a Guy (Mar 27, 2012)

Are these the same analysts and major banks which monitored such entities as Nortel, BreX, Worldcom, Enron, sino Forrest...


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## Pluto (Sep 12, 2013)

My opinion is that any reits you buy now will be under pressure as we move into inflation fighting mode. 

http://www.marketwatch.com/story/us-consumer-prices-rise-sharply-in-may-2014-06-17

REITS compete with other income producing assets. Central banks will eventually raise rates to keep inflation inside their preferred range. REIT prices will inch down to keep yields competitive with other income producing assets. I'm echoing HaroldCrump's view. 
I believe it is wise to buy RIETS when yields are higher than their median yield, and when dividend yields, and Bond yields are higher than their median. Buy on very bad economic news (when prices are low, and yields are high) then if you hold forever, at least your cost base is low, so the odds of going into a paper loss situation is low.


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## doctrine (Sep 30, 2011)

I am on board with tygrus. REITs are fantastic investments. No, they're not likely to see +25% or higher returns in a single year, but they have gone very long periods with 10-12% annual returns, which is in line with the market. I have a core holding of real estate that I add to whenever I can. 

If the 20% drop in REITs last year didn't faze you, then you're on the right track (not sure if you owned from Apr-Jun last year). That was a great time to add REITs and many still haven't gone past 2013 highs.


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## Spidey (May 11, 2009)

I'm also partial to REITs and have 15% of my portfolio in this sector. They are not without risk but the while a product can become obsolete or out of favour, I figure people will always need somewhere to live, shop or go to work. I count on these as one of the streams of income when I retire. I saw the 20% drop earlier as a buying opportunity and an opportunity to add BEI.UN and AX.UN to my portfolio, as well as add to my positions of CAR.UN and MRG.UN. I don't expect much more than the dividend plus a couple of percent over the next couple of years but that's all right with me.


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## gt_23 (Jan 18, 2014)

It's pretty risky to have 25% in REIT sector given the low rate environment. The extra 2-3% yield you get comes with significant risk: implied valuations for Cdn REITs are anywhere from 5-25% lower than current levels with a 1% increase in the 10 year rate, given the high payouts.

I think they will get hit hard at even the slightest hint of higher rates...


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## Synergy (Mar 18, 2013)

I'm also somewhat partial to REIT's. However, we really don't know how they'll perform in a rising rate environment. REITs have performed well in the past partly because of a declining interest rate environment. The dividends are nice but I'm more concerned over capital preservation. I've lowered my exposure somewhat but I still have a healthy 12-13% allocation. My goal is to eventually maintain a 5-10% allocation in REITs.


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## My Own Advisor (Sep 24, 2012)

I'm also partial to REITs, about 15% of portfolio here.

I also saw the dip as a chance to buy, got more REI.UN, D.UN and CWT.UN. 

If I can get some appreciation and continue to yield 5%+ I will be happy. I think they will pass their fees onto their tenants with any rate hike. Rates are historically low and they need to go higher, eventually, supposedly, maybe, possibly, I have no clue.


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## leeder (Jan 28, 2012)

My personal REIT allocation in my portfolio is about 10%. REITs are interest sensitive; although rates may stay put for a while longer, I believe the next rate movement is up not down. We had a taste of what would happen last summer with the talks of tapering and rate hikes. I ended up buying more in about October, but it was more to rebalance my REIT allocation. My personal favorite REIT is Allied Properties (AP.un). It's well run and has a history of increasing the distribution.


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## Eder (Feb 16, 2011)

Getting 5% yield on a reit like Rio Can is much different than 5% yield on BCE.


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## My Own Advisor (Sep 24, 2012)

Good point Eder.


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## gt_23 (Jan 18, 2014)

tygrus said:


> The REITs I own are widely followed by analysts at all the major banks and also make up the largest holdings in XRE and ZRE ETFs so that gives me some confidence that they aren`t a scam.
> 
> I like real estate, but I certainly do not want to manage renters and tenants and thats where the REITs come in. The management team do all that for you.


The fact they are followed by Street analysts gives you confidence?

The big investment houses have made a killing off of new REIT equity and debt issuance in the last few years...same place where these analysts work.


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## gt_23 (Jan 18, 2014)

Eder said:


> Getting 5% yield on a reit like Rio Can is much different than 5% yield on BCE.


