REIT prices tend to climb in tandem with interest rates during periods of economic expansion. The rationale behind this is that as the value of their underlying real estate assets rises, so does the value of REITs. As the economy grows, so does the demand for funding, resulting in higher interest rates. In a declining economy, as the Fed tightens monetary policy, the link becomes negative. This relationship may be observed in the graph below, which shows the relationship between REIT total returns and 10-year Treasury yields from 2000 to 2019.
REIT returns and interest rates have a favorable association for the most part, advancing in the same direction. This is most evident between 2001 and 2004, and 2008 and 2013. The periods of inverse correlation, immediately after 2004, 2013, and 2016, are all associated with Fed monetary tightening policies, which are aimed at undoing the effects of monetary stimulus policies implemented mostly in response to recessions. Interest rates soared in this area, while REIT values fell.
A study by S&P, which looked at six periods starting in the 1970s when the yield on the 10-year Treasury increased significantly, adds to this thesis. Increased interest rates were compared to REIT and stock performance throughout those times in the study. The following table summarizes the information.
REIT returns improved during four of the six times of interest rate hikes, outpacing the stock market in three of them.
However, depending on the interest rate environment, there are additional aspects and other comprehensive observations to examine, which may suggest good or negative returns for REIT investments.
The first important consideration is that not all REITs are made equal. First and foremost, REITs are involved in a wide range of sectors. Healthcare, hotel, residential, industrial, and a variety of other industries are among them. Each of these industries has its own set of variables that react to the economy in distinct ways. Another crucial indicator is a REIT’s debt profile, or how much money they borrow to expand their business. The debt profile defines a REIT’s ability to pay down debt and the timeframe in which it may do so, which is influenced by interest rate conditions.
The findings suggest that REITs may not be overly reliant on interest rate scenarios, and that there are other other elements at play when deciding how a REIT would perform at various interest rates. Interest rate fluctuations may have no effect on the returns from REIT investments. As with any investment, it’s critical to research the REIT in question, as well as its past performance, dividend distribution history, and debt levels.
Do rising interest rates hurt REITs?
While rising interest rates might be a negative stimulus for high-dividend investments like real estate investment trusts, this does not automatically indicate that their stock values will fall. Matt Frankel, CFP, senior real estate analyst at Millionacres, discusses the general relationship between REITs and interest rates in this video clip from Motley Fool Live, which was recorded on Sept. 3.
Do REITs do well in rising inflation?
“In general, REITs do well in inflationary times simply because of their capacity to raise rents and then pass that money on to shareholders,” said Marco Rimassa, president of CFE Financial in Katy, Texas.
Are REITs good during a recession?
It’s crucial to remember that nothing can fully protect you against a recession. Any venture has weaknesses and hazards, and each economic downturn presents new obstacles.
While no recession is the same as the last, there are some real estate sectors that are more robust during a downturn. Real estate investments that meet people’s basic requirements, such as housing and agriculture, or that provide important services for economic activity, such as data processing, wireless communications, industrial processing and storage, or medical facilities, are more likely to weather the storm.
Investors can own and manage properties in any of the asset classes, but many prefer to invest in real estate investment trusts (REITs) (REIT). REITs can be a more affordable and accessible method for investors to enter into real estate while also obtaining access to institutional-quality investments in a diversified portfolio.
Data centers
We live in a data-driven technology era. Almost everything we do now requires data storage or processing, and the demand for data centers will only grow in the next decades as more technological or data-driven gadgets are released. During recessions, more people stay at home to watch TV, use their computers or smartphones, or, in the case of the recent coronavirus outbreak, work from home, increasing the need on data centers. According to the National Association of Real Estate Investment Trusts, there are currently five data center REITs to select from, with all five up 33.73 percent year to date (NAREIT).
Self-storage
Self-storage is widely regarded as a recession-proof asset type. As budgets tighten, some families downsize, relocating to other places to better their quality of life or pursue a new work opportunity, or downsizing by moving in with each other to save money. This indicates that there is a higher need for storage.
The COVID-19 pandemic, on the other hand, has had an unforeseen influence on the storage industry. While occupancy has remained high, eviction moratoriums and increasing cleaning and safety costs have resulted in lower revenues. According to NAREIT, self-storage REITs are down 3.51 percent year to date. However, this industry is expected to recover swiftly, particularly for companies like Public Storage (NYSE: PSA), the largest publicly traded self-storage REIT, which has a strong credit rating and a diverse portfolio.
Warehouse and distribution
E-commerce has altered the way our economy works. Demand for quality warehousing and distribution centers has soared as more consumers purchase from home than ever before. Oversupply of industrial space, particularly warehouse and distribution space, is a risk, given that this sector has been steadily growing for the past decade; however, as a result of COVID-19, it has already proven to be the most resilient asset class of all commercial real estate, making it an excellent choice for a recession-resistant investment. Prologis (NYSE: PLD), one of the major warehousing and logistics REITS, and Americold Realty Trust (NYSE: COLD), a REIT that specializes in cold storage facilities, have both proven to be quite durable in the present economic situation, with plenty of space for expansion.
Residential housing
People will always require housing. Residential housing, which can range from single-family homes to high-rise flats or retirement communities, fulfills a basic need that is necessary even in difficult economic times. During economic downturns, rents may stagnate and evictions or foreclosures may increase, but residential rentals are a relatively reliable and constant source of income. Despite the COVID-19 challenges, American Homes 4 Rent (NYSE: AMH), which specializes in single-family rental housing, and Equity Residential (NYSE: EQR), which specializes in urban high-rises in high-density areas, are two of the largest players in residential housing, both of which have maintained high occupancy and collection rates.
Agriculture
Aside from housing, agriculture and food production are two additional critical services on which our country and the rest of the world rely. Our existing food system is primarily reliant on industrial agriculture, but more and more autonomous and regenerative agricultural projects are springing up, allowing for more crop diversification, increased productivity, and reduced economic and environmental risk.
Wireless communication
Wireless communication has grown into a giant sector, with American Tower (NYSE: AMT) and Crown Castle International (NYSE: CCI) being two of the world’s largest REITs. Cell tower REITs that provide telecommunication services are an important part of our world today, and while growth prospects can be difficult to come by, very good track records and rising demand make this a terrific real estate investment that will weather any economic downturn.
Medical facilities
Medical facilities, senior housing, hospitals, urgent care clinics, and surgery centers all provide a vital service that will always be in demand, even during economic downturns.
Retail centers
Before you abandon ship when you see this category, let me state unequivocally that retail is not dead, at least not in all forms. Grocery stores and other retail outlets that provide critical services and products will continue to be in demand, as they did during the last pandemic. The issue here is for retail REITs to invest in the vital service sector with such focus that other sectors such as tourism, restaurants, or general shopping and goods do not put the company or investment at risk.
Are REITs a good investment during inflation?
Real estate investment trusts (REITs) offer natural inflation protection. When prices rise, so do rentals and values in real estate. This helps REIT dividend growth and ensures a steady supply of income, especially during periods of high inflation.
In all but two of the last twenty years, REIT dividends have exceeded inflation as assessed by the Consumer Price Index.
Directly comparing REIT dividend growth with inflation is a practical technique to measure the inflation protection provided by REITs. Dividend growth in REITs have exceeded inflation in all but two of the last 20 years, as assessed by the Consumer Price Index.
Commodities and Treasury inflation-protected securities (TIPS) are examples of investments that can provide good inflation protection. Stocks, too, can play a role in a portfolio that shields investors from inflationary shocks.
Weak Growth
REITs that are publicly listed are required to pay out 90% of their profits in dividends to shareholders right away. This leaves little money to expand the portfolio by purchasing additional properties, which is what drives appreciation.
Private REITs are a good option if you enjoy the idea of REITs but want to get more than just dividends.
No Control Over Returns or Performance
Investors in direct real estate have a lot of control over their profits. They can identify properties with high cash flow, actively promote vacant rentals to renters, properly screen all applications, and use other property management best practices.
Investors in REITs, on the other hand, can only sell their shares if they are unhappy with the company’s performance. Some private REITs won’t even be able to do that, at least for the first several years.
Yield Taxed as Regular Income
Dividends are taxed at the (higher) regular income tax rate, despite the fact that profits on investments held longer than a year are taxed at the lower capital gains tax rate.
And because REITs provide a large portion of their returns in the form of dividends, investors may face a greater tax bill than they would with more appreciation-oriented assets.
Potential for High Risk and Fees
Just because an investment is regulated by the SEC does not mean it is low-risk. Before investing, do your homework and think about all aspects of the real estate market, including property valuations, interest rates, debt, geography, and changing tax regulations.
Fees should also be factored into the due diligence process. High management and transaction fees are charged by some REITs, resulting in smaller returns to shareholders. Those fees are frequently buried in the fine print of investment offerings, so be prepared to dig through the fine print to find out what they pay themselves for property management, acquisition fees, and so on.
Are REITs good for retirement income?
Nareit commissioned Wilshire Funds Management to investigate the function of REITs in Target Date Funds (TDFs). REITs, according to Wilshire, play a crucial role in boosting investment returns and lowering risk in these popular investment vehicles.
Individuals can use TDFs to make portfolio planning easier. Over the next few decades, it is predicted that the bulk of new 401(k) and IRA assets will be put in TDFs, and millions of Americans’ retirement security will be dependent on their investment performance.
REITs Important Across the Target Date Fund Lifecycle
For workers with various retirement horizons, the figure below highlights the recommended proportion of US REITs in a retirement portfolio.
- REIT allocations range from 15.3 percent of a young worker’s portfolio with 40 years till retirement to over 10% for an investor nearing retirement age.
- The REIT allocation drops with other equities throughout retirement, but it still exceeds 6% for an investor nearly ten years later.
REIT Attributes: High and Stable Income, Long-term Capital Appreciation, Diversification and Inflation Protection
Because they provide income, capital appreciation, diversification, and inflation protection, REITs are a significant aspect of retirement portfolios.
Adding assets with low correlations to the current assets in the portfolio can reduce portfolio volatility. The long-term correlations of equity REITs with the other major asset classes studied range from 0.19 to 0.65, indicating that adding REITs to an investing portfolio can provide diversification benefits.
Table 1 compares asset allocations for an optimal portfolio in the glide path for the 15-year-to-retirement cohort, excluding and incorporating REITs in the set of possible investments.
U.S. TIPS, U.S. High Yield Bonds, and U.S. Small Cap Equities have much lower or nil allocations in the REIT-based portfolio. REITs are a more efficient asset class for combining the investing features of high and consistent income, long-term capital appreciation, and inflation protection since they take “shelf space” in the optimal allocation from these assets.
REITS Improve Retirement Readiness
Incorporating REITs into the TDF portfolio boosts returns while lowering risk. Over the 44-year period 1975 to 2019, Table 2 compares risk and return for optimal portfolios in the middle of the glide path, excluding and incorporating REITs. A TDF portfolio that includes REITs has a higher return and lower risk than one that does not. With an average portfolio risk of 9.33 percent, the TDF REIT portfolio returned 10.49 percent annually. Without REITs, the return would be 10.02 percent and the annualized portfolio risk would be 9.50 percent. The TDF portfolio utilizing Surplus Optimization would have had a portfolio value at the end of 2019 that was 20.4 percent greater than a portfolio without REITs during the 44-year investing period.
*The Wilshire study detailed on this page is an updated version of a 2012 Wilshire study.
Why are REITs a hedge against inflation?
In the 1970s, the same three acts were taken. Everyone understands that rising oil prices and the federal government’s reckless financial maneuvering were to blame.
Despite the government’s enhanced social programs, inflation stayed at only 1.1 percent in the early 1960s. However, in 1965, the Vietnam War broke out, and increased demand for industrial goods drove up prices.
Consumers had greater spending money in 1969, when consumer price inflation had risen to more than 5%.
The same can be said of government attitudes in the two periods. In fact, it’s possible that this is the most important comparison.
In her article, Kathy Jones expands on this “Is 1970s Style Inflation Making a Comeback?” from Charles Schwab:
Today, the Fed, like in the 1970s, is deciding whether or not to allow inflation to rise. After a thorough examination of its actions over the past few decades, it came to the conclusion that it had placed too much emphasis on inflation, which had stifled economic growth and kept down job growth and salaries for many workers. Before the Covid-19 crisis, it was the case. Faced with the pandemic’s deflationary effects, the Fed now believes it has room to err on the side of being too easy for too long.
However, we are not entirely reliving history at this time. As I’ll demonstrate further down, history never repeats itself word for word.
As Scott Horsley points out in his article, “Do You Think Inflation Is a Problem Right Now? NPR’s “Let’s Take a Step Back to the 1970s”:
Treasury Secretary Janet Yellen and others in the administration say that the present price increase is a one-time occurrence caused by supply shocks related to the pandemic and pent-up consumer demand.
The mentality of today’s America, though, is a significant and distinct difference. In the 1970s, the general population in the United States believed that inflation was unavoidable. However, not everyone is now so negative.
People will be more willing to accept lower salary increases if they feel prices will remain relatively stable. People who sell products will not demand large price rises. Once that psychology has taken hold, it has a tendency to repeat itself.
Alan Blinder, an economist who served as the Federal Reserve’s vice chairman in the 1990s, agrees with this assessment:
If you’re a business and expect inflation to be 5%, your prices will almost certainly go up 5% when it’s time to set them for the next year. On the other hand, if you believe inflation will be 1%, you’re more likely to increase by 1%.
Whether those predictions prove to be correct or entirely incorrect will be determined by the passage of time. For the time being, however, we do have options for dealing with the current and even future situations, whatever they may be.
Investors, understandably, hope that the current round of inflation isn’t a one-time occurrence. And it’s possible that it will be.
Regardless of whether we see a speedy rebound or continued inflation, REITs remain a strong investment option.
Regardless, “While “inflation” may appear to be a nasty term, a small amount of it can be beneficial to the economy. And a lot of money doesn’t always kill certain industries, particularly REITs.
After all, the value of real estate tends to rise in tandem with the value of consumer items. Cohen & Steers, a worldwide investment manager, explains this in their report “Three Inflation-Resilient Portfolio Building Strategies”:
1st “Higher prices for labor, land, and construction supplies might raise the economic threshold for new development, therefore property values tend to rise with the general pricing environment. As a result, new supply may be constrained, encouraging higher occupancies and allowing landlords more flexibility to raise rents.”
2. Inventive+ phrasing “Hotels, self-storage, apartments, senior housing, and billboards, among other property types with shorter lease terms, might benefit from rising rents quite quickly.”
3. If you’re looking for a “Many commercial leases, particularly outside the United States, include explicit inflation linkages, with rent escalators related to a publicized inflation rate.”
REIT dividends tend to grow faster than inflation as a result of these variables, as detailed in the same article:
We expect REITs to produce above-average dividend growth over the next three years, similar to what we witnessed post-2009, following pandemic-driven dividend reduction in 2020. Despite the fact that the pandemic has hastened changes in how real estate is used (some for the better, others for the worst), we believe REITs’ ability to grow rents faster than inflation remains unaltered.
At the risk of seeming repetitious, I really want to emphasize this: REITs provide investors with some inflation protection because real estate rental rates rise in lockstep with the price of goods and services. As I recently stated in an essay, “How to Think About Inflation Like a REIT”:
Overall, REITs are well-positioned to gain from rising inflation while also delivering appealing current income streams that should rise over time.
Whether inflation rises or falls as a result of unexpected pandemic-related issues, REITs provide investors with reliable income streams. That’s why, happily, I’m sticking with them.
Are REITs a good hedge against stocks?
REITs are a cross between mutual funds and real estate investment trusts. Although they trade like stocks, their dividend yields can be comparable to trash bonds. I purchased two of them in late March—Starwood Property Trust (symbol STWD) and Apollo Commercial Real Estate Finance (ARI)—because I believe REITs should be part of every well-diversified portfolio. REITs offer stock market returns, but they don’t always move in lockstep with the market. As a result, holding REITs can help you diversify your portfolio without sacrificing profits. Even better, REITs are a solid inflation hedge because rents and real estate values tend to rise in tandem with rising prices.
What are the safest REITs?
These three REITs are unlikely to appeal to investors with a value inclination. When things are uncertain, though, it is generally wise to stick with the biggest and most powerful names. Within the REIT industry, Realty Income, AvalonBay, and Prologis all fall more generally into that category, as well as within their specific property specialties.
These REITs are likely to have the capital access they need to outperform at the company level in both good and bad times. This capacity should help them expand their leadership positions and back consistent profits over time. That’s the kind of investment that will allow you to sleep comfortably at night, which is probably a cost worth paying for conservative sorts.
What percentage of my portfolio should be in REITs?
Despite the fact that REITs trade on major stock exchanges, many financial planners (including myself) consider real estate to be a separate asset class from stocks and bonds. As a general guideline, allocating 5 percent to 10% of your assets to REITs is an excellent approach to diversify your exposure and/or improve your portfolio’s dividend income.
Of course, this is just a starting point; in some cases, the optimum answer for you may be substantially higher. REITs, for example, account for around 30% of my stock portfolio. It’s wise to invest in what you know, as many prominent investors have said. Real estate is the sector in which I am most comfortable appraising, thus it accounts for the majority of my portfolio’s allocation.
For income-seeking investors, REITs could be a solid choice for more than 10% of a stock portfolio. Let’s face it: today’s bond and other fixed-income investment yields aren’t exactly stellar. However, there are a slew of REITs with dividend yields in the 3% to 4% range that are completely sustainable. As a result, a retiree or other income-oriented investor might benefit from a bigger REIT investment.
Are REITs a good buy now?
- No corporation tax: A company must meet certain criteria in order to be classed as a REIT. It must, for example, invest at least three-quarters of its assets in real estate and pay shareholders at least 90% of its taxable income. If a REIT fits these criteria, it receives a significant tax benefit because it pays no corporate tax, regardless of how profitable it is. Profits from most dividend stocks are effectively taxed twice: once at the corporate level and then again at the individual level when dividends are paid.
- High dividend yields: REITs offer above-average dividend yields because they must pay at least 90% of taxable revenue to shareholders. It could, for example, offer a secure dividend yield of 5% or more, but the typical S&P 500 company yields less than 2%. If you need income or wish to reinvest your dividends and compound your gains over time, a REIT can be a good solution.
- Total return potential: As the value of its underlying assets rises, a REIT’s total return potential rises as well. Real estate values rise over time, and a REIT can grow its worth by employing a variety of tactics. It might either build properties from the ground up or sell valued assets and reinvest the proceeds. A REIT can be a good total return investment when this is combined with substantial dividends.
- REITs were designed to provide average investors with access to commercial real estate assets that would otherwise be out of reach. Most people can’t afford to buy an office tower outright, but there are REITs that can.
- Diversification of your financial portfolio: Most experts think that diversifying your investment portfolio is a smart idea. Despite the fact that REITs are technically stocks, real estate is a distinct asset class from stocks. During difficult economic times, REITs tend to keep their value better than equities, and they’re a terrific way to add stable, predictable income. These are only two examples of how an all-stock portfolio’s inherent risk can be mitigated.
- Real estate transactions might take a long time to buy and sell, but REITs are a very liquid investment. A REIT can be bought or sold at any time. Because traded REITs can be purchased and sold like stocks, it’s simple to receive money when you need it.
- Direct ownership and management of a property is a business that demands time and effort. REIT shareholders do not own the properties or mortgages in its portfolio, thus they do not have to deal with property maintenance or development, landlord services, or rent collection as a property owner or management would.
