Since their introduction into Canada about 12 years ago, real estate investment trusts (REITs) have undergone a significant transformation and maturation. Today, Canada boasts over 25 publicly-traded REITs with a combined market capitalization in excess of $20 billion.

To understand their growing popularity, consider the advantages REITs confer on both real estate companies and REIT unitholders:

• Favourable tax treatment. Income earned within a REIT is generally not taxable to the REIT as long as it is distributed to unitholders each year.
• Improved access to equity markets. Companies that convert to a REIT structure can often improve their access to capital, enabling them to more readily pursue strategic opportunities and finance growth.
• Improved tax efficiency on distributions. Unlike corporate distributions, which are subject to both corporate tax and personal dividend tax in the hands of the investor, REIT distributions are generally only taxable to the unitholder, effectively eliminating double taxation.
• High yield through regular distributions. Because REITs are usually required to distribute a specific percentage of their distributable income to unitholders, they generally provide investors with a stable stream of income as well as the potential for capital growth.
• Stable market performance. Compared to other Canadian equities, REIT units have traditionally maintained a higher yield despite short-term economic fluctuations.

Different REIT structures
Companies in a wide variety of real estate sectors are exploring the advantages and challenges of converting to a REIT structure. Although all REITs are used to pool capital to invest in real estate assets, no two REITs are exactly alike. As you embark on this journey, here are some of the things you should keep in mind.

• In Canada, REITs are structured as either closed-end or open-ended mutual fund trusts. Governed by complex trust indentures, the larger REITs tend to be internally managed, while smaller REITs may share either strategic or asset management to help reduce operational costs.
• In addition to investing in income-producing properties, REITs may also buy, develop, manage, and sell a wide variety of real estate assets.
• While REITs may hold many different types of property within their portfolio, certain properties are more suitable to REIT ownership than others, depending on the risk tolerance of investors. For instance, hotel properties are often subject to short-term market fluctuations, which may result in less cash flow to distribute to unitholders. Office, retail, and industrial properties are often seen as less risky holdings that benefit from long-term rental agreements. Apartments can also generally secure stable income streams.

Added management responsibility
Despite the flexibility of REIT structures, converting to a REIT places a great deal of added responsibility on corporate executives. Consider the following:

• Companies that are currently private must adapt to the added costs, regulatory and public scrutiny, and administration associated with being a public entity.
• Some companies may have to retool their executive suite to ensure their staff possesses the requisite skills to operate a public entity.
• Converting corporations must also be committed to enhancing their corporate governance and maintaining regular distributions.

Learn more about our Real Estate practice.