Filed under: Buying, Financing, Refinancing
Filed under: Economy, Investing
By Kira Brecht
Concerns about the potential impact of higher interest rates have sent real estate investment trusts on a roller coaster ride this year, after chalking up double-digit gains in 2014. Despite their recent fickle behavior, however, this asset class belongs in the diversified portfolios of long-term investors, experts say. What’s more, the volatility could provide a buying opportunity.
A REIT is simply a company that owns or finances income-producing real estate. Most REITs are traded on major stock exchanges, and investors can purchase a share of the REIT just as they would any other stock. One major draw of REITs is that they provide investors with a regular income stream, as they typically pay out their taxable income as dividends to shareholders.
In the low interest-rate environment that has prevailed in recent years, income investors have turned to REITs to generate potentially higher rates of return than more traditional income-generating investments, such as Treasury bills or certificates of deposit. In 2014, the FTSE NAREIT All Equity REITs Index gained an eye-popping 28 percent. But so far this year through May 28, the index is down 0.32 percent, erasing an 8.8 percent gain in January.
“REITs are about the only game in town if you are looking for strong yield,” says Brad Case, senior vice president at the National Association of Real Estate Investment Trusts, an industry association group. Even compared with stocks, the dividend yield for equity REITs is favorable at 3.61 percent, versus a 2 percent dividend yield on the Standard & Poor’s 500 index through April 30.
This spring, REIT shares sold off amid concerns over whether an increase in interest rates will hurt REIT prices, Case says, adding that it’s a common misconception that REITs perform like bonds. Real estate is a separate asset class from stocks and bonds, and investing in REITs offers an opportunity to diversify your portfolio with exposure to the real estate sector.
Here are three reasons to consider adding REITs to your portfolio.
REITs typically perform well when interest rates are going up. “With bonds, when interest rates go up, bond values go down. But for REITs, when interest rates go up because the economy is strengthening, you have higher rent growth and higher occupancy rates, which means higher income from buying real estate,” Case says.
Looking back over the previous 16 periods of rising interest rates, Case notes that REIT returns were “positive in 12 of those periods and strongly positive in nine of 12.” He highlights the June 2005-June 2006 period as a time when interest rates were rising in response to a growing economy. From June 2, 2005, to June 26, 2006, 10-year Treasury yields climbed from 3.89 percent to 5.25 percent, while REITs gained 20.7 percent during that period.
REITs complement a well-diversified portfolio. “Long-term investors seeking to construct and maintain a well-diversified portfolio should invest in REITs to gain exposure to an important asset class that is otherwise difficult to access,” says Michael Knott, managing director of Green Street Advisors, a Newport Beach, California, real estate research and advisory firm. “REITs are the best way to achieve real estate-like returns and the benefits of diversification to one’s portfolio.”
For investors who don’t have exposure to real estate, now may be a good time to consider adding an allocation, Knott says. He recommends a target of 5 percent to 15 percent for most investors.
“Despite the recent volatility, REIT valuations are more attractive than earlier in the year,” wrote Mark Litzerman, co-head of real estate strategy at Wells Fargo Investment Institute in a May research report. “Investors may want to consider taking advantage of potential opportunities to add to underweighted portfolios.”