REITs: Is it still a viable investment?

In a version of the MFS Investments investment return cycle chart from 2001 to 2020, real estate investment trusts (REITs) are the best performing asset class. On average, the average annualized rate of return is 9.71%, slightly higher than that of small and medium-sized Stocks.

Of course, past performance does not guarantee future returns. So in the current environment, are REITs still viable investments for individual investors and financial advisers and their clients?

Interest rate + REITS

The Vanguard Real Estate Investment Trust Index Fund (VGSLX), which tracks the MSCI US Real Estate Investment Trust Index, has a current yield of 3.13% as of September 2021. In today’s low interest rate environment, this is undoubtedly attractive to many investors. Rising interest rates are usually a negative factor for REITs; their outflows increase due to higher interest payments, which reduces the cash they can use to pay dividends to investors.

Real estate investment trust funds that have excessive debt levels or need to refinance real estate in the short term are more susceptible to interest rate hikes than other real estate investment trust funds.

For example, in 2018, the price of Vanguard REIT ETF (VNQ) fell by more than 12% from its January 2015 high, partly due to uncertainty about the timing and willingness of the Fed to raise interest rates.

REIT’s past performance in an environment of rising interest rates

Cohen & Steers, an investment management company that provides a variety of REIT funds, used the Fed tightening cycle from June 2004 to June 2006 as an example to illustrate that higher interest rates initially hurt REIT performance. But over time, a strong economy can help increase the returns of REITs. The company said that during this period, the cumulative return on REITs was 57.9%, compared with 15.5% for stocks and 5.9% for bonds.

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The company stated, “When the economy is improving and fundamentals are strong, yield-driven adjustments have historically provided attractive buying opportunities for long-term investors. As the benefits of stronger economic growth become more apparent, estimates Values ​​tend to return to normal. We believe that in the long run, investors who are willing to take advantage of these opportunities may reap the rewards.”

REITs provide diversified advantages

According to the comparison between the Standard & Poor’s 500 Index and the NAREIT Stock REIT Index in the 10 years to the end of 2020, the correlation between REITs and stocks is as high as 70%, which proves that REITs are not very diversified stocks. However, in terms of low or negative correlations with core bonds, commodities, and currencies, REITs do provide good diversification.

In addition to interest rates, the performance of REITs will depend on the performance of the economy and the stock market. In an interview with CNBC, Joseph Smith, chief investment officer of CB Richard Ellis Clarion Securities, which manages approximately US$22 billion in real estate assets, said: “There has been a flip between economic growth expectations and interest rates. This uncertainty has caused volatility and During periods of volatility, the relevance of REITs to the broader stock market will increase.”

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Recently, the new crown pneumonia epidemic has brought new risks and opportunities to the real estate market. Initially, work stoppages and isolation forced many commercial companies to close, and pandemic-related unemployment prevented many people from paying rent. However, government aid and stimulus measures have helped ease this fluctuation.

According to the 2021 report by Cohen & Steers, REITs are in a good position in 2022 as analysts expect the global economy to recover. They wrote: “Just as COVID has disrupted the REIT market in 2020, we believe it may become a major beneficiary of vaccines and potential economic recovery.”

Factors affecting personal REITs

Like any mutual fund or ETF, there are related REITs in these funds. Personal REITs can include real estate investment trusts that own a basic portfolio of commercial real estate, residential real estate, hotels, or resorts. In addition, specific industries such as healthcare and professional fields such as timber and mortgage real estate investment trusts are also involved.

The point here is that some of the performance of these REITs will be linked to the performance of their related stock markets and business units. This means that the performance of these REITs exceeds the performance of the overall stock market or economy. This is no different from quoting the real estate motto that all real estate is local.

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Individual REITs are also influenced by those who manage them. As with any other stock or similar tool, management is important. What is their experience? Are they shareholder-centric? Do they have their own money to invest with your money?

The 2017 Tax Cuts and Employment Act (TCJA) is beneficial to investors in real estate. Some changes in the new tax law affect REITs. For example, REITs benefit from a 20% deduction of the income of the passing entity.

Bottom line

Like many other investments today, REITs may be affected by a period of interest rate hikes, at least initially. Highly leveraged REITs and those that may need to refinance debt when interest rates rise may be more vulnerable than others. Those who focus on a single REIT need to focus on the management of the company and its underlying investment portfolio. There are many mutual funds and ETFs that also provide reliable exposure in this area. Over time, REITs have proven to be a reliable part of many investment portfolios and are likely to continue to move forward.

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