Will REITs crash if interest rates rise?
They will often be more influenced by the interest rates. As interest rates go down REITs will often go up. As interest goes up the value of REITs usually will go down. Since interest rates are so low there is more chance of them going up than down.
Rising interest rates hurt not only the value of REITs' property holdings but also the cost of debt to finance those properties or even refinance already-owned assets.
Real estate investment trusts (REITs) have been hammered since 2022 with interest rate increases. At the last Federal Open Markets Committee (FOMC) meeting, the Federal Reserve promised another hike in 2023 and spooked the markets by stating that higher rates may have to continue for a longer time.
The valuation divergence between REITs and private real estate will likely converge in 2024, making REITs an attractive option for investors. Solid balance sheets will enable REITs to navigate ongoing economic uncertainty while providing an advantage in terms of acquisitions and growth.
Historically, REITs have provided inflation protection with their unique ability to increase revenue through rent repricing, as well as via inflation-linked growth of their portfolio values, since replacement cost value increases exhibit strong correlation with inflation.
Although interest rates certainly affect real estate values and, therefore, the performance of REITs, rising interest rates do not necessarily lead to poor returns. Since the early 1970s, there have been six periods during which 10-Year U.S. Treasury Bond yields rose significantly.
REITs historically perform well during and after recessions | Pensions & Investments.
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.
Give us cheap REITs (real estate investment trusts) because they are likely to rise as rates fall. Yes, that's what happens in a recession. Investors flood into fixed income. Interest rates fall, and REITs—which tend to move opposite rates—rise.
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.
Are REITs safe long-term?
Investing in REITs can add some diversification to your portfolio and give you access to passive income, liquidity and excellent long-term returns. However, taxes can be more expensive with REITs compared to other investment options, and there are still risks involved with the real estate market.
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.
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.
In most cases, REITs utilize a combination of debt and equity to purchase a property. As such, they are more sensitive than other asset classes to changes in interest rates., particularly those that use variable rate debt. When interest rates rise, REITs share prices can be prone to volatility.
REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
2023: A sideways year
For the second consecutive year, rising borrowing costs were the most significant factor impacting REITs in 2023. The overall volume of purchases and sales remained low due to high interest rates and scarce capital.
The Nareit All Equity REIT index has posted positive total returns year-to-date in 2023 after a steep decline in 2022. Nareit has also chronicled the spread between public and private markets, and although that gap has narrowed in 2023, there is still room for convergence.
Publicly traded REITs offer investors a way to add real estate to an investment portfolio or retirement account and earn an attractive dividend. Publicly traded REITs are a safer play than their non-exchange counterparts, but there are still risks.
Share prices for US real estate investment trust stocks jumped in the fourth quarter of 2023, outperforming the broader market. The Dow Jones Equity All REIT Index closed the quarter with a 17.9% total return, while the S&P 500 logged an 11.7% return for the quarter.
Economic Risk: REITs get influenced by market conditions, and their prices can fluctuate based on factors such as interest rates, economic conditions, and real estate market trends. During periods of economic downturn or market instability, REITs may experience a decline in value.
Why are REITs bad in a rising rate environment?
Therefore, if rates begin to rise then REIT cash flows will decline at a time when discount rates are rising. They fear the end result will be capital losses that offset the higher distribution yield and result in negative total returns.
Rising interest rates raised borrowing costs and hammered property valuations. Attractive yields on bonds offered stiff competition to the distributions from REITs. Perhaps most worrisome, office vacancy rates have soared, as many tenants gave up space amid entrenched hybrid work.
Risks of REITs
REITs closely follow the overall real estate market and are subject to much of the same risks, including fluctuations in property value, leasing occupancy, and geographic demand. Real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.
However, bonds and REITs are very different, both in terms of their advantages and disadvantages. REITs are a form of equity (stock) that should continue enjoying total returns that are superior to bond returns over time while also doling out higher amounts of current income.
In the past two decades, market research and academic literature have suggested that adding REITs to a mixed-asset portfolio offers diversification benefits over long time horizons, primarily because of a low correlation with the U.S. stock market since the late 1990s.
