What happens to REITs when interest rates go up?
REIT Stock Performance and the Interest Rate Environment
While higher rates negatively impacted nearly every sector of the economy in 2022 and most of 2023, real estate was hit especially hard. Rising interest rates hurt not only the value of REITs' property holdings but also the cost of debt to finance those properties or even refinance already-owned assets.
The REIT has a Zacks Rank #2 at present. The Zacks Consensus Estimate for the retail REIT's 2023 FFO per share has been unchanged over the past month. Despite this, the estimate figure suggests year-over-year growth of 2.3%.
Right now, REITs (VNQ) are at an inflection point and time is running out for investors. But now as we head into 2024, we expect the polar opposite and this should lead to an epic recovery across the REIT sector. The Fed expects at least 3 interest rate cuts in 2024 and the market is predicting even more.
Finally, as owners of real assets, REITs typically enjoy an appreciation in portfolio value along with the price level. With rents and values tending to increase with prices, REIT dividends help provide a reliable stream of income even during inflationary periods.
He says: “Our analysis shows REITs perform very well historically in periods of high inflation. I could easily see global REIT returns in the low double-digits over the next 12 months – and if the economic situation turns out to be more positive it could be considerably more than that.”
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.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
Although the higher cost of borrowing was a headwind, many segments of real estate investment trusts (REITs) continued to show strong fundamentals and supply-demand dynamics. 2024 could be a calmer year if interest rates level off and the pace of commercial real estate transactions normalizes.
Only 9.55% of REITs had a positive total return in January. During January 2023, the average REIT had a strong +11.77% return, whereas REITs had a much rougher start to 2024 with a -5.72% total return.
Why I don t invest in REITs?
The value of a REIT is based on the real estate market, so if interest rates increase and the demand for properties goes down as a result, it could lead to lower property values, negatively impacting the value of your investment.
According to expert panelists at the recent Nareit REITworld annual conference, 2024 could be a year of opportunity for Real Estate Investment Trusts (REITs). They added a note of caution, however, that there are still headwinds affecting investor perspectives on REITs and capital markets in general.
What this means is that REITs are ideal borrowers for banks. They are exactly who they want to do business with because they know that the risk of a REIT bankruptcy is extremely low. Just look at the past. There have been very few REIT bankruptcies over the past 50+ years.
REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
Historically, REITs have provided inflation protection with their unique ability to increase revenue through rent repricing, as well as via inflation-linked growth of their portfolio values, since replacement cost value increases exhibit strong correlation with inflation.
REITs have so far reported higher interest expenses and lower acquisition and development activity compared with prior years. However, most real estate subsectors have also produced rate, revenue, and net operating income growth above the historical average so far in 2023.
REITs historically perform well during and after recessions | Pensions & Investments.
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.
For purposes of the REIT income tests, a non-qualified hedge will produce income that is included in the denominator, but not the numerator. This is generally referred to as “bad” REIT income because it reduces the fraction and makes it more difficult to meet the tests.
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.
How long should I hold a REIT?
REITs should generally be considered long-term investments
This is especially true if you're planning to invest in non-traded REITs since you won't be able to easily access your money until the REIT lists its shares on a public exchange or liquidates its assets. In many cases, this can take around 10 years to occur.
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.
How to Qualify as a REIT? 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.
1. Federal Realty: The king. Federal Realty has increased its dividend annually for 54 consecutive years, which it claims (and there's no reason to doubt it) is the longest streak of any publicly traded real estate investment trust (REIT).
The valuation divergence between REITs and private real estate will likely converge in 2024, making REITs an attractive option for investors. Solid balance sheets will enable REITs to navigate ongoing economic uncertainty while providing an advantage in terms of acquisitions and growth.
