Why have REITs crashed?
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.
Undoubtedly, rising interest rates pose challenges for REITs. All else being equal, higher interest rates tend to decrease the value of properties and increase REIT borrowing costs.
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.
Does Warren Buffett invest in REITs? The short answer is yes. Berkshire Hathaway does allocate capital real estate ownership throughout REITs. Learn Warren Buffett REIT investments below.
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.
REIT bankruptcies have indeed been a rarity since the REIT debacle of the mid-1970s, when high leverage and highly speculative real estate investments resulted in numerous REIT failures. Thereafter, REIT managers became far more conservative in their investment and financing practices.
Benefits of investing in REITs include tax advantages, tangibility of assets, and relative liquidity compared to owning physical properties. Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
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.
Is it a good time to get into REITs?
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.
Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.
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.
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.
# | Name | C. |
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1 | Redefine Properties 1RDF.JO | πΏπ¦ |
2 | Prologis 2PLD | πΊπΈ |
3 | Fortress REIT 3FFA.JO | πΏπ¦ |
4 | American Tower 4AMT | πΊπΈ |
So, are REITs the magic shortcut to becoming a millionaire? Not quite. But they can be a powerful tool to build your wealth over time, like a slow and steady rocket taking you towards financial freedom. Remember, the key is to invest wisely, do your research, and choose REITs that match your goals and risk tolerance.
Symbol | Fund name | 1-year return |
---|---|---|
BRIUX | Baron Real Estate Income R6 | 12.08% |
JABIX | JHanco*ck Real Estate Securities R6 | 11.07% |
RRRRX | DWS RREEF Real Estate Securities Instil | 9.26% |
CSRIX | Cohen & Steers Instl Realty Shares | 9.84% |
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.
REITs historically perform well during and after recessions | Pensions & Investments.
Are REITs safe during inflation?
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.
Like all common stocks, returns and principal invested in REITs are not guaranteed. REITs typically provide high dividends plus the potential for moderate, long-term capital appreciation. A REIT must distribute at least 90% of its taxable income to shareholders annually.
Reinvesting REIT dividends can help retirement savers grow their portfolio's investment, and historically steady REIT dividend income can help retirees meet their living expenses.
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.
Key Takeaways. REITs allow individual investors to make money on real estate without having to own or manage physical properties. Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making.
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