Why REITs Can Help You Win—or Lose Less—Right Now (2024)

FAQs

Why REITs Can Help You Win—or Lose Less—Right Now? ›

Refinancing worries

Tighter financial conditions suggest that Reits with high leverage may find it increasingly difficult to meet their debt obligations or roll over existing debt maturities. The spillover impact from financial stresses is well documented in the US office Reit segment.

Refinancing worries

Tighter financial conditions suggest that Reits with high leverage may find it increasingly difficult to meet their debt obligations or roll over existing debt maturities. The spillover impact from financial stresses is well documented in the US office Reit segment.

Real estate can protect against inflation because rental or lease payments can increase annually to reflect price increases and land and building values can rise alongside inflation. Past research on listed real estate as an inflation hedge has used mean variance as a metric for measuring risk.

Historically, REITs are one of the better-performing sectors during inflationary periods. We can see this in the following image. You'll notice REITs are in the upper right area, showing they are outperformers during periods of high inflation.

Can You Lose Money on a REIT? As with any investment, there is always a risk of loss. Publicly traded REITs have the particular risk of losing value as interest rates rise, which typically sends investment capital into bonds.

The economy continues to be strong, but rates are cyclically high. While property values and REIT prices have been declining, 2023 should see the beginning of a rebound, especially in the public markets, which tend to be a forward indicator.

Disadvantages of REIT Investment

REITs are subject to interest rate risk, which is the risk associated with changes in interest rates. REITs may be subject to liquidity risk, making it difficult for investors to sell their REIT investments quickly.

Stocks have delivered higher returns in recent years, with the S&P 500 beating REITs over the previous five- and 10-year periods. However, the overall data shows that REITs have outperformed stocks over the long term.

Interest Rates. During periods of economic growth, REIT prices tend to rise along with interest rates. The reason is that a growing economy increases the value of REITs because the value of their underlying real estate assets increases.

Buy Treasury Bonds

There are two popular types of treasury bonds that are good investments for individuals who are worried about inflation: Series I Savings Bonds. Series I bonds are interest-bearing government savings bonds. They are a low-risk option that earn interest and are protected against inflation.

What are the top 3 REITs in the US? ›

Top-performing real estate investment trusts (REITs) in May include Peakstone Realty Trust, Apartment Investment & Management Co., and Service Properties Trust, which have risen 45% or more in the past year, even as volatility in U.S. real estate markets persists.

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.

Buying inflation bonds, or I Bonds, is an attractive option for investors looking for a direct hedge against inflation. These Treasury bonds earn monthly interest that combines a fixed rate and the rate of inflation, which is adjusted twice a year. So, yields go up as inflation goes up.

Summary of Why Investors May Not Want to Invest in REITs

But, REITs are not risk free. They may have highly variable returns, are sensitive to changes in interest rates, have income tax implications, may not be liquid, and fees can impact total returns.

“I recommend REITs within a managed portfolio,” Devine said, noting that most investors should limit their REIT exposure to between 2 percent and 5 percent of their overall portfolio. Here again, a financial professional can help you determine what percentage of your portfolio you should allocate toward REITs, if any.

The property held to produce rental income must remain in the REIT for at least two years. Any accumulated expenditures made through the REIT, during the two-year duration, may not exceed 30% percent of the property's net sale price.

There is no set lifetime for the trust in most cases. Investors who buy publicly traded shares in a REIT can usually buy as much or little as they like and dispose of the shares when they want or need to.

Investment manager Hazelview Investments sees upside for REITs this year. Not only because their balance sheets are strong, but also because their valuations are low. Investor sentiment drove the 2022 decline for REITs, more so than business results. That positions high quality REITs for a comeback this year.

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.

Bad REIT Income means (i) the amount of gross income received by the Borrower (directly or indirectly) that would not constitute (A) “rents from real property” as defined in Section 856 of the Internal Revenue Code or (B) interest, dividends, gain from sales or other types of income, in each case, described in Section ...