What are you implying? RioCan is currently selling at a 6% premium to its NAV vs. many other REITs at discount to NAV

It's current price implies a bond yield (10Y) of 2.5% - pretty close. However, if borrowing rates increase +1%, it's price would decline to $23-$24 to maintain historical spreads, unless investors are willing to accept much lower yields when the div is cut (currently pays out 92% AFFO).


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## Eder (Feb 16, 2011)

RoC will fool many investors, non eligible dividends will as well. Then there are other risks that need to be considered...like the risk of changing laws governing trust tax shelters...a more likely scenario than changing laws regarding dividend tax credits,etc.

I own REITS and other trusts but feel they need a few more points of sustainable yield to compare favorably with conventional dividend growing equities. 

Therefore I do not consider Rio Can compares favorably with BCE if or sole goal is dividend investing rather than diversification.


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## doctrine (Sep 30, 2011)

> unless investors are willing to accept much lower yields when the div is cut (currently pays out 92% AFFO).


You're assuming that the div will have to be cut if/when rates increase, and that increasing rents can't cover increasing interest costs. I agree face value of REITs will probably fall if interest rates do rise, but dividends will only have to be cut if the REIT can't raise prices enough to pay for interest rate increases. That question is entirely dependent on the specific REIT and its pricing power. Presumably a higher interest rate environment is one in which the economy is doing good and inflation is healthy, allowing REITs to manage the increased costs with increase prices. Nothing is easy, and saying higher interest rates->bad for REITs is too simple. 

I'd argue BCE and RioCan are far more similar than you might think. BCE today has a higher payout ratio than 2-3 years ago, and arguably less room for high dividend growth. RioCan, on the other hand, has dropped from a 110%+ AFFO payout to a 92% AFFO payout in those same two years, increasing the likelihood of increases if they choose to move back to a 100% payout.


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## Moneytoo (Mar 26, 2014)

I haven't owned REIT ETF long enough, so found comfort in yesterday's Garth Turner's post:

_My office building is not going to empty of bankers and lawyers because the residential real estate starts to descend, or stays comatose for years. Cash flows will not diminish from major shopping centres where tenants come and go but traffic stays consistent.[...]In fact, when real estate stops booming, renters stop buying, and this is great news for REITs that own all those thousands of apartment units._

http://www.greaterfool.ca/2014/06/17/stubborn


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## Just a Guy (Mar 27, 2012)

Funny how people think real estate is ultra safe...

Prices are at record highs
Rents are at all time highs
Interest rates are at all time lows
Debt levels are at all time highs

Anyone remember the 80's with mortgage rates over 21%? Not saying that's going to happen again any time soon, but the only reason you can buy a property at current prices is money is cheap. If money increases in cost, the values of the properties will decrease, the costs to maintain will increase...and rents probably won't increase much because it is close to being unaffordable now...

2007/8 in the USA should show what could happen...great buying opportunity for a new REIT, as they can buy the assets of the underwater ones who've been buying at these inflated prices.


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## gt_23 (Jan 18, 2014)

Eder said:


> RoC will fool many investors, non eligible dividends will as well. Then there are other risks that need to be considered...like the risk of changing laws governing trust tax shelters...a more likely scenario than changing laws regarding dividend tax credits,etc.
> 
> I own REITS and other trusts but feel they need a few more points of sustainable yield to compare favorably with conventional dividend growing equities.
> 
> Therefore I do not consider Rio Can compares favorably with BCE if or sole goal is dividend investing rather than diversification.


In that case I agree with you. It was unclear from your original post which one you were advocating over the other.

I think you are correct that the 2-3 % of extra yield is not worth the risk of share capital depreciation at current. I think the class of real estate should also play a factor: retail, I & C, and multifamily, in order of declining risk.


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## gt_23 (Jan 18, 2014)

doctrine said:


> You're assuming that the div will have to be cut if/when rates increase, and that increasing rents can't cover increasing interest costs.


Consider that even a 100 bps increase to borrowing rates would translate up to a 25% increase in rents. You think all the tenants in Riocan's portfolio will just roll-over and absorb that? Although they will get more $ psf, their occupancies will go down and so will their total revenues.

I own some REITs, but focus on those that are selling at discount to NAV (automatic margin of safety) vs. premium to NAV ( such as RioCan), less geographic risk (U.S. better than Can exposure), and safer asset types (i.e. multifamily res>all others). I think 25% is a risky weighting in today's environment.


