Investors flee to safety in every excellent asset they can find when interest rates increase. Depending on the situation of the market, alternative investments like REITs can be a sound choice. How real estate investment did trusts fare when interest rates were high and low?
REIT Review
To engage in real estate through properties or mortgages through a publicly traded security is to invest in a real estate investment trust, which is listed on major exchanges. Therefore, real estate investment trusts provide ample liquidity.
Regional REITs emphasize real estate in specific regions rather than the global market and include offerings for the United States, Europe, China, and Japan. Investing in a real estate investment trust can be advantageous for several reasons, including those already mentioned
REIT Returns vs. Interest
The value of real estate investment trusts and interest rates tend to rise during expansionary economic times. The value of real estate assets held by REITs rises in tandem with the overall economy, which is why a thriving economy is good for REITs.
Interest rates rise when the economy is doing well because more people want to borrow money. On the contrary, the correlation becomes negative when the economy contracts and the Fed tightens monetary policy. The following figure shows the connection between REIT total returns and 10-year Treasury rates from 2000 through 2019.
REIT Investor Benefits
Furthermore, REITs are advantageous for a variety of time horizons due to the following features:
Earning Potential
Income securities are what we call REITs. REIT dividends provide a significant portion of total returns, while capital appreciation is possible. To avoid paying corporation taxes, REITs must transfer at least 90% of their profits to their unitholders. This subsidy leads to consistent dividend payments to REIT investors.
Embracing Global Differences
Exposure to international markets is made possible through REITs. Since the 1990s, numerous nations have introduced REIT listings, allowing investors to enter overseas real estate markets.
These nations include the UK, Singapore, Japan, Australia, the Netherlands, and South Africa. For instance, American investors exposed to the Singapore real estate market through REITs in their investment portfolios stand to gain if the local real estate market in the United States drops due to the impact of high-interest rates.
Exposure to Risk in a Particular Industry
Interest rate hikes may hurt the real estate market, but not all real estate niches will feel the pinch. While prime-location shopping malls might not be impacted, residential rentals might.
Profitable investing in REITs may be achieved regardless of interest rate effects by rigorous real estate industry analysis, the influence of interest rates on specific sub-sectors, and individual REITs based on their linked property holdings.
Why Reit Weakness Is Often Short-Term
Rising interest rates, however, have been shown to hurt REIT performance. Cohen and Steers report that the duration of these effects is often short-lived. This is because the Federal Reserve's decision to raise interest rates typically reflects indicators that the Fed perceives of a growing economy, such as rising GDP for many quarters in a row and low unemployment rates.
Higher Rates Don't Reduce Property Prices And Returns
There is a common misconception amongst investors that higher interest rates will lead to lower returns and underperformance from Real Estate Investment Trusts. This is a widespread misunderstanding.
Historically, while interest rates have been rising, commercial real estate returns have been trending upwards rather than downwards. According to NCREIF, rising interest rates have resulted in positive returns on commercial property in 19 of the last 22 quarters.
Real estate demand, which may increase during an economic expansion, counters this misunderstanding when the economy expands, as it is now doing in the United States.
Slowly Rising Interest Rates Will Boost Real Estate
Since the coupon rate and maturity date of a bond are both set at the time of purchase, bond prices are susceptible to changes in the market interest rate. The value of a fixed-rate bond decreases when interest rates increase and increase while the value of other bonds decreases.
However, the worth of a real estate investment trust fluctuates. Active managers make real estate investments on behalf of REITs. By expanding the REIT's asset base, raising rents, adding income-generating services to the buildings they hold, and other accretive actions, the REIT's management team may increase the value of the REIT and the dividends paid out to investors.
Conclusion
Looking at the correlation patterns and historical data, it appears that REIT returns vary between eras of rising or falling interest rates; yet, in most situations, there is a positive link between rising interest rates and rising REIT returns. Investors may diversify their portfolios beyond stocks and bonds by purchasing REITs after doing their homework and selecting the right real estate sub-sectors and geographic locations.
