What happens to REITs when interest rates go down?
With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts. However, REIT stocks are only as good as the properties they own — and some real estate sectors may be better positioned than others.
More than a year of interest rate hikes by the Federal Reserve pushed down returns on real estate investment trusts, or REITs. While higher rates negatively impacted nearly every sector of the economy in 2022 and most of 2023, real estate was hit especially hard.
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.
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.
- High-yield investments.
- Bond ETFs.
- Preferred stock.
- REITs.
- Housing stocks.
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.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
However, an examination of the historical record suggests that this is a misconception. Although interest rates certainly affect real estate values and, therefore, the performance of REITs, rising interest rates do not necessarily lead to poor returns.
Investing in REITs can be a passive, income-producing alternative to buying property directly. However, investors shouldn't be swayed by large dividend payments since REITs can underperform the market in a rising interest-rate environment.
Factors to Drive REITs' 2024 Performances
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.
Can REITs go to zero?
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.
After looking at correlation patterns and historical data, it appears that returns from REITs vary during different interest rate periods, but for the most part have shown a positive correlation during increasing interest rates.
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.
Health care and tech are the major themes among this year's best-performing stocks. March 1, 2024, at 3:26 p.m. With health care and artificial intelligence stocks as leading performers, the S&P 500 hit new all-time highs after two years.
Higher interest rates tend to negatively affect earnings and stock prices (often with the exception of the financial sector). Changes in the interest rate tend to impact the stock market quickly but often have a lagged effect on other key economic sectors such as mortgages and auto loans.
Along with generating a larger income stream, such bonds may be subject to less interest rate risk, as there may be a reduced chance of rates moving significantly higher from current levels. However, even when interest rates are low, bonds can still be appropriate for inclusion in a well-diversified portfolio.
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
Like rent checks earned every month from rental properties, several of the worlds' top billionaire investors have been scooping up monthly dividends from REITs that specialize in different niches of the property market, including shopping centers, office buildings, distribution centers and warehouses, recreational ...
Even with a challenging market, REITs are considered a staple for many investment portfolios thanks to the 90% rule. As the name implies, this rule stipulates that real estate trusts must distribute 90% of their taxable earnings to existing shareholders.
The generous dividend payments enjoyed by REIT investors may look particularly attractive moving forward. With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts.
Why are REITs down 2024?
“The next two years, 2024 and 2025, will have more commercial real estate debt due to be refinanced in the history of CRE, that will cause some assets to be lost as values have decreased as interest rates have gone up,” Chancey said.
REITs' average return
Return a minimum of 90% of taxable income in the form of shareholder dividends each year. This is a big draw for investor interest in REITs. Invest at least 75% of total assets in real estate or cash.
Realty Income Corp (NYSE: O) is currently trading at almost 8% below its 2023 high, while WP Carey Inc (NYSE: WPC) has fallen more than 14% from its high of $85.55 in January. Two of the primary factors contributing to the recent underperformance of REITs are the rising interest rates and the recent bank failures.
Summary. REITs have access to capital and are acquiring assets, making it a good time to invest. REITs historically rebound when interest rates pivot and have the potential for rent growth.
The overall business performance of the S-REIT sector has been lacklustre and some segments of the industry have not been able to recover to pre-COVID levels, either due to a change in business dynamics or due to an inflationary environment. Office REITs have faced challenges due to the new work-from-home (WFH) trends.
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