Q: Hi Peter & 5i,
Just a comment. I always find your answers to ROC (Return of Capital) perplexing to me. 5i seems to view ROC as almost a completely negative situation and that you are almost always receiving your own money back. That is just not the case. Today's response to a question from Albert regarding the ROC with regards to CAR.UN and REIT'S highlighted this situation even more. I like a stock (CAR.UN) that has went from $30 in 2016 and is $60 in 2021 and that 63.8% of the distribution during those 5 years has been ROC. Multiple great things to like in a non-registered account from a total return basis and a tax scenario.
The technical details for ROC and REIT's can be highlighted in this response from John Heinzl of the Globe and Mail. It is one of the best answers that I've seen.
Please post as Public if you think it can help with the ROC understanding.
This is the question posed to John Heinzl - I have a question about calculating the yields of real estate investment trusts. Many REITs distribute significant amounts of return of capital. It has never made sense to me to include getting my own money back when calculating my yield. Do posted yields need to be adjusted by deducting the ROC to get a more realistic idea of what one is receiving?
Answer - Return of capital doesn’t necessarily mean you are “getting your own money back.” In general, ROC is defined as the portion of a distribution that does not consist of dividends, interest, realized capital gains or other income. In some cases – for example, a high-yielding mutual fund that distributes so much ROC that its net asset value erodes over time – you are indeed getting paid with a portion of your original capital.
But with REITs, it’s not that simple. ROC typically arises when a REIT’s distributions exceed its taxable income. This isn’t necessarily a problem, however, because income is affected by accounting items, such as depreciation, that don’t reduce cash available for distributions. In other words, when you receive ROC, you are getting cash generated by the business, not some sleight-of-hand trick by the REIT.
For investors, ROC has one big advantage: It is not taxed immediately. Rather, ROC is subtracted from the investor’s adjusted cost base, which gives rise to a larger capital gain – or smaller capital loss – when the units are eventually sold. For REITs that distribute large amounts of ROC, it can significantly reduce the tax burden in non-registered accounts.
Interested in a particular REIT? Most REIT websites provide a detailed annual breakdown of the tax characteristics of their distributions. In addition to distributing ROC, REITs typically pay out capital gains (50 per cent of which is taxable), other income (which is fully taxable) and in some cases, dividends (which benefit from the dividend tax credit).
One final note: When assessing their operating performance, many REITs focus on real estate cash-flow measures, such as funds from operations (FFO) and the more stringent adjusted funds from operations (AFFO). These measures are also useful for determining a REIT’s payout ratio and assessing the sustainability of its distributions.
Just a comment. I always find your answers to ROC (Return of Capital) perplexing to me. 5i seems to view ROC as almost a completely negative situation and that you are almost always receiving your own money back. That is just not the case. Today's response to a question from Albert regarding the ROC with regards to CAR.UN and REIT'S highlighted this situation even more. I like a stock (CAR.UN) that has went from $30 in 2016 and is $60 in 2021 and that 63.8% of the distribution during those 5 years has been ROC. Multiple great things to like in a non-registered account from a total return basis and a tax scenario.
The technical details for ROC and REIT's can be highlighted in this response from John Heinzl of the Globe and Mail. It is one of the best answers that I've seen.
Please post as Public if you think it can help with the ROC understanding.
This is the question posed to John Heinzl - I have a question about calculating the yields of real estate investment trusts. Many REITs distribute significant amounts of return of capital. It has never made sense to me to include getting my own money back when calculating my yield. Do posted yields need to be adjusted by deducting the ROC to get a more realistic idea of what one is receiving?
Answer - Return of capital doesn’t necessarily mean you are “getting your own money back.” In general, ROC is defined as the portion of a distribution that does not consist of dividends, interest, realized capital gains or other income. In some cases – for example, a high-yielding mutual fund that distributes so much ROC that its net asset value erodes over time – you are indeed getting paid with a portion of your original capital.
But with REITs, it’s not that simple. ROC typically arises when a REIT’s distributions exceed its taxable income. This isn’t necessarily a problem, however, because income is affected by accounting items, such as depreciation, that don’t reduce cash available for distributions. In other words, when you receive ROC, you are getting cash generated by the business, not some sleight-of-hand trick by the REIT.
For investors, ROC has one big advantage: It is not taxed immediately. Rather, ROC is subtracted from the investor’s adjusted cost base, which gives rise to a larger capital gain – or smaller capital loss – when the units are eventually sold. For REITs that distribute large amounts of ROC, it can significantly reduce the tax burden in non-registered accounts.
Interested in a particular REIT? Most REIT websites provide a detailed annual breakdown of the tax characteristics of their distributions. In addition to distributing ROC, REITs typically pay out capital gains (50 per cent of which is taxable), other income (which is fully taxable) and in some cases, dividends (which benefit from the dividend tax credit).
One final note: When assessing their operating performance, many REITs focus on real estate cash-flow measures, such as funds from operations (FFO) and the more stringent adjusted funds from operations (AFFO). These measures are also useful for determining a REIT’s payout ratio and assessing the sustainability of its distributions.
