Do REITs do well in a recession?
REITs historically perform well during and after recessions.
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.
The generous dividend payments enjoyed by REIT investors may look particularly attractive moving forward. With rate cuts on the horizon, dividend yields for REITs may look more favorable than yields on fixed-income securities and money market accounts.
April 2, 2024, at 2:50 p.m. Real estate investment trusts, or REITs, are a great way to invest in the real estate sector while diversifying your options. Real estate investments can be an excellent way to earn returns, generate cash flow, hedge against inflation and diversify an investment portfolio.
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.
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.
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.
REITs have typically enjoyed strong absolute and relative total return performances after monetary policy tightening cycles end. The valuation divergence between REITs and private real estate will likely converge in 2024, making REITs an attractive option for investors.
A lot of REIT investors focus too way much on the dividend yield. They think that a high dividend yield implies that a REIT is cheap and a good investment opportunity. In reality, it is often the opposite, and the dividend does not say much, if anything, about the valuation of a REIT.
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 90% rule for REITs?
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.
| 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% |
| # | Name | M. Cap |
|---|---|---|
| 1 | Prologis 1PLD | $96.25 B |
| 2 | American Tower 2AMT | $80.28 B |
| 3 | Equinix 3EQIX | $71.57 B |
| 4 | Welltower 4WELL | $54.08 B |
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.
Two of the primary factors contributing to the recent underperformance of REITs are the rising interest rates and the recent bank failures. However, the fundamentals of many of these REITs remain strong. Their performance is tied more to stock market fears than the actual performance of the real estate market.
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.
Bad REIT earnings tend to run afoul of Section 856, which provides that at least 95% of a REIT's gross income must be derived from “rents from real property.” It also provides that at least 75% of its gross income must be derived from that source.
| REIT SUBGROUP | AVERAGE ANNUAL TOTAL RETURN (1994-2023) |
|---|---|
| Industrial | 14.4% |
| Residential | 12.7% |
| Health Care | 11.6% |
| Retail | 11.2% |
REITs make money by investing the corpus into various real estate properties such as commercial properties, workspaces, malls, etc. They receive rental income from these properties, which are distributed as dividends to the unitholders. Also, they make money through capital gains by selling the assets.
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 bounce back?
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.
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.
In 2021 and 2022, amid a strong economy driven by cash-rich consumers, demand heavily outpaced supply across most sectors of commercial real estate. This spurred developers to start a huge slate of projects that began to come to market in 2023 and will continue over the course of 2024.
Rising interest rates and expectations of future changes in monetary policy have at times impacted the share prices of equity REITs. However, increases in interest rates often are driven by economic growth that may support the growth of REIT earnings and dividends in the future.
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.
