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Similar to a true gold bug’s aversion to mining stocks and preference for physical bullion, institutional real estate investors know that REITs are far too closely correlated to the equity markets on which they are listed. For these managers, nothing beats the real thing: a portfolio of physical real estate holdings.

Since real estate’s role is to stabilize the overall portfolio, the lower the correlation to equities or bonds, the better. And despite the traumatic nature of the occasional real estate market downturn, the standard deviation on the real estate index is lower than that of both the long-bond index and the TSX, according to Catherine Marshall, CFA, senior vice president, research and strategy, LaSalle Investment Management.

How can that be? For institutional investors, real estate is seen more as a fixed income investment, with capital gains being a nice equity kicker which is seldom realized, because the investor is in the market for the long haul.

The average retail investor will not have the wherewithal to invest in real estate the way a pension fund can. But there are ways for wealthy investors to achieve the similar goals of portfolio stabilization.

There are a handful of different structures which allow wealthy investors and their advisors to assemble a portfolio of real estate holdings and each structure has its own advantages and draw-backs.

At a recent conference hosted by the Toronto CFA Society, Frank Baldanza, CA partner, real estate & international tax services, Deloitte and Touche, outlined these various structures.

Co-ownership

This type of arrangement is probably the easiest to understand. For the sake of simplicity, let us assume the group of investors consists of two people, each with a 50% stake in the investment.

Each owner must report their own proportionate share of the income or loss from the property. The two owners can deal independently with their stake unless they are limited by contract with their co-owner. This structure is relatively easy to manage but one major pitfall is that the co-owners assume unlimited personal liability, proportionate to ownership, but this liability can be mitigated with insurance.

Note the absence of the term “partner”?

Partnerships

The preferred form of partnership is the limited partnership, as the structure limits each investor’s liability to the amount they contributed to the partnership — perhaps the greatest attraction of this structure. One drawback is that to maintain that “limited” status, partners must not actively manage the partnership.

There are tax advantages to the LP as well, Baldanza says. Losses accrued by the partnership can be flowed out to the partners, but this is limited by the CRA’s “at-risk” rule, which disallows claiming tax losses greater than their stake. Like the co-ownership, the partners are responsible for taxation, not the partnership itself.

Baldanza points out that the partnership can be structured in such a way that it includes different classes of partners. For example, if one of the partners is a tax-exempt entity and the other is a HNW individual, capital losses can be flowed entirely to the taxable HNW partner. But arranging such a structure must be done in good faith, or the partners risk running afoul of the anti-avoidance rule.

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