Should you go all in on REITs in your TFSA? - MoneySense

Should you go all in on REITs in your TFSA?

Nino D’Andrea gets decent income from his REIT ETF, but his portfolio may be set up to underperform

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Me and my TFSA

Nino D’Andrea

AGE: 46
PLACE: Toronto
TFSA TOTAL: $62,000
STRATEGY: Just REITs

Me and my TFSA

Nino D’Andrea is a general manager in the manufacturing industry. He’s been contributing to TFSAs since they started back in 2010. “I make the full contribution on the first Monday of every year,” says D’Andrea, who loves the tax-free capital gains that TFSAs offer.

D’Andrea first became interested in investing more than 15 years ago. “I bought Nortel shares when they were 67 cents and sold them when they reached $3,” he says. “It was easy and I thought I was so smart.” So when it came time to make his first TFSA contribution he decided to buy a stock.

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His first choice was Encana—“a real loser,” he says. In fact, D’Andrea bought it at $30 a share with that first contribution and sold it at about $10 in 2015. “I watched it fall all the way down,” he says. That’s when he knew he had to change his strategy. “I realized I wasn’t so smart after all and since I was getting closer to retirement, I wanted something safer that would provide me with a regular income stream to grow for retirement.”

Today, D’Andrea has only one holding, a BMO Equal Weight REITs ETF (ZRE)—a holding he’s been adding to for several years now. “I get $263 in monthly distributions and have been able to grow my TFSA nicely with it,” he says. His aim? “To reach the point where my TFSA will distribute $1,000-a-month by age 65 so I can supplement my CPP and OAS with the payments.”

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Without a TFSA D’Andrea figures he’d need $250,000 to buy an annuity that would pay him $15,000 annually—and that income would be taxable. But with his present TFSA strategy of collecting distributions in retirement, the payment would be completely tax-free. “And it won’t cost me $250,000 to do it,” he says.

Still, D’Andrea plans to work as long as he can—even part-time—into retirement. “Travelling isn’t something I want to do in retirement. It’s a big inconvenience and not relaxing for me. I have no desire to unpack and then days later, repack my suitcase.” D’Andrea instead plans to spend time with family and friends, work a little, and entertain himself right here in Toronto with dinners out and other sports activities. It’s where he’s happiest.

Pro Tip

Beware of rising interest rates

Jon Parry, a chartered investment manager with Ironshield Financial Planning in Etobicoke, Ont., recommends D’Andrea make some short term moves in this portfolio given its 100% exposure to REITs. That’s because interest rates are rising, which hurts the value of REITs in two ways, according to Parry. First, rising rates push all REIT costs up as the cost of borrowing escalates. Their ability to raise their revenues or rents is constrained by the fact that their leases are locked in for defined periods of time. “This means profit margins for REITs get squeezed and the market will punish them for it,” says Parry.

Second, the volatility of REITs generally (including ZRE) is related to the volatility of their underlying asset. “In the case of ZRE, it has roughly 22% exposure to the housing sector,” says Parry. “So if reports of a 10% correction in GTA housing prices in the last quarter are true, the volatility of the REIT will increase.”

Parry notes that a quick chart on ZRE shows that it is trailing the TSX by 7.65% over the last year and it is quite possible that this underperformance will continue if rates continue to rise. “Either way, diversification is in order,” says Parry. “Look to add some global exposure gradually with diversified ETFs.”

As well, given that Nino likes BMO ETFs he should look at adding holdings like BMO MSCI EAFE Index (TSX:ZEA). This fund invests outside of Canada and the United States. “If you look under the hood you will see exposure to global titans like Nestle’s SA, Bayer AG and Toyota,” says Parry.

And if Nino is concerned about the value of the Canadian dollar climbing he can hedge by investing in ZDM, which is the currency-covered version of this ETF. “Other great ETFs providers in the global space include First Asset Management and Vanguard,” says Parry. “First Asset, though less well known, has some really innovative solutions known as actively managed ETFs that may be a good fit.

And if Nino wants to stay with a yield-focused play, then he should consider purchasing First Asset’s U.S. & Canada Lifeco Income ETF (FLI) with a covered call overlay. This could be a good play if interest rates continue to rise as Lifecos typically do well in a rising rate environment. In fact, historically Lifeco’s have outperformed banks during periods of rising rates so some exposure here could be timely.

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