Why are REITs failing?
"REIT share prices were hurt by macro issues such as hybrid work model-driven office space demand, slower IT & ITES hiring, expected global recession and high interest rates," said Shantanu Bhargava, head of discretionary investment services at Waterfield Advisors.
Here's an explanation for how we make money . 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.
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.
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.
But despite that, most REITs have kept growing their dividend. Most of them hiked in 2022, 2023, and will hike again in 2024. This is the ultimate proof that REITs are doing better than what the market appears to believe.
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.
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.
No investment is without risk, and REITs can and do go bankrupt – so it's important to do your own research. One downside of these investments is that, due to the rigid structure of the dividend pay-outs, it can be difficult for the companies to reinvest much capital back into the business.
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. Moreover, low interest rates contribute to higher valuations.
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.
What is the long term outlook for REITs?
Though REITs have typically experienced relative total return underperformance during Fed tightening cycles, they have outperformed both private real estate and equities in post-rate hike periods. With the Fed at or near the end of its interest rate hike cycle, this bodes well for 2024 REIT performance.
As the REIT industry continues to evolve, its future growth prospects remain promising. According to the reports, the global REIT market is projected to reach a staggering $5.8 trillion by 2030, growing at a CAGR of 7.1% during the forecast period of 2023-2030.
Finally, a REIT is not a pass-through entity. This means that, unlike a partnership, a REIT cannot pass any tax losses through to its investors. Consider consulting your tax adviser before investing in REITs.
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.
During the REIT operation period that can last up to 7 to 10 years, the sponsor manages its properties to produce an income stream. REIT management seeks to monetize the portfolio in an effort to realize a capital gain for investors, although there's always the risk of a loss instead.
Due in part to their attractive current yields, REITs have tended to deliver annualized total returns to investors of 10 to 12 percent over time.
While a REIT is still open to public investors, investors may be able to sell their shares back to the REIT. However, this sale usually comes at a discount; leaving only about 70% to 95% of the original value. Once a REIT is closed to the public, REIT companies may not offer early redemptions.
Key Points. REITs have outperformed stocks on 20-to-50-year horizons. Most REITs are less volatile than the S&P 500, with some only half as volatile as the market at large.
Because the REIT manages the property, investors are not burdened with the everyday stress of vacancies, tenants, management or repairs. REITs also pay out dividends to investors, providing a reliable passive income stream.
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.
What is the downside of REITs?
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
REIT Stock Performance and the Interest Rate Environment
Over longer periods, there has generally been a positive association between periods of rising rates and REIT returns. This is because rising rates generally reflect improvement in the underlying fundamentals.
While they provide a compelling set of benefits, it should be noted that, like any investment, non-traded REITs come with risks, including illiquidity, loss of principal, real estate risks, and more.
Over time, the cash flow generated by those dividend payments can supplement your Social Security and pension income. Perhaps, it can even provide all the money you need to maintain your preretirement lifestyle. It is possible to live off dividends if you do a little planning.
Investors can buy and sell shares of public REITs at any time during trading hours. With private REITs, on the other hand, investors may have to wait for a redemption event, which can occur quarterly or annually, before they can cash out their investment. Additionally, private REITs may charge redemption fees.
