Real estate investment trusts (REITs) are companies that own and operate real estate properties. Like stocks, you can buy and sell shares through brokerage accounts, and they're required by law to pay at least 90% of their taxable income to shareholders as a dividend.
As much as I've loved REITs in the past, 2023 hasn't exactly produced the ideal climate for them to thrive. While that's not totally a bad thing, I think potential REIT investors should be aware of what they're getting into and the hiccups that, like air bubbles in wallpaper, won't go away.
Why I wouldn't invest in REITs in 2023
Disregarding for a moment some popular real estate speculation -- market crashes, the commercial real estate crisis, you know, the usual hubbub -- the real estate sector isn't performing great right now.
Looking at the S&P 500 Real Estate index, which gives us an overview of the sector's top performers, real estate hasn't changed much in 2023, sporting a rather stagnant year-to-date increase of roughly 2.7% (as of July 3). If we look closely at different REIT types in this sector, we'll see that most are underperforming its larger real estate sector. Take a look for yourself. Here's a quick snapshot of how REITs have moved year to date.
| S&P 500 Real Estate Sector | 2.7% |
|---|---|
| Health Care REITs | -1.8% |
| Hotel & Resort REITs | -4.4% |
| Industrial REITs | 2.9% |
| Office REITs | -19.1% |
| Residential REITs | -2.3% |
| Retail REITs | -8.6% |
| Specialized REITs | -1.1% |
Data source: Yardeni Research "Performance 2023 S&P 500 Sectors & Industries"
Only one of these REIT types -- industrials -- is outperforming the wider real estate market and by such a narrow margin (2.7% vs. 2.9%) it's hard to say one is even outperforming the other.
Investor confidence in REITs is low. Part of that could be due to speculation, but a larger part is due to the Fed's aggressive interest rate hiking campaign, which has increased the federal funds rate by its fastest pace in 40 years. Since REITs typically employ heavy leverage to develop and manage properties, high interest rates tend to increase borrowing costs and at the same time slow down property appreciation. That could leave some REITs with less revenue to dish out to shareholders, making them slightly less attractive this year.
Now, I will say this -- rising interest rates could affect REITs differently, and while bearish investor sentiment could affect the REIT industry as whole, certain REITs could find a way to flourish. Understanding how a specific REIT company makes money -- as well as how much debt it's leveraging -- could help you make a smart investment decision.
As for me, the REIT industry is a bit too volatile right now, and I think my money could be invested in better places. I understand that certain great REIT companies could be trading at discounted prices, but I'm also attracted to those investments that are positively impacted by interest rates, like CDs. I'll likely stay away from REITs until I feel like the sector has stabilized enough to prop up those fat dividends these investments are known for.
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