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Types of Income Trusts: REITs and Business Trusts in Canada

Explore the various types of income trusts, including Real Estate Investment Trusts (REITs) and Business Trusts, their subcategories, and their roles in the Canadian financial landscape.

22.13 Types of Income Trusts

Income trusts are a popular investment vehicle in Canada, offering investors a way to earn income through distributions. This section will delve into two primary types of income trusts: Real Estate Investment Trusts (REITs) and Business Trusts. We will explore their structures, subcategories, and how they fit into the broader Canadian financial landscape.

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are companies that own, operate, or finance income-producing real estate. They provide a way for individual investors to earn a share of the income produced through commercial real estate ownership without actually having to buy, manage, or finance any properties themselves.

Subcategories of REITs

  1. Commercial REITs: These REITs focus on properties such as office buildings, shopping centers, and industrial facilities. They generate income through leasing space to tenants. For example, a commercial REIT might own a portfolio of office buildings in downtown Toronto, collecting rent from various businesses.

  2. Residential REITs: These trusts invest in apartment buildings, student housing, and other residential properties. They earn income through rental payments from tenants. A residential REIT might own a series of apartment complexes across major Canadian cities.

  3. Healthcare REITs: These REITs specialize in properties such as hospitals, nursing facilities, and medical offices. They benefit from the stable demand for healthcare services. An example could be a REIT that owns a network of healthcare facilities leased to major hospital operators.

  4. Retail REITs: Focused on shopping malls and retail spaces, these REITs earn income through leasing space to retailers. They are sensitive to consumer spending trends and economic conditions.

  5. Industrial REITs: These REITs own warehouses and distribution centers, benefiting from the growth of e-commerce and logistics. They typically have long-term leases with tenants.

Advantages of Investing in REITs

  • Diversification: REITs allow investors to diversify their portfolios with exposure to real estate without the need to directly purchase properties.
  • Liquidity: Unlike direct real estate investments, REITs are traded on major stock exchanges, providing liquidity.
  • Income Generation: REITs are required to distribute a significant portion of their income as dividends, providing a steady income stream.

Business Trusts

Business Trusts are entities that hold and manage income-generating businesses. They distribute the income generated from these businesses to unitholders. Unlike REITs, which focus on real estate, Business Trusts can encompass a wide range of industries.

Subcategories of Business Trusts

  1. Forest Products Trusts: These trusts invest in companies involved in the production and sale of forest products such as timber and paper. They benefit from the demand for raw materials and finished goods in the forestry sector.

  2. Natural Gas Processing Trusts: These trusts focus on businesses involved in the processing and distribution of natural gas. They earn income from the sale of processed gas and related products.

  3. Energy Trusts: These trusts invest in oil and gas production companies, distributing the income from the sale of energy products. They are sensitive to fluctuations in commodity prices.

  4. Infrastructure Trusts: These trusts invest in infrastructure projects such as toll roads, bridges, and utilities, providing stable income from long-term contracts.

Advantages of Investing in Business Trusts

  • Income Distribution: Business Trusts typically offer attractive yields due to their income distribution mandates.
  • Sector Exposure: They provide exposure to specific sectors, allowing investors to capitalize on industry trends.
  • Tax Efficiency: Business Trusts can offer tax advantages, depending on the structure and jurisdiction.

Glossary

  • Commercial REIT: REITs that own income-producing commercial properties like offices and shopping centers.
  • Business Trust: A trust that holds income-generating businesses and distributes income to unitholders.

Resources for Further Exploration

  • Article: REITs vs Business Trusts
  • Book: Real Estate Investment Trusts: Structure, Performance, and Investment Opportunities by Su Han Chan and John Erickson

Practical Examples and Case Studies

To illustrate the concepts discussed, consider the following examples:

  • Case Study: Canadian Apartment Properties REIT (CAPREIT): CAPREIT is one of Canada’s largest residential REITs, owning a diverse portfolio of residential properties across the country. It provides investors with exposure to the residential rental market, benefiting from stable rental income and property appreciation.

  • Example: Enbridge Income Fund Holdings: This Business Trust focuses on energy infrastructure assets, providing investors with exposure to the energy sector’s income-generating potential. It distributes income derived from its pipeline and energy transportation businesses.

Best Practices and Common Pitfalls

  • Best Practices: Diversify your investment across different types of REITs and Business Trusts to mitigate risk. Consider the economic and market conditions affecting each sector before investing.

  • Common Pitfalls: Avoid over-concentration in a single sector or trust type. Be aware of the impact of interest rate changes on REIT valuations, as higher rates can lead to increased borrowing costs and reduced property values.

Conclusion

Income Trusts, including REITs and Business Trusts, offer Canadian investors a way to earn income and diversify their portfolios. By understanding the different types and subcategories, investors can make informed decisions that align with their financial goals and risk tolerance.

Ready to Test Your Knowledge?

Practice 10 Essential CSC Exam Questions to Master Your Certification

### What is a primary characteristic of a Commercial REIT? - [x] Owns income-producing commercial properties like offices and shopping centers. - [ ] Focuses on residential properties. - [ ] Specializes in healthcare facilities. - [ ] Invests in natural gas processing. > **Explanation:** Commercial REITs focus on income-producing commercial properties such as offices and shopping centers. ### Which of the following is a subcategory of Business Trusts? - [x] Forest Products Trusts - [ ] Residential REITs - [ ] Healthcare REITs - [ ] Retail REITs > **Explanation:** Forest Products Trusts are a subcategory of Business Trusts, focusing on the production and sale of forest products. ### What is a key advantage of investing in REITs? - [x] Liquidity - [ ] High risk - [ ] Limited diversification - [ ] Low income potential > **Explanation:** REITs offer liquidity as they are traded on major stock exchanges, unlike direct real estate investments. ### What type of properties do Healthcare REITs specialize in? - [x] Hospitals and medical offices - [ ] Shopping centers - [ ] Office buildings - [ ] Residential complexes > **Explanation:** Healthcare REITs specialize in properties such as hospitals, nursing facilities, and medical offices. ### Which trust type benefits from the growth of e-commerce? - [x] Industrial REITs - [ ] Residential REITs - [ ] Healthcare REITs - [ ] Natural Gas Processing Trusts > **Explanation:** Industrial REITs benefit from the growth of e-commerce due to their focus on warehouses and distribution centers. ### What is a Business Trust? - [x] A trust that holds income-generating businesses and distributes income to unitholders. - [ ] A trust that focuses solely on real estate investments. - [ ] A trust that invests in government bonds. - [ ] A trust that only invests in foreign markets. > **Explanation:** A Business Trust holds income-generating businesses and distributes the income to its unitholders. ### Which REIT subcategory focuses on shopping malls? - [x] Retail REITs - [ ] Healthcare REITs - [ ] Industrial REITs - [ ] Residential REITs > **Explanation:** Retail REITs focus on shopping malls and retail spaces. ### What is a potential risk of investing in Energy Trusts? - [x] Fluctuations in commodity prices - [ ] High liquidity - [ ] Stable income - [ ] Low market exposure > **Explanation:** Energy Trusts are sensitive to fluctuations in commodity prices, which can impact their income. ### Which of the following is NOT a subcategory of REITs? - [x] Natural Gas Processing Trusts - [ ] Commercial REITs - [ ] Residential REITs - [ ] Healthcare REITs > **Explanation:** Natural Gas Processing Trusts are a subcategory of Business Trusts, not REITs. ### True or False: REITs are required to distribute a significant portion of their income as dividends. - [x] True - [ ] False > **Explanation:** REITs are required by law to distribute a significant portion of their income as dividends to maintain their tax-advantaged status.