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## gt_23 (Jan 18, 2014)

Moneytoo said:


> I haven't owned REIT ETF long enough, so found comfort in yesterday's Garth Turner's post:
> 
> _My office building is not going to empty of bankers and lawyers because the residential real estate starts to descend, or stays comatose for years. Cash flows will not diminish from major shopping centres where tenants come and go but traffic stays consistent.[...]In fact, when real estate stops booming, renters stop buying, and this is great news for REITs that own all those thousands of apartment units._
> 
> http://www.greaterfool.ca/2014/06/17/stubborn


Somewhat unrelated...but this is a pretty big reversal for Garth Turner. He used to claim that residential rents would fall with a real estate crash, but now appears to have changed his view. Maybe he learned something from the U.S. were residential rents increased with higher demand following the RE price collapse.


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## AltaRed (Jun 8, 2009)

I became more interested in REITs about a year ago for income diversification and now have a goal of about 10% of my investable assets in REITs (along with 15% in prefs). I've owned RioCan forever but more recently added CREIT and AAR during the dip last fall. About halfway to my goal but will wait for at least as significant a dip as last year before adding more. I like the commercial/industrial space much better than residential ones, but could be convinced to get on board I suppose. Somehow I have not been able to bring myself to owning housing (apartment/retirement) REITs.


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## gt_23 (Jan 18, 2014)

AltaRed said:


> I became more interested in REITs about a year ago for income diversification and now have a goal of about 10% of my investable assets in REITs (along with 15% in prefs). I've owned RioCan forever but more recently added CREIT and AAR during the dip last fall. About halfway to my goal but will wait for at least as significant a dip as last year before adding more. I like the commercial/industrial space much better than residential ones, but could be convinced to get on board I suppose. Somehow I have not been able to bring myself to owning housing (apartment/retirement) REITs.


I have AAR too...it sucks how they keep offering new equity at below-market prices (again today). It seems to be limiting the upside relative to peers. I'm really hoping they get acquired at a nice premium since they are an attractive takeover target.

If you like industrial, check out DIR - better quality than AAR IMO, has performed relatively better, and still selling at good discount (NAV @ ~$10.40).


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## Moneytoo (Mar 26, 2014)

gt_23 said:


> Somewhat unrelated...but this is a pretty big reversal for Garth Turner. He used to claim that residential rents would fall with a real estate crash, but now appears to have changed his view. Maybe he learned something from the U.S. were residential rents increased with higher demand following the RE price collapse.


Also somewhat unrelated - do you own/what do you think about healthcare REITs? Aging population, baby boomers and stuff  I've been watching OHI, it came down a bit, but I'm hesitant to buy individual REITs and thought maybe to stick with ETFs for now (also watching RWX, that tracks international REIT index)


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## Spidey (May 11, 2009)

Since the comparison was made, I'm not sure that BCE is totally immune to interest rate increases. I haven't looked into it but I also have heard that BCE has significant pension liabilities. And then in the telecommunications industry who knows what a new technology or competitor could suddenly do to that industry. People once though Kodak and Polaroid were very safe as well. Real estate has share of risks but we will still need it 100 years from now. I'm not sure we can say that with certainty about the products that BCE provides. None of this is to say that BCE is a bad investment but I personally feel safer over the long-term in REITs.


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## doctrine (Sep 30, 2011)

> Consider that even a 100 bps increase to borrowing rates would translate up to a 25% increase in rents. You think all the tenants in Riocan's portfolio will just roll-over and absorb that? Although they will get more $ psf, their occupancies will go down and so will their total revenues.


Unless 100% of the loans are floating rate, actual interest payments don't increase overnight - it depends on the average term of the loan portfolio, which you need to include in your analysis. If the average loan term is 10 years, then a 25% increase in cost can be rolled out at 2.5% a year - entirely absorbable with room to spare, given most rents increase at 3-4% a year. In a high interest rate environment, with high inflation and a roaring economy, perhaps even more than 3-4%/year could be absorbed.


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## AltaRed (Jun 8, 2009)

gt_23 said:


> I have AAR too...it sucks how they keep offering new equity at below-market prices (again today). It seems to be limiting the upside relative to peers. I'm really hoping they get acquired at a nice premium since they are an attractive takeover target.


