Why are REITs performing poorly?
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.
This is because when interest rates rise, it becomes more expensive for Reits to borrow money to refinance their loans, resulting in an erosion of their dividends. On top of that, returns from yield products like fixed deposits and government Treasury bills were also on the rise, competing for investors' capital.
The biggest risk to REITs is when interest rates rise, which reduces demand for REITs. 6 In a rising-rate environment, investors typically opt for safer income plays, such as U.S. Treasuries. Treasuries are government-guaranteed, and most pay a fixed rate of interest.
Due to the strong negative correlation, rising interest rates in 2022 directly led to the negative performance of the real estate sector that year. While interest rates have mostly flattened out since October 2022, the higher rates have kept REIT stock prices down.
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 REIT sector has faced many challenges over the past few years, including COVID-related closures and tightening monetary policy. Franklin Equity Group Portfolio Managers Blair Schmicker and Daniel Scher discuss how a return to pre-pandemic monetary policy could mean a promising 2024 for publicly traded real estate.
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.
Some of the main risk factors associated with REITs include leverage risk, liquidity risk, and market risk.
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.
How well do REITs do 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.
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.
After a volatile couple of years, we're optimistic about the potential for a calmer year in 2024. Given the strong fundamentals and compelling long-term drivers among certain REIT subsectors, we think the coming year could be constructive for patient real-estate investors.
With healthy property fundamentals and a favorable interest rate environment, REIT fund managers expect the sector to deliver double digit returns this year.
If the REIT fails this ownership test for more than 30 days (31 days if the year has 366 days) in a taxable year of 12 months, it can lose REIT status and cannot elect to be treated as a REIT for five years (IRCазза856(a)-(b)). The test is pro-rated for taxable years shorter than 12 months.
Thus, between falling interest rates, the coming decline in new deliveries, and attractive relative valuations, REITs appear to be poised for a strong rally over the next few years.
Considering their past performance, analysts have presented a positive outlook for the REIT sector in 2024. As mentioned above, the capital market activity within the sector has significantly grown last year, which would positively impact the sector's productivity this year.
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.
Real estate investment trusts, or REITs, allow investors to add a diversified collection of real estate to their portfolio through a single entity. Real estate investments can be an excellent way to earn returns, generate cash flow, hedge against inflation and diversify an investment portfolio.
“Both public and non-public REIT investments should be considered long-term, and that could mean different things to different folks, but in general, investors who typically invest in REITs look to hold them for a minimum of three years, and some of them could hold them for 10+ years,” Jhangiani explained.
What is the 90% REIT rule?
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.
Since most non-traded REITs are illiquid, there are often restrictions to redeeming and selling shares. 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.
Stocks and REITs are not guaranteed and have been more volatile than bonds. Stocks provide ownership in corporations that intend to provide growth and/or current income. REITs typically provide high dividends plus the potential for moderate, long-term capital appreciation.
It's not necessarily a bad idea to own REITs in taxable brokerage accounts. But because of complex REIT taxation rules, they certainly make more sense in IRAs. This way, the REITs avoid taxation on the corporate level and you can defer or avoid taxes on the individual level, as well.
By default, all dividends distributed by a REIT are considered ordinary, or non-qualified, and are taxed as ordinary income.
