Best REIT ETFs in Canada

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Data from morningstar.ca as of January 25, 2024

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There are more than 16,500,000 private dwellings of different types in Canada. The average home price in Canada is approximately $657,000 as of December 2023. As a result, around $10,840 billion of Canadian wealth is in the residential real estate market, while the Toronto Stock Exchange market capitalization is around $4,753 billion. Thus, real estate is the largest class of investments in Canada.

There are several drawbacks associated with real estate investment. These drawbacks include

1. a large minimum investment size,
2. lack of liquidity,
3. the difficulty of diversification,
4. the necessity of involvement,
5. high transaction cost.

On the positive side, real estate is considered a safe investment; thus, one can often use leverage in a real estate investment. Leverage is the use of financial instruments for amplifying profit or loss. The simplest and most common form of leverage is using debt to finance your trade or investment.

In the case of a real estate investment, that is to say; you can use the property you are buying as collateral to borrow money at a favourable mortgage rate. In real estate investment, it is common to use a debt-to-equity ratio of 4, meaning that you borrow 4 dollars for every dollar you put toward purchasing your future property. The debt-to-equity ratio is commonly used to measure and compare leverage. Despite using leverage, most of us need to use an intermediate investment to prepare our down payment for a real estate investment.

This intermittent investment can be a combination of savings accounts, guaranteed investment certificates, exchange-traded funds and mutual funds. It can be placed under a tax shelter like a Tax-Free First Home Savings Account, a Tax-Free Savings Account or even up to $35,000 in a Registered Retirement Savings Plan.

Another drawback of real estate investments is a lack of liquidity. After buying a property, there is no guarantee that you will be able to sell at a reasonable price when you need to cash out your investment. Depending on the market conditions in the location of your property, you might have to keep your property on the market for months before you can cash out.

Then you have difficulty with diversification which is a direct result of the large minimum investment size. When you buy a stock, all that is expected is to participate in the annual general meeting of shareholders. Most retail investors don’t even do that. Thus investing in stocks is a passive investment.

On the contrary, after buying an investment property, you will be responsible for the upkeep of your property. Also, when renting out your property, you are exposed to the risk that your tenant might not honour their obligations. This is a serious risk because the eviction process can be both costly and time-consuming.

Lastly, note that buyer closing costs and seller closing costs are sizable and can eat your profit away.

Real estate investment trusts (REITs) are a solution to all five limitations we listed for real estate investment. A REIT is similar to a mutual fund or an exchange-traded fund in that it pools investors' resources and deploys them effectively and professionally. The REIT would pay on your behalf for the management of your property, but the diversification and liquidity benefits come at a low price.

The role of the REIT is to own and manage several properties on behalf of its unit holders and distribute the rent it receives among its unit holders. REITs are often structured as trusts. If they were structured as corporations, they would have faced corporate tax. That extra layer of taxation would have made them an inefficient vehicle for holding real estate investments.

Often REITs specialize in a specific section of the real estate market or a specific geographic region.

For example, holdings of a REIT might be concentrated in retail stores, commercial real estate, industrial real estate, residential real estate or health care real estate. To achieve diversification, it is best to use an ETF representing the whole real estate sector by holding a selection of REITs.

The performance of a REIT ETF depends on the performance of the underlying REITs. The performance of each REIT depends on the performance of properties owned and managed by that REIT. As can be seen below, Canadian REIT ETFs have limited price gain and receiving dividends is the main reason for holding a Canadian REIT ETF. So Canadian REITs and REIT ETFs often attract investors interested in fixed income, which makes this a very interest-rate sensitive investment. Over the years, when bonds were yielding very little, REIT ETFs partially substituted bonds ETFs in some investors’ portfolios. Interest rate dependence explains the inferior performance of REITs in 2022 and 2023, as 2022 and 2023 have seen fast-rising interest rates.

Data from morningstar.ca as of January 25, 2024

XRE gives you broad exposure to Canada’s real estate sector and pays monthly distributions to investors. XRE replicates the performance of the S&P/TSX Capped REIT Index. This is a subindex of the S&P/TSX Composite index and, similar to the S&P/TSX Composite index, is float weighted. As a result, REITs are represented in XRE mostly proportional to their size.

As of 23 January 2024

As of 23 January 2024

Note that the ticker symbol for each REIT ends in UN to emphasize that these are units of a trust rather than shares of a corporation.

Data from morningstar.ca as of January 25, 2024

RIT is an actively managed ETF investing in the real estate sector. It is concentrated on Canadian equities but might invest as much as 30% of its portfolio in foreign equities. RIT provides monthly distributions to investors. Currently, its portfolio is 91% invested in Canada and 9% in the US.

As of 23 January 2024

Data from morningstar.ca as of January 25, 2024

ZRE invests equally in all liquid Canadian REITs. It gives broad exposure to the Canadian real estate sector, similar to XRE. The difference is that XRE invests in different REITs proportional to their size while ZRE invests equally in all liquid Canadian REITS.

As of 25 January 2024

Data from morningstar.ca as of January 26, 2024

Data from morningstar.ca as of January 26, 2024