5 Reasons Why These Securities Will Be Phenomenal Income Investments in 2011

With interest rates near the lowest point in generations, the hunt for high yields continues in haste. Right now, strong income investments can increasingly be found in an unlikely place — real estate.

Real estate investment trusts or REITS have typically been solid income investments because of tax advantages. These trusts pay no taxes at the corporate level, provided they pay the bulk of income to shareholders in the form of distributions, which enables them to pass on money that would otherwise be lost to taxes. As a result, yields are typically higher than those of non tax-advantaged investments.

Then there was the financial crisis.

Real estate was at the epicenter of the financial crisis as the real estate bubble burst and prices plummeted. In 2007 and 2008, REITs in the aggregate lost half their value. In addition, many REITs slashed distributions and payout levels plummeted.

But, things are changing.

While real estate prices are still far below pre crisis levels, they have stabilized. Many weaker REITs have gone bust or revamped their balance sheets and are solidly profitable. In fact, the Vanguard REIT Index (NYSE: VNQ) exchange-traded fund (ETF) which offers broad exposure to publically traded U.S. REITs, returned +30% in 2009 and more than +23% so far this year. The ETF also pays a solid 3.5% yield.

While the U.S. REIT market is turning around, the best way to play REITs right now is actually north of the border. Canadian REITs offer higher yields, which are usually paid monthly, and more promise for price appreciation.

Here are five reasons why…

1. The expiration of the tax benefits for Canadian Royalty Trusts
Canadian royalty trusts (CanRoys), which typically own oil and natural gas wells, have provided investors with high yields for years. These trusts also avoid taxation at the corporate level provided they pay the bulk of their income to unit holders, a tax incentive created by the Canadian government to encourage investment in the country’s energy infrastructure. But, what the government gives — it can take away.

On December 31, 2010, the current tax benefits expire and much of what was paid to investors as dividends will instead go to the Canadian government. Where will money seeking high income in Canada go? REITs are a strong possibility. REITs manage to escape the tax law change and are still tax-advantaged trusts with the ability to pay higher yields than regular companies. Money fleeing reduced dividends from CanRoys could flow into REITs — the only other class of Canadian stock left that will pay higher tax advantaged yields — and prop up prices.

2. Canadian REITs are in better shape than U.S. REITs
While real-estate values in Canada have fallen, Canada had nowhere near the leverage or the exposure to subprime borrowers as the United States. As a result, the Canadian real estate has experienced a much less severe correction. Analysts at Canadian brokerage Canaccord Adams say that commercial real estate in Canada has lower vacancy rates and less supply than in the United States.

Canadian REITs are generally “in much better shape than the ones in the U.S.,” a recent study by Canadian rating agency BDRS found, concluding that Canadian REITs are still well-capitalized, have excellent debt structures and generally higher-quality assets.

3. It’s a great time to be in a position to buy
Many well-capitalized Canadian REITs are taking advantage of the depressed real estate market and buying up properties at dirt cheap prices. Canadian commercial real estate values plunged during the credit crisis but have begun to recover.

But, the United States is experiencing one of the worst real estate markets since the 1930s. According to the most recent PricewaterhouseCoopers Korpacz Real Estate Investor Survey, which polls major institutional equity investors, the financial crisis has created “lifetime opportunities” in the U.S. real-estate market. Some Canadian REITs have been using their superior capitalization to snap up U.S. properties as well.

4. A hedge against a falling dollar and inflation
Real estate, as a hard asset, typically holds up well during times of inflation as property assets appreciate and rents riseMany have forecasted that astronomical debt levels along with continued low interest rates will cause the U.S. dollar to plunge in the future. . And most Canadian REITs earn the majority of their revenue and pay distributions in Canadian dollars. A weaker U.S. dollar compared with the Canadian dollar will increase the price and dividends in dollar terms.

5. Track record

Canadian REITs, represented by the iShares S&P/TSX Capped REIT Index (TSX: XRE.TO), an index of Canada’s largest REITs, have been phenomenal performers. The index returned a whopping +55% in 2009 and +22% so far this year. Despite the rising price, the index still yields a stellar 5.9%. The index‘s longer term track record is equally impressive as it has returned an average of more than +14% a year for the past 10 years, compared with +1% on average for the S&P 500.

Action to Take –> Investors can buy Canadian REITs through the iShares ETF or with some of the largest REITs including RioCan (TSX: REI.TO) and Calloway (TSX: CWT.TO). [Buying securities traded on the Toronto Stock Exchange is easy for most U.S. investors and can be done with most online brokerages. But it’s always best to call your broker if you have any questions.]

While REIT prices have soared in the past year and a half, the fundamentals are so strong that they should continue to perform well. Most of the large Canadian REITs, as well as the ETF, can be purchased at current prices.

P.S. Investing in dividend-paying stocks is one of the most profitable ways to beat the market. For more on stable stocks that will grow your money with ever-increasing dividends, see Carla Pasternak’s latest course, The 5 Rules Every Income Investor Has to Know.