That is the price of an aggressively expanding REIT (kind of like CPG in oil). I generally hate that rate of expansion but they claim their acquisitions are accretive with competitive cap rates. I am in it for the income, not capital appreciation, and to diversify from retail/commercial. I will take a look at DIR although I've never liked Dundee as a company.


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## Eclectic12 (Oct 20, 2010)

Eder said:


> RoC will fool many investors, non eligible dividends will as well ...
> Therefore I do not consider Rio Can compares favorably with BCE if or sole goal is dividend investing rather than diversification.


I'll say ... over the last ten years, the "other income" part of the distribution ranges between 31.24% through 61.77% (2013). 
This is going to be taxed more heavily than a dividend (which for RioCan distributions was only once in 2001 for a measly 0.94% in the last sixteen years or so).

BCE is pretty much always 100% eligible dividends and benefiting from the DTC.


However ... I'm not sure RoC is always a bad thing in a REIT.



> ... the key point noted by Deloitte is that "Although a REIT claims a deduction for CCA, this is in no way representative of the actual deterioration of its assets; it is simply the prescribed rate at which the taxing authorities will allow real estate owners to amortize their acquisition cost." If the REIT maintains its facilities, there is no reason the economic value of its building assets should decline, nor should the REIT's stock market price decline as a result.


http://howtoinvestonline.blogspot.ca/2010/07/return-of-capital-separating-good-from.html

So RoC which is most commonly tax deferred until the REIT is sold and less commonly reported as a capital gain on that year's tax return, will be taxed more favourably without the usual deterioration that is associated with the investor "getting their own money back".


Cheers


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## Eder (Feb 16, 2011)

Spidey said:


> Since the comparison was made, I'm not sure that BCE is totally immune to interest rate increases. I haven't looked into it but I also have heard that BCE has significant pension liabilities. And then in the telecommunications industry who knows what a new technology or competitor could suddenly do to that industry. People once though Kodak and Polaroid were very safe as well. Real estate has share of risks but we will still need it 100 years from now. I'm not sure we can say that with certainty about the products that BCE provides. None of this is to say that BCE is a bad investment but I personally feel safer over the long-term in REITs.


I think the point of my previous point was lost...I was trying to point out that dividends from reits vary substantialy from most equities....I could have substituted RY, Teck, or Fortis for BCE.
Reits are a different animal and many do not recognize their elevated risks.


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## Eclectic12 (Oct 20, 2010)

^^^^

Agreed ... though I suspect that since you are still referring to REIT cash payments as "dividends", you may be missing my point that RioCan hasn't paid a dividend in twelve years.

What people are calling a "dividend" for RioCan is really a mix of "other income", "capital gains", "foreign non-business income" and "return of capital" - all of which have dramatically different tax treatments and none are eligible for the DTC.

Which is why I've moved all of my RioCan units into my TFSA to reduce my tax bill.


From the REITs I have looked at the breakdown for the cash paid, dividends are rarely paid and where they are paid - it is usually a small part of the total cash paid.


BTW - the iShares XTR ETF is similar in that it's best year from an eligible dividend perspective is 12.7 cents of 72 cents paid, with the rest a mix of income types. So there's more than just REITs to keep the income types in mind for.


Cheers


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## My Own Advisor (Sep 24, 2012)

"What people are calling a "dividend" for RioCan is really a mix of "other income", "capital gains", "foreign non-business income" and "return of capital" - all of which have dramatically different tax treatments and none are eligible for the DTC.

Which is why I've moved all of my RioCan units into my TFSA to reduce my tax bill."

Same, keep REI.UN in TFSA and keep all REITs for that matter in registered accounts. No tax headaches to worry about.


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## HaroldCrump (Jun 10, 2009)

gt_23 said:


> Consider that even a 100 bps increase to borrowing rates would translate up to a 25% increase in rents.
> You think all the tenants in Riocan's portfolio will just roll-over and absorb that?


Well, REITs are not carrying floating rate (3-month) mortgages.
They often have long-term (i.e. 10 yr.) term, commercial mortgages.
A 100 bps increase in overnight lending rates (even if it happens within a fairly short period of time), will not have immediate cash flow impact for them.

Indeed, if long rates rise 100 bps (or more) eventually it will impact them of course.

But the other aspect of the issue is - where will these tenants of RioCan that you speak of - go?
There are less than half a dozen large retail REIT players in the Canadian market (RioCan, H&R, etc.).
All of them have, more or less, similar loan terms.
Rental agreement terms may vary, and some of them are more efficient operators than others (some have internalized management, etc.) but by and large, there isn't that much choice for retailers to relocate.

Once a retailer is established in a location (strip mall, shopping plaza, etc.) they wouldn't want to relocate.
They lose the current customer base and have to re-establish themselves.

What is more likely to happen is that the REITs will pass on the increased financing costs to the retailers (when the agreements come up for renewal), and the retailer, in turn, will pass on the costs to the consumers.

Assuming, of course, there is no significant slow-down of retail and consumer spending in Canada.



gt_23 said:


> I have AAR too...it sucks how they keep offering new equity at below-market prices (again today).


But that is the REIT model.
They do not retain any earnings.
They issue new units to finance new acquisitions.
As long as the acquisitions are accretive, it should be alright.



gt_23 said:


> Somewhat unrelated...but this is a pretty big reversal for Garth Turner.


That guy is the greatest bumbling, blithering idiot on the blogosphere.
He has no credibility.


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## tygrus (Mar 13, 2012)

My Own Advisor said:


> "What people are calling a "dividend" for RioCan is really a mix of "other income", "capital gains", "foreign non-business income" and "return of capital" - all of which have dramatically different tax treatments and none are eligible for the DTC.


People are pretty fussy about how they get their income. Yes the DTC is great, but capital gains and return of capital are taxed quite favorably. I am willing to foot a little tax bill for any stock that can return 7-8%.

And lets talk risk, is it riskier to invest in a company that owns property and buildings and rents it out, or in companies trying to beat a commodity cycle or develop the next fad gadget or social media site? Risk is relative.

The biggest risk to REITs I think is that one day shopping malls are obsolete and people just shop online, but I think they would have plans to redevelop those spaces into something more entertainment oriented.


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## Eclectic12 (Oct 20, 2010)

^^^^

Where the CG and RoC is high, sure.

Since RioCan is the example - buying early enough in 2013 to get twelve months cash payments means a 5.2% yield, where 69% of the cash paid is going to be taxed at the highest rate.

Buying BNS in a similar timeframe is somewhere around a 4.2% yield with 100% eligible for the DTC.


Even looking back over the last ten years for RioCan, the "other income" ranges for a low of 31.24% though 2013's high of 61.77%. Most of the years seem to be hovering a bit above or below 50% of the cash paid.


As I say ... I much prefer RioCan in my TFSA or RRSP and the high RoC/CG paying REITs in my taxable account.


Cheers


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## gt_23 (Jan 18, 2014)

HaroldCrump said:


> Well, REITs are not carrying floating rate (3-month) mortgages.
> They often have long-term (i.e. 10 yr.) term, commercial mortgages.
> A 100 bps increase in overnight lending rates (even if it happens within a fairly short period of time), will not have immediate cash flow impact for them.


I was in fact referring to a 100 bps increase to 10 Y GOCs, not O/N rates. The big REITs have hundreds of millions of $ in mortgages maturing each year, they also carry some floating debt. Increasing med- to long-term rates will start impacting their average cost of debt capital right away. Also considering the market tends to look well into the future, I think the public REITs have the potential to get hit hard. In any case, as was already stated, the 2-3% yield premium that these REITs offer is not worth the increased risk in the current environment to overweight the sector.



HaroldCrump said:


> But the other aspect of the issue is - where will these tenants of RioCan that you speak of - go?


Many of these tenants have long-term leases. However, in the office, commercial, and industrial space, it's quiet common for firms to move various parts of their operations to lower cost jurisdictions (from high $ psf to lower $ psf) if the cost of the moving is less than the long-term benefit of moving. I work in a building with supposedly the most expensive real estate in Toronto - many of the floors are vacant and my company has been moving groups that are not required to be downtown to other cheaper locations in the city for at least the past 5 years. You mentioned H&R, which actually owns the building across the street. At night I can see at least ten empty floors in a row directly across.

Finally, you mention retail - I agree it is probably harder for a retail merchant to move locations once they are established. However, retail is an incredibly competitive space and I don't think the market will bear the increased costs as smoothly as you suggest. If anything, it will just drive consumers to find cheaper sources of goods, such as the internet or more aggressive merchants who are willing to absorb their higher costs.


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