| Royalty trusts, in Finance, are classic flow-through | | | | to drop. On the other hand, when interest rates rise, |
| investments vehicles. The trust, like a mutual fund, holds | | | | prices of REIT's drop thus causing yields to rise.For |
| a portfolio of assets, which can be anything from | | | | example, when interest rates were pushed up by both |
| producing oil and gas wells to power generating | | | | the Federal Reserve Board and the Bank of Canada |
| stations to interests in land. The net cash flow, i.e. the | | | | all the way back in 2000, the typical REIT was yielding |
| total cash flow minus revenues, is passed on to the | | | | close to 14 percent as prices per share fell. When |
| unit-holders as distribution.The purpose of a Real | | | | interest rates subsequently dropped, yields fell to less |
| Estate Investment Trusts is to reduce or eliminate | | | | than 10 percent as demand for REIT's increased thus |
| corporate income taxes. In the United States, where | | | | pushing share prices higher.This is a very important |
| they are generally more widespread as investment | | | | consideration to be kept in mind when investing or |
| vehicles, Real Estate Investment Trusts pay little or no | | | | otherwise trading units involving this type of trusts. If |
| federal income tax but are subject to a number of | | | | interest rates appear to be poised to rise, investors |
| special requirements set forth in the Internal Revenue | | | | may want to defer purchases, and those who own |
| Code, one of which is the requirement to distribute | | | | this type of shares already may consider reducing their |
| annually at least 90 percent of their taxable income in | | | | exposure by selling and take in some profit.There are |
| the form of dividends to shareholders.Real Estate | | | | typically two catches with REIT's. The first is that since |
| Investment Trusts are, therefore, a special type of | | | | investors are ‘unit-holders' rather than |
| royalty trust. They specialize in real property, anything | | | | shareholders, they are potentially jointly and severally |
| from office buildings to long-term care facilities. For | | | | liable together with all other unit-holders (plus the trust |
| illiquid assets like real estate, closed-end funds of this | | | | itself) in the eventuality of insolvency. Instead of limited |
| type make good sense. Open-end or ‘mutual' | | | | liability, investors rely on the REIT's management to |
| real estate funds are subject to new money and | | | | have property, casualty and liability insurance, prudent |
| redemption problems, entirely absent in closed-end | | | | lending policies and other reasonable safeguards in |
| trusts. The first Real Estate Investment Trust was | | | | place. Nevertheless there is always the possibility of a |
| introduced in the United States in 1960. The vehicle | | | | problem - say a catastrophic fire or a building collapse |
| was designed to facilitate investments in large-scale | | | | - that is not covered by insurance. This may have |
| income-producing real estate by smaller investors. The | | | | seemed like a very small matter prior to the attacks |
| US model was simple, enabling small investors to | | | | on the World Trade Center in 2001. Since then, |
| acquire equity interests in vehicles holding large-scale | | | | however, it is something that has to be taken |
| commercial property.But the birth of Real Estate | | | | seriously.The second problem with REIT's is less |
| Investments Trusts as a mass investment vehicle can | | | | transparent. All real estate properties depreciate in |
| be traced directly to the liquidity crisis encountered by | | | | value over time (not the land, only the buildings). |
| open-end real estate mutual funds all the way back to | | | | Depreciation can be somewhat slowed down by |
| 1991-92, during the slowdown of real estate that | | | | earmarking at times significant amounts of money for |
| characterized those years. Faced with redemption | | | | maintenance and renewal of facilities. Since most of |
| demands on the part of unit-holders, real estate mutual | | | | the REIT's income is being distributed and the capital |
| funds were presented with the unpalatable option of | | | | cost allowance is being allocated to investors, investors |
| selling valuable real properties into a distressed market | | | | are factually getting their own capital back over time. |
| to raise cash. Many of them, therefore, chose to close | | | | As such, the book value of the underlying real |
| off redemptions and converted into Real Estate | | | | properties will be steadily depleting.Obviously, if real |
| Investment Trusts, since then most commonly known | | | | estate markets are on the upswing the depreciation |
| as REIT's. Only a few open-end real estate mutual | | | | factor will not be overly important, since it will be offset |
| funds continue to own real estate directly. Most now | | | | by the appreciation of the underlying assets. But in |
| invest in shares of real estate-related companies.The | | | | essence, the point is that the long-term income stream |
| typical REIT usually distributes about 85 to 95 percent | | | | is quite variable, certainly more variable than some |
| of its income (rental income from properties) to the | | | | managers would have investors believe.As stated |
| shareholders, usually on a quarterly basis. This income | | | | above, the inverse relationship between interest rates |
| gets a special tax break, because REIT's shareholders | | | | and prices of REIT's shares plays an important role. |
| are entitled to a deduction for the pro-rata share of | | | | On average, it is safe to assume that interest rate |
| capital cost allowance (depreciation on the real | | | | increases are likely to be met by REIT's price declines |
| properties). As a result, a high percentage of the | | | | in the Stock Exchange, because increasing rates |
| distributions are normally tax-deferred. However, the | | | | correspond to a slowdown in the economic growth |
| amount will vary from year to year and will differ | | | | and less demand. But out of the context of the frantic |
| depending on the particular REIT.As with royalty trust, | | | | buy and sell of Wall Street, even a slowdown in the |
| the value of tax-deferred income will reduce the | | | | market for single-family houses can actually benefit |
| adjusted cost base of the shares owned. For | | | | REIT's. This is so, because even though real property |
| example, if an investor purchases 1,000 units at $15.50 | | | | prices are in decline, it is still cheaper to rent than to |
| per unit, receives $3,000 ($3.00 per share) in aggregate | | | | own, especially during a period of rising interest rates. |
| tax-deferred distribution over time, and the sells the | | | | And REIT's thrive on rentals. In fact, no city is a better |
| shares for $17.50 each, the capital gain will be | | | | environment for REIT's to operate in than New York |
| calculated as follows:[1,000 x ($17.50 - $15.50 + $3.00)] | | | | City, where some 70 percent of residents rent.Luigi |
| = $5,000 before adjustments for commissions. In | | | | FrascatiLuigi Frascati is a Real Estate Agent based in |
| Canada, this gain will be subjected to capital gain | | | | Vancouver, British Columbia. He holds a Bachelor |
| treatment, so only 50 percent or $2,500 will be included | | | | Degree in Economics and maintains a weblog entitled |
| in income and taxed accordingly. In fact, Canada | | | | the Real Estate Chronicle where you can find the full |
| allows preferential tax treatment to REIT's by making | | | | collection of his articles on Real Estate Economics and |
| them RRSP-eligible and by not considering them | | | | Finance. Luigi is associated with the Sutton Group, the |
| foreign property (which would taxed at a higher rate), | | | | largest real estate organization in Canada, and is |
| so long as the real estate portfolio does not contain | | | | based with Sutton-Centre Realty in Burnaby, BC.Luigi is |
| non-Canadian property in excess of the allowable | | | | very proud to be an EzineArticles Platinum Expert |
| limit.REIT's yields and the market price of units tend to | | | | Author. Your rating at the footer of this Article is very |
| be strongly influenced by interest rates movements. | | | | much appreciated. Thank you. |
| As rates drop, prices of REIT's rise thus causing yields | | | | |