International REITs vs. Buying Property
Many people choose the International REITs over buying their real estate abroad. Regardless, if you choose to dip your toes into the various real estate markets overseas, there are a few things that you need to be aware of.
We know that property acquisitions cost money, so we are going to hit on some areas you might want to avoid. For instance, some areas have had a lot of changes and improvements in the past couple of years.
If you are looking to integrate your investment portfolio with an International REIT, you need to consider the current state of the local economy in the market that you are going to purchase.
Many factors will determine the success of a market. The general political climate and its ability to affect the business climate in the country is very important. The mix of private and public industries in the local market is an important factor. Look at the prospects for growth of the local business sectors and the think long-term about this before you commit. For example, a lot of companies in China and India have the most profit margins. But that market may have huge expansion issues because of a growing middle class.
In most markets, your contract will be governed by the laws of the country in which your property is located.
Direct Investment vs. ETFs
In my opinion, ETFs are useful for U.S. real estate investment, and direct investment is the better option for international real estate. ETFs are easier to use and might have lower expenses, but the underlying investments are usually U.S. REITs, and their income streams will likely be limited to the U.S. market. International REITs, on the other hand, can offer more diversification both geographically and in terms of product type, and income streams could be more stable and higher. Don’t think of REITs as a U.S. equity-only trade!
Let’s look at the last year of performance for REITs generally (using the FTSE NAREIT Global Index) and REIT ETFs/ETNs domestically (using the Schwab U.S. REIT ETF and Global X Funds Real Estate ETF (NYSEARCA:REX)), all compared to foreign REITs (using the iShares Global REIT ETF (NYSEARCA:FIRE)).
While the Strongest Growth and Best Value (in terms of price to book value) categories were closer, the highest returns came from foreign REITs. Over the course of one year (which isn’t a very long time), foreign REITs have outperformed both REIT ETFs and REITs generally by 1.61%, 1.
What about Taxes?
While the Foreign REITs have different tax structures than REITs in the US, they still pay dividends like REIT. This causes two potential problems.
Foreign REIT Dividends are Taxed at the Corporate Level
Foreign REIT’s dividend payouts are often taxed at the corporate level and not at the individual level. This is considered a corporate level withholding tax. The rate of withholding will vary country by country.
REIT Dividends are Taxed as Ordinary Income
In the US, REIT’s dividend payouts are considered income and are taxed at the ordinary income tax rate. This means REITs aren’t as tax-friendly as other investments like the bond market. While this isn’t necessarily a problem, it does change the expected yield on a REIT.
Low-Taxed, High-Yielding Foreign REITs
There is a trend in the United States towards no tax equity REITs (or N-Tweed). These N-Tweed arrangements take advantage of a low-taxed equity vehicle that benefits from tax free depreciation.