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Your gains from REITs