Greetings, today we’re going to take a look into one of the most talked about investment classes and how it fits into your portfolio on your journey to financial independence and early retirement.
For almost all early retirees real estate plays a huge role, there are several ways this comes into effect. First off, many people build up large real estate portfolios through buying not only their main residence but also tack on additional houses, duplexes etc. that they hold strictly for the purpose of renting out and living off of the passive income from said properties.
Today we’re going to take a dive into why we don’t plan on owning a series of rental properties and how you are able to receive a whopping 10% yearly return through real estate without the hassle of finding tenants or dealing with calls to replace broken items within these properties.
Real Estate Investment Trusts
More commonly referred to as “REITs”, these trusts trade in our brokerage accounts and are treated essentially the exact same as buying and selling a share in any other company such as Apple, Enbridge, Amazon etc.
If you’re wanting exposure to the real estate sector but aren’t sure where to buy, when to buy or if you’re just not sure you are up to dealing with the stress associated with owning multiple properties then REITs are a great alternative and let’s take a look into what kind of returns you can expect from owning these shares.
The first fund we’ll look at is a name everyone in the investing community knows: Vanguard.
Let’s take a look at their fund the VNQ .
VNQ will give you exposure to a whopping 186 stocks in the real estate sector with a total asset value of over $65 Billion. And you can own all of these for an affordable 0.12% management expense. Not too bad.
Let’s take a look at how truly diversified this fund is:
As you can see you truly get exposure to nearly every corner of the real estate market by holding just this one fund! And the best part is, if you trend back on the performance of this fund you’ll see the following.
The fund has delivered a remarkable 14.52% return this year and since its inception date has returned you over 9% annually.
If you’re looking to get into real estate this is a great way for the smaller investor to get involved while diversifying their risk across many markets.
Let’s have a look at another fund that’s on our radar. We actually found this one through our Scotia iTrade account, since its one of the commission free ETF’s that they offer.
The fund is XRE and is the iShares Capped REIT Index ETF.
The performance on this fund is again right around that 10% mark and has a past breakdown as follows:
This fund has a slightly higher MER of 0.61% but that is still quite good when you consider the overall exposure you’re receiving to truly passive real estate income.
This fund gives you exposure to 19 separate holdings and a distribution yield (dividend) of nearly 4%! This is another great alternative to investors looking to get into real estate without having to come up with tens of thousands of dollars to do so.
Where do we hold REITs?
Now on to some finer details of REIT investing. There are 2 accounts where we would hold these funds. The first is a TFSA or Tax Free Savings Account and the second is our RRSP or Registered Retirement Savings Plan.
Why? good question. The reason we hold REITs in these accounts is due to the taxation on them. In a TFSA this is obvious, any distributions received or capital gains on this product will be completely tax free as it is with all holdings in these accounts (with the exception being withholding tax on foreign company dividends).
For the RRSP account these distributions aren’t taxed nor are the capital gains – directly. However when you pull these funds out of your RRSP account you will be taxed at whichever tax bracket you are in for that year. ie pulling $10k out while already making $100k for the year gives you a taxable income of $110k.
To get a good grasp on why we would only hold REITs in these two accounts we also have to explore our unregistered or “cash” investing accounts. In these accounts the distributions of REITs are taxed as normal income but if you instead hold your Canadian Eligible Dividends in this account you are looking at very low and even potentially 0% taxation on the distributions so given the choice it makes far more sense to hold the REITs in the registered accounts and your Canadian dividend payers in the cash account – IF you’re in a scenario where you fill your TFSA, RRSP and have additional room to invest and need a cash investment account that is.
If you don’t come close to filling your TFSA and RRSP then by all means, hold all of your holdings in those accounts and don’t worry about the taxation at all.
Why we choose REITs over rental properties.
Our main why? It’s because we’re indecisive about what exactly our future looks like. Are we going to be travelling steadily in our 30’s and 40’s? Are we going to buy an acreage and have the goats, alpaca’s, dogs that we’ve always dreamed of? We’re not quite sure what our priorities are just yet. As such, we don’t want to tie ourselves down to a specific location where we have to monitor our properties and make a job for ourselves out of it once we’re ready to pull the plug on full time work.
We just want plain passive income.
We also understand that in some markets at some points in time you can make FAR beyond these 10% returns buying physical property in certain markets such as San Francisco but for us, the 100% passive investing income just far outweighs the time, work and effort you’d have to contribute in the physical property.
We hope that this is helpful for readers out there, especially ones that have been thinking about buying physical properties. Maybe this will spark a conversation in your household about just how badly you want to get into rentals or maybe there’s a more passive way that suits your lifestyle better the way these do for our lives.
Thanks for reading,
FIC.