What happens to REITs in a recession?
The FTSE Nareit All Equity index, consisting of REITs that exclude mortgages, generated a 15.9% annualized return during recessions and 22.7% in the year following the end of a downturn, according to the National Association of Real Estate Investment Trusts.
REITs. When interest rates are falling, dependable, regular income investments become harder to find. This benefits high-quality real estate investment trusts, or REITs. Strictly speaking, REITs are not fixed-income securities; their dividends are not predetermined but are based on income generated from real estate.
Bottom line. Investors eyeing REITs may find a potential recovery ahead. With rate cuts on the horizon, many publicly traded REITs have rebounded, and the industry as a whole seems well-poised for a recovery in the coming year.
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.
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.
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.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
Non-traded REITs have little liquidity, meaning it's difficult for investors to sell them. Publicly traded REITs have the risk of losing value as interest rates rise, which typically sends investment capital into bonds.
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.
Will REITs crash if interest rates rise?
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.
“REITs often structure buildings as separate financial entities. If they default on debt, creditors generally can foreclose on the building but have no recourse against the rest of the company … in this way, the loss incurred by the REIT is contained,” says Sharma.
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.
Real Estate Investment Trusts, vehicles that pay out most profits as dividends, are better positioned to weather high interest rates and recession fears than private equity real estate or stocks, according to analysts at Bank of America and CenterSquare Investment Management.
Even with a challenging market, REITs are considered a staple for many investment portfolios thanks to the 90% rule. As the name implies, this rule stipulates that real estate trusts must distribute 90% of their taxable earnings to existing shareholders.
Since the value of a mortgage bond trades inversely to interest rates (higher rates cause mortgage bond values to decline), higher rates will mean that the NAV of a mortgage REIT will decline and often take the share price with it.
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.
REITs must prioritize short-term income for investors
In exchange for more ongoing income, REITs have less to invest for future returns than a growth mutual fund or stock. “REITs are better for short-term cash flow and income versus long-term upside,” says Stivers.
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.
REITs historically rebound when interest rates pivot and have the potential for rent growth. Realty Income, Agree Realty, VICI Properties, Essential Properties Trust, and American Tower are strong picks for long-term growth and income.
What is the future outlook for REITs?
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.
Because REITs use debt to purchase investments, rising interest rates could mean these companies would have to pay more interest on future loans. This could in turn reduce their return on investment. Because of this, REITs could potentially lose value when interest rates rise.
Bankruptcies are extremely rare in the REIT sector. After all, REITs are required to keep the bulk of their assets in physical properties, or debt backed by real estate. Most real estate tends to appreciate over time, and as long as it holds its value, a REIT can sell properties to pay down debt in a pinch.
Positive returns -- but smaller than in 2023
I think that the overall stock market will deliver positive returns in 2024. However, I expect those returns to be somewhat smaller than they were last year.
The structure leveled the playing field that was once only available to those with a high net worth. Today, anyone with an online brokerage account and some spare cash can invest in REITs with just a few clicks. Overall, REITs have been a good investment throughout the years.
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