Do REITs lose value when interest rates rise?
Rising interest rates hurt not only the value of REITs' property holdings but also the cost of debt to finance those properties or even refinance already-owned assets.
REIT Stock Performance and the Interest Rate Environment
Over longer periods, there has generally been a positive association between periods of rising rates and REIT returns. This is because rising rates generally reflect improvement in the underlying fundamentals.
For example, Realty Income (NYSE:O) had a beta of 0.5. A beta of 0.5 implies this REIT is half as volatile as the S&P 500, so if the S&P 500 slumps 10%, this REIT should only decline in value by 5%. Because of their lower volatility, REIT returns are less correlated with the stock market.
Right now, REITs (VNQ) are at an inflection point and time is running out for investors. But now as we head into 2024, we expect the polar opposite and this should lead to an epic recovery across the REIT sector. The Fed expects at least 3 interest rate cuts in 2024 and the market is predicting even more.
The value of a REIT is based on the real estate market, so if interest rates increase and the demand for properties goes down as a result, it could lead to lower property values, negatively impacting the value of your investment.
After lagging equities the past two years, REITs offer an attractive investment opportunity in 2024. The headwind of higher bond yields and central bank rate hikes is likely to abate and may turn into a tailwind if our view about an impending economic slowdown and decelerating inflation trends is correct.
April 2, 2024, at 2:50 p.m. Real estate investment trusts, or REITs, are a great way to invest in the real estate sector while diversifying your options. Real estate investments can be an excellent way to earn returns, generate cash flow, hedge against inflation and diversify an investment portfolio.
Interest rates remain high. The other factors driving the commercial real estate crisis, like falling demand for office space due to remote working, persist. On top of these macro factors, many REITs are even contending with their own tenant-related headwinds.
But from a REIT-wide perspective, one of the biggest problems has been rising interest rates. Rising interest rates impact REITs in a number of ways. Directly, interest expenses can go up as the interest rates on variable-coupon debt increase and as fixed-rate debt rolls over.
Therefore, if rates begin to rise then REIT cash flows will decline at a time when discount rates are rising. They fear the end result will be capital losses that offset the higher distribution yield and result in negative total returns.
What is the downside of REITs?
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
As we dive into 2024, the Fed's accommodative approach to tackling inflation is likely to provide an impetus to the REIT sector, which depends highly on the debt market to carry out business activities. These companies benefit from lower borrowing costs. Moreover, low interest rates contribute to higher valuations.
What this means is that REITs are ideal borrowers for banks. They are exactly who they want to do business with because they know that the risk of a REIT bankruptcy is extremely low. Just look at the past. There have been very few REIT bankruptcies over the past 50+ years.
A lot of REIT investors focus too way much on the dividend yield. They think that a high dividend yield implies that a REIT is cheap and a good investment opportunity. In reality, it is often the opposite, and the dividend does not say much, if anything, about the valuation of a REIT.
While a REIT is still open to public investors, investors may be able to sell their shares back to the REIT. However, this sale usually comes at a discount; leaving only about 70% to 95% of the original value. Once a REIT is closed to the public, REIT companies may not offer early redemptions.
If you are interested in a real estate investment that is reliable, hands-off and offers dividends, REITs could be the answer. If you're looking for a higher-risk – but high-potential – investment or want to be able to invest in specific companies you admire, buying individual stocks could be the answer.
After a volatile couple of years, we're optimistic about the potential for a calmer year in 2024. Given the strong fundamentals and compelling long-term drivers among certain REIT subsectors, we think the coming year could be constructive for patient real-estate investors.
There is no set lifetime for the trust in most cases. Investors who buy publicly traded shares in a REIT can usually buy as much or little as they like and dispose of the shares when they want or need to. However, if an investor buys a non-traded or private REIT, the investment should be considered illiquid.
1. Federal Realty: The king. Federal Realty has increased its dividend annually for 54 consecutive years, which it claims (and there's no reason to doubt it) is the longest streak of any publicly traded real estate investment trust (REIT).
Historically, REITs tend to deliver their highest returns during early stages of the real estate recovery cycle, according to research from Nareit, an association representing the REIT industry. That could spell a strong performance for REITs moving forward.
What is the most profitable REITs to invest in?
| Symbol | Fund name | 1-year return |
|---|---|---|
| BRIUX | Baron Real Estate Income R6 | 12.08% |
| JABIX | JHanco*ck Real Estate Securities R6 | 11.07% |
| RRRRX | DWS RREEF Real Estate Securities Instil | 9.26% |
| CSRIX | Cohen & Steers Instl Realty Shares | 9.84% |
| # | Name | M. Cap |
|---|---|---|
| 1 | Prologis 1PLD | $98.50 B |
| 2 | American Tower 2AMT | $80.32 B |
| 3 | Equinix 3EQIX | $69.71 B |
| 4 | Welltower 4WELL | $53.01 B |
In fact, REIT total returns bounced back with impressive performance in the last quarter of 2023. Based on historical experience, the convergence of the wide valuation gap between public and private real estate will likely ensure continued REIT outperformance into 2024.
The global REIT market is experiencing steady growth. According to the recent market reports, the market size is reaching an impressive $3.5 trillion in 2022 and is estimated to reach USD 4.2 trillion by 2027, growing at a Compound Annual Growth Rate (CAGR) of 2.8% from 2022.
But since REITs are invested in property, there's more protection against the horror show of having shares crash to $0. By law, 75% of a REITs asset must be invested in real estate. The market value of the property owned by the REIT offers a bit of protection, as long as the value of the property doesn't go to zero.
