As rates go up, there’s a lot of bad news for REITs, but there’s also a chance.
Lately, it hasn’t been easy to invest in real estate.
This year, real estate investment trusts have lost more money than the stock market as a whole. The S&P 500 fell 21% so far this year, but REITs fell 30%, according to the MSCI US Reit Index. The 132 stocks that make up the index represent about 99% of all U.S. REITs. Last year, the MSCI US REIT Index went up by 42% while the S&P went up by almost 27%.
Reits’ poor performance this year may be due to investors who bought REITS for their high dividend yields, which may sell them for risk-free Treasurys. This year, the yields on these Treasury bonds have been going up, and the yield on a 10-year bond topped 4% last week.
On top of that, REITs used to be known as a way to protect against inflation, but a recent Morningstar report says that isn’t the case right now.
Higher inflation won’t help the assets right away, and it might even hurt them for a number of reasons, such as the fact that many sectors won’t be able to raise rents because they have long-term leases, said Morningstar senior equity analyst Kevin Brown in a report. He said that inflation also drives up the cost of running a business, the price of building materials, and the cost of labour. Also, the market for REITs has changed a lot over the years.
When deciding whether to invest in REITs and what to buy, there are several things to think about.
For one thing, REITs should be investments that are made for the medium to long term. They should also be part of a portfolio with a wide range of investments.
CFP Chuck Failla, founder and CEO of Sovereign Financial Group in Stamford, Connecticut, said to keep an eye on how the Federal Reserve’s continued interest rate hikes affect Treasury yields. Names that do worse when interest rates go up are likely to keep doing so until those yields go down.
On the other hand, Failla is now trying to get ahead of the Fed. Even though he cut his firm’s exposure to REITs because he was worried about rising interest rates, he is now considering making that exposure bigger. REITs usually make up between 5% and 10% of their firm’s portfolio of investments with a term of 10 years or more. At the moment, the firm’s exposure is on the lower end of that range.
When focusing on certain areas of the REIT market, you should do so in a strategic way.
For example, REITs that own office buildings might not be the best idea right now since hybrid and remote work keep office occupancy rates low. According to a National Bureau of Economic Research paper called “Work From Home and the Office Real Estate Apocalypse,” the value of commercial office buildings in New York City fell by 45% in 2020 and by 39% in the long run. The long-term loss of value was worth $453 billion. Kastle’s Back to Work Barometer says that as of the end of September, an average of 47.2% of offices in 10 cities were being used.
Still, experts say that there are some REITs that are likely to do well.
Brown from Morningstar said that in this market, companies that are less affected by rising interest rates should do better. His top choice is Simon Property Group, because it has long-term leases that protect it from the effects of a slowing economy. He also said that the company has a strong balance sheet and a lot of free cash flow.
Hotels Brown said that real estate investment trusts (REITs) are another good investment, especially since they have many years of revenue growth ahead of them. Inflation will help them in the short term because they can raise room rates right away, he said.
Brown said, “They should be less affected by changes in interest rates overall, since most investors don’t buy hotel names for the dividend.”
Investors just need to know that a recession will make their recovery take longer.