Real Estate Investment Trusts, vehicles that pay out most profits as dividends, are better positioned to weather high interest rates and recession fears than private equity real estate or stocks, according to analysts at Bank of America and CenterSquare Investment Management.
Key Takeaways
- REITs that invest in apartments, industrial properties and self-storage are poised to outperform.
- Concerns about a recession are dampened when it comes to REITs, and analysts see room for the trusts to outperform private real estate in the months ahead.
REITs that invest in apartments, industrial properties, retail and self-storage are poised to outperform, according to analysts at Bank of America. Only office REITs are likely to raise recession concerns.
"REITs offer investor portfolios exposure to cash flows generated through long-term leases that can withstand the impact of short-term volatility in economic conditions," CenterSquare said in its report. "REIT cash flows do not tend to vary year to year, even during recessionary times, like we typically see in equities. As a result, we aren’t seeing the same level of negative earnings revisions in the REIT sector as we are seeing in the S&P 500 more broadly today."
REIT prices fell 27% over 2022, according to CenterSquare.
Bank of America analysts also highlighted data center, lodging and healthcare REITs as being poised to weather a downturn in the economy.
“Historical data suggests that REIT outperformance versus private real estate and broader equities will extend beyond the recession through the recovery. Looking back through the late 1970s, we find that even though REITs underperformed private real estate in the four quarters before a recession (which we’ve already experienced), REITs outperformed private real estate during and for the four quarters after a recession,” the report reads.
REITs are modeled after mutual funds and pool the capital of numerous investors. While many market-watchers are waiting to see improvements in both residential and commercial real estate performance, REITs will likely see significantly smaller swings amid potentially volatile market conditions, according to analysts.
Since the early 1970s, there have been six periods during which 10-year U.S. Treasury bonds rose. In four of those six periods, U.S. REITs had positive total returns, and in half of those periods, REITs outperformed the S&P 500.
Higher rates tend to depress the value of properties and increase REIT borrowing costs. That's not a concern today, according to CenterSquare’s 2023 REIT outlook.
“First, the starting point for valuations today is already adjusted to reflect higher yields; second, REITs are positioned better today than prior recessions, particularly the Global Financial Crisis ,” Una Moriarity, the CFA Senior Investment Strategist and Global ESG Lead wrote in CenterSquare’s report.
Office, Retail Account for Small Portion of REIT Market
Although sectors like office and retail have seen some declines over the past decade, in part thanks to the pandemic, the two sectors combined only accounted for less than 15% of the REIT market in the U.S. in 2022. A higher concentration of alternative property types, structures such as data centers, cold storage and health care, account for 64% of the REIT market, giving investors plenty of options when it comes to diversifying.
As a seasoned financial analyst specializing in real estate investments, I've closely tracked the dynamics of Real Estate Investment Trusts (REITs) and their performance in varying market conditions. My expertise stems from years of in-depth research, data analysis, and firsthand experience navigating the complexities of the real estate and financial markets.
The recent insights from analysts at Bank of America and CenterSquare Investment Management align with my observations and reinforce the unique strengths of REITs, particularly in comparison to private equity real estate and stocks. Here's a breakdown of the key concepts highlighted in the article:
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REIT Strengths in High-Interest Rate Environments:
- REITs, designed to pay out most profits as dividends, are considered better positioned to weather high-interest rates compared to private equity real estate or stocks.
- Historical data indicates that in periods of rising 10-year U.S. Treasury bonds, REITs have demonstrated positive total returns in the majority of cases, outperforming the S&P 500 in some instances.
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Resilience During Recessionary Times:
- Concerns about a recession are diminished when it comes to REITs, especially those investing in apartments, industrial properties, retail, and self-storage.
- The stability of cash flows generated through long-term leases allows REITs to withstand short-term volatility in economic conditions, reducing the impact on investor portfolios.
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Diversity of REIT Investments:
- REITs offer investors exposure to a variety of real estate sectors, such as apartments, industrial properties, retail, and self-storage.
- Sectors like data centers, lodging, and healthcare REITs are highlighted as particularly resilient during economic downturns.
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Performance Comparison with Private Real Estate and Equities:
- Despite a 27% decline in REIT prices in 2022, historical data suggests that REIT outperformance versus private real estate and broader equities may extend beyond a recession.
- REITs have shown the ability to outperform private real estate during and after recessionary periods, providing a potential advantage for investors.
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Interest Rate Impact on Property Values:
- Higher interest rates typically depress the value of properties and increase REIT borrowing costs. However, the current report suggests that this is not a significant concern, attributing it to adjusted valuations and improved positioning compared to previous recessions.
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Concentration of REIT Market:
- Sectors like office and retail, despite experiencing declines, accounted for less than 15% of the REIT market in the U.S. in 2022.
- The majority (64%) of the REIT market comprises alternative property types, including data centers, cold storage, and healthcare, providing investors with ample options for diversification.
In conclusion, the comprehensive analysis presented by Bank of America and CenterSquare Investment Management supports the view that REITs, particularly those focusing on specific property types, offer a resilient investment avenue amid economic uncertainties and high-interest rate environments. This aligns with my extensive knowledge and experience in the field, reinforcing the value of considering REITs in a well-rounded investment portfolio.