What are the 3 principal risks that all REITs face? ›

Berkshire has a history of outperforming the S&P 500 during recessions, and performing especially well during bear markets, according to data from Bespoke Investment Group. Since 1980, Berkshire shares have beat the broader market over the course of six recessions by a median of 4.41 percentage points.

General requirements

A REIT cannot be closely held. A REIT will be closely held if more than 50 percent of the value of its outstanding stock is owned directly or indirectly by or for five or fewer individuals at any point during the last half of the taxable year, (this is commonly referred to as the 5/50 test).

Investing in U.S. exporters, tangible assets (foreigners who buy U.S. real estate or commodities), and appreciating currencies or stock markets provide the basis for profiting from the falling U.S. dollar.

When the prices for goods and services are rapidly rising, holding cash in your portfolio becomes less attractive. The prospect of prolonged inflation “argues against having too much in cash,” Christine Benz, director of personal finance and retirement planning at Morningstar, recently told The New York Times.

Adding certain asset classes, such as commodities, to a well-diversified portfolio of stocks and bonds can help buffer against inflation. Be cautious about overallocating to cash, but make sure your emergency fund is keeping up with rising costs.

Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making. Many REITs are publicly traded on exchanges, so they're easier to buy and sell than traditional real estate.

This 2007 and 2008 underperformance was due, largely, to the financial crisis freeze of credit markets for most REITs, which had spent the relatively low-interest rate years of 2001 to 2007 taking on too much debt.

Are REITs a good investment in a bear market? ›

Although the prospect of an economic downturn rippling across the waters is not an encouraging picture, one of the best investment ideas for productive protection is REITs to buy for a bear market.

You may also want to consider inflation risk as you figure out what kind of asset allocation to have in your portfolio. Fixed investments, like bonds or fixed annuities, can be adversely affected by inflation. To diversify, some investors choose to add gold or inflation-indexed investments to their portfolios.

As of March 15, 2023 publicly traded U.S. equity REITs posted a one-year average dividend yield of 3.49 percent. The health care REIT sector recorded the highest one-year average dividend yield among this group, at 4.82 percent, outperforming the broader Dow Jones Equity All REIT Index by 1.33 percentage points.

Bond returns consist primarily of income with little chance for major capital appreciation. REIT returns consist of some income and the chance for capital appreciation. As such, they are slightly more risky and typically carry higher returns to compensate.

REITs primarily pay through dividends and generally don't appreciate in value significantly. Because of their high dividend yield, holding a REIT in your Roth IRA or health savings account is generally the most tax-efficient strategy.

What is the 95% rule for REIT? ›

In order to meet the 95% test, at least 95% of a REIT's gross income must be derived from sources described in the 75% test as well as from earnings from certain types of portfolio income such as interest, dividends and gains from sales of securities.

To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.

This means that if a foreign corporation owns 40% of the stock of a domestic corporation, which owns 80% of a REIT, the look-through rules would attribute 32% of the REIT stock (i.e., 40% x 80%) to foreign owners, despite a substantial majority of the REIT (80%) being owned by a domestic corporation.

Soaring interest rates and the weakening economy have crushed real estate investment trusts in 2022, with the FTSE Nareit All Equity REIT index dropping 23% year to date.

Recession and REITs: An Opportunity for Outperformance

REITs started 2022 priced at an implied 4.14% cap rate when the 10-year treasury yield was at 1.5%. By the end of the year, 10-year treasury yields had expanded to 3.6%, and in response, REIT implied cap rates expanded to 5.80%.

Most REITs are less volatile than the S&P 500, with some only half as volatile as the market at large. The self-storage REIT subgroup shows the highest returns, with annualized returns of 18.8% from 1994 to 2021.

Out of more than 200 publicly-traded REITs in the U.S., only two companies have managed to attract Buffett: Store Capital (NYSE: STOR)³ and Seritage (NYSE: SRG)⁴.

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.