REIT Index Funds

REIT Index Funds

Looking to get into the real estate game but lack the funds to get started? No biggie, real estate income trusts (REIT) index funds may be your next best option!

Real estate has long been an attractive investment options for many individuals. Most people “accidentally” become involved in this type of investment when they purchase their first house as a place to live. After the sale of this first house a few years down the road the homeowner may notice they sold for a lot more than they originally paid (all of which is tax free if the home is your principle residence).

The house price index in Canada has almost doubled since the year 2000, which has lured a lot of eager investors into the market. That means on average in Canada that if you bought a $100,000 property in 2000, it would be worth about $200,000 today (this index averages out cities across the country).

House price index

 

This 100% increase doesn’t include any rental income a lot of investors receive from their properties, nor does it include the cost of mortgage interest, maintenance and other expenses relating to property management.

In a previous article I compared the investment returns of a house to the stock market to see which came out on top – it was more less a tie and came down to investor preference rather than outright return.

Now that I’m in the wealth generation phase of my life I’m constantly looking at investment options (usually more looking than actually buying). Real estate has shown great returns throughout the past decade (probably due to HGTV and that handsome Scott MacGillivray), but I would be hesitant to put a large chunk of my savings in one basket due to the lack of diversification. Another hurdle is the 20% down payment minimum required on your second property in Canada, which would require anywhere from a $50k to $200k buy in. For me this buy in amount would represent 50%-100% of my current savings, which would be way too much exposure in any one given asset!

The other drag about rental/investment properties is dealing with potentially brutal tenants. This can usually be mitigated with some decent due diligence beforehand (reference/credit checks, income verification) but there will certainly be some level of interaction involved unless you hire a property manager.

The high buy-in, lack of diversification, and potentially unruly tenants are enough to scare me away from purchasing a rental property on my own, however, I still like the potential returns and wouldn’t mind a piece of the action…Enter REITs.

What’s a REIT?

A Real Estate Income Trust (REIT) is similar to a mutual fund in that it bakes a whole bunch of real estate properties into one pie and you get a slice when you purchase a share. Typically shares of REITs sell for under $100 per unit, which is much less than the 20% buy in required for a full property.

REITs may focus on specific types of properties (residential housing, apartments, condos, retail, hotels) or they may be broad and have some of each. To go one step further, iShares provides a REIT ETF (symbol: XRE) that takes a group of REITs and bakes them into one pie, for even additional diversification. Here’s how the iShare ETF has done since 2002 (its first year of inception):

ishare reit(Source: Blackrock Canada)

Notice the similar trend in the house price index and the ETF graphs above. While the ETF has come out on top in these graphs in terms of growth, the house price index does not include potential rental payments so it’s not exactly apples to apples.

The obvious drawback to purchasing REITs versus an investment property is missing out on the larger potential upside of an investment property (just ask anyone that purchased property in Toronto or Vancouver in 2000). You’re also likely to be paying management fees and investment fees for owning REITs whereas with property ownership you are able to reduce costs by putting in some sweat equity.

Given my personal preference for a low-maintenance, low-risk I’m more inclined to buy REITs rather than actual property to include some real estate exposure in my savings portfolio. While the gains in REITs may not always exceed that of hard real estate, the piece of mind I gain is just as valuable.

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12 comments

  1. That is some serious capital appreciation on the REIT ETF for anyone getting in in the early 2000s! REIT advocates also point to the income generation potential on top off the capital appreciation.

    All the large-cap REITs are paying investors a consistent monthly/quarterly income distribution. This can be nice for retirees who need a stream of cash given no more weekly pay cheque. Dividend investor looking for yield could diversify in a sense by incorporating REITs.

    Real estate investing resonates with a lot of people because they can understand it – a tangible asset you can see and touch with widespread demand (everyone needs a home, most businesses need an office). You hear a lot of “experts” tout this idea and it makes a lot of sense. I suspect that the majority of people investing in riskier/complex products such as permanent insurance, short-selling, leveraged buying, start-up companies, etc. don’t fully appreciate what they are getting themselves into.

    • Jonny

      Ya, I know of a lot of people that have started to get into real estate very early on in their careers. There’s a very good chance it will work out great for them, especially if they plan on holding onto the property for the long term. I suppose if I had a large amount of savings I’d consider real estate, so long as it didn’t take up more than 15-20% of my total savings. Even then the maintenance and upkeep still would worry me. Much like in high school basketball, with real estate I’m fine to sit on the sidelines and observe!

  2. Not that you asked, but if you wanted some great REIT ideas, my faves are STAG, O, DLR, & HCP.. I’m definitely using REITs, but the cash-on-cash return potential of mortgaged rental property is too enticing to pass up. I’m going to try to get at least one small(ish) one before the year is out.
    Eric recently posted…3 N.E.A.T. Ways To Lose 32 lbs. and Extend Retirement By Two YearsMy Profile

    • Jonny

      Thanks for the REIT suggestions.
      There’s a ton of uncertainty here in Canada about the future of real estate, especially in the larger cities. However, prices seem to raising at an increasing rate. What are your thoughts on the overall potential growth in REITs over the next 5-10 years?
      I suppose if you have a long investment time horizon the risk of owning a rental property is relatively low, so long as you’re not buying in at a market high! That would certainly be my concern buying in a city like TO right now.

  3. Ya, I know of quite a few people that have begun to get into land right off the bat in their vocations. There’s a decent risk it will work out extraordinary for them, particularly on the off chance that they anticipate clutching the property for the long haul. I assume in the event that I had a lot of funds I’d consider land, inasmuch as it didn’t take up more than 15-20% of my aggregate funds. And, after its all said and done the upkeep still would stress me. Much like in secondary school b-ball, with land I’m fine to sit on the sidelines and watch!

    • Jonny

      Haha, I completely hear you on sitting on the bench in high school!
      I’ve decided to stay away from the direct real estate investment for similar reasons.
      It will be interesting to see if I continue to feel this way down the road as other options become available.
      Thanks for stopping by!

  4. DAVID M. GOLDSTEIN

    on the off chance that you needed some awesome REIT thoughts, my faves are STAG, O, DLR, & HCP.. I’m unquestionably utilizing REITs, yet the money on-money return capability of sold rentable house is excessively alluring, making it impossible to leave behind. I’m going to attempt to get no less than one small(ish) one preceding the year is out.
    DAVID M. GOLDSTEIN recently posted…Hitachi C12RSH 15 Amp 12-Inch Sliding Compound Miter Saw with Laser ReviewMy Profile

    • Jonny

      Hi David,
      Thanks for the suggestions. I’m really interested in learning more about REITs and determining how much of my total portfolio I’ll dedicate.
      Glad you stopped by!

  5. Real estate investment is a good investment if you will do it right. Thanks for this insights Jonny. Could be a good data for me for re evaluation.
    Mich recently posted…5 Apartment Money Saving Tips That Are Proven Effective Space Savers TooMy Profile

    • Jonny

      Yup, real estate has been an absolute lottery for a lot of people, especially when you leverage cleverly (like yourself).
      Do you find yourself stressed out ever managing different properties? I think that’s what sort of turned me off.
      Thanks for commenting, Mich!

  6. Great Share!

    I deal in real estate and my years of experience says that refinancing is the best way to repay the mortgage amount which makes it easier and convenient for you. I do consider it for my most expensive deals where I feel that I may face difficulty in repaying the amount.

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