How Do Rising Interest Rates Affect REITs?

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.

How does rising interest rates affect mortgage REITs?

Because the value of a mortgage bond is inversely proportional to interest rates (higher rates cause mortgage bond values to fall), higher rates will cause the NAV of a mortgage REIT to fall, and the share price will often follow.

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.

Is inflation bad for REITs?

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.

Why are REITs a bad investment?

Real estate investment trusts (REITs) are not for everyone. This is the section for you if you’re wondering why REITs are a bad investment for you.

The major disadvantage of REITs is that they don’t provide much in the way of capital appreciation. This is because REITs must return 90 percent of their taxable income to investors, limiting their capacity to reinvest in properties to increase their value or acquire new holdings.

Another disadvantage is that REITs have very expensive management and transaction costs due to their structure.

REITs have also become increasingly connected with the larger stock market over time. As a result, one of the previous advantages has faded in value as your portfolio becomes more vulnerable to market fluctuations.

Do REITs lose money?

  • REITs (real estate investment trusts) are common financial entities that pay dividends to their shareholders.
  • One disadvantage of non-traded REITs (those that aren’t traded on a stock exchange) is that investors may find it difficult to investigate them.
  • Investors find it difficult to sell non-traded REITs because they have low liquidity.
  • When interest rates rise, investment capital often flows into bonds, putting publically traded REITs at danger of losing value.

How often do REITs fail?

Historically, buying REITs following a market crisis has always been a smart move, and we have little doubt that this time will be no different. REITs, on the other hand, aren’t “ideal investments.” In truth, there are numerous ways for a REIT investor to lose money. Over the last 20 years, REITs have returned 15% a year, according to NAREIT.

What drives REIT performance?

The attraction of REITs has been aided by their strong long-term total returns, as well as other significant investment features like as liquidity, high dividend yields, and the ability to diversify and hedge against inflation.

Why do mortgage REITs pay high dividends?

When it comes to real estate investment trusts (REITs), there are two types: equity REITs and mortgage REITs (also known as mREITs). When most people hear the word “real estate investment trust,” they think of equity REITs. Commercial real estate is owned, managed, and developed by these firms.

Mortgage real estate investment trusts (REITs) invest in mortgages, mortgage-backed securities, and other associated assets. Mortgage REITs, according to Nareit, assist in the financing of 1.8 million homes in the United States. As you may expect, this is a completely different industry than owning real estate. Mortgage REITs aren’t even categorized as real estate equities; instead, they’re categorised as financial stocks.

The home loan The REIT industry is complicated, and different REITs take different tactics. However, they typically use significant amounts of debt to profit on the spread between mortgage rates and short-term borrowing rates.

If you have a mortgage, The profit margin is 1.5 percent, and REIT can borrow money at 3 percent interest to buy mortgages at 4.5 percent interest. Because most investors aren’t interested in a yield of 1.5 percent, these businesses borrow a lot of money to increase profits.

Assume you have a mortgage. Investors have put $2 billion into REIT. In addition to this, it loans $10 billion at 3% interest to purchase mortgages with an average interest rate of 4.5 percent. This corporation would possess $12 billion in mortgages, paying $540 million in annual interest (4.5 percent of $12 billion). For a total annual income of $240 million, the REIT would pay $300 million in interest on its debt. This represents a 12 percent return on the $2 billion invested.

That is a very basic illustration. There are a number of additional factors that influence mortgage REIT profitability, and we’ll go over a few of them in the next section. This just goes to show why mortgage REITs have such high dividend yields.

It’s also worth noting that mortgage REITs are only meant to be used as a source of revenue. To put it another way, mortgage REITs don’t invest in assets because they expect them to appreciate in value. They’re primarily concerned about making money.

Can you retire on REITs?

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.

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.