Why do REITs do well in a recession?
By law, a REIT must pay at least 90% of its income to its shareholders, providing investors with a passive income option that can be helpful during recessions. Typically, the upfront costs of investing in a REIT are low, while their risk-adjusted returns tend to be high.
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.
The strong finish kept domestic REITs in line with the broader markets in 2008. The S&P 500 dropped 37 percent for the year, while the NASDAQ Composite fell 40.54 percent. The Russell 2000 was down 33.79 percent, and the Dow Jones Industrial finished 2008 down 33.84 percent.
Meanwhile, real estate is a hedge against inflation and has tax advantages. Even with inventory levels driving up prices, investing in real estate during a recession could still result in significant long-term returns. If you're willing to hold on to your investment, you can benefit from the eventual market rebound.
The thinking is that REITs are highly-levered, bond proxies with very little growth. Therefore, if rates begin to rise then REIT cash flows will decline at a time when discount rates are rising.
By law, a REIT must pay at least 90% of its income to its shareholders, providing investors with a passive income option that can be helpful during recessions. Typically, the upfront costs of investing in a REIT are low, while their risk-adjusted returns tend to be high.
With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts. However, REIT stocks are only as good as the properties they own — and some real estate sectors may be better positioned than others.
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.
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.
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.
What is the best real estate opportunity in a recession?
Historically, multifamily properties have been a source of stability for real estate investors. They provide a steady source of income through rent, and there is always a demand for occupancy. The risks associated with owning a multifamily property are much lower during a recession than a single-occupancy home.
Because a decline in disposable income affects prices, the prices of essentials, such as food and utilities, often stay the same. In contrast, things considered to be wants instead of needs, such as travel and entertainment, may be more likely to get cheaper.
Cash: Offers liquidity, allowing you to cover expenses or seize investment opportunities. Property: Can provide rental income and potential long-term appreciation, but selling might be difficult during an economic downturn.
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.
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.
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.
REITs don't have to pay a corporate tax, but the downside is that REIT dividends are typically taxed at a higher rate than other investments. Oftentimes, dividends are taxed at the same rate as long-term capital gains, which for many people, is generally lower than the rate at which their regular income is taxed.
Treasury Bonds
Investors often gravitate toward Treasurys as a safe haven during recessions, as these are considered risk-free instruments. That's because they are backed by the U.S. government, which is deemed able to ensure that the principal and interest are repaid.
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.
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.
Have REITs outperformed the S&P 500?
REITs have outperformed the S&P 500 over the long term. A big driver has been the robust returns from self-storage, industrial, and residential REITs.
REITs tend to outperform in the high inflation periods, with strong income returns offsetting falling REIT prices. On average, REITs outperformed the S&P 500 by 5.6 percentage points during these periods.
Is Five Years the Standard "Hold" Time for a Real Estate Investment? Real estate investment trusts (REITS) and other commercial property investment companies frequently target properties with a five-year outlook potential.
Since they aren't publicly available and don't register with the SEC, it's difficult to pinpoint specific investment minimums. However, investment firm Edward Jones says minimum investments for private REITs can range from $1,000 to $50,000.
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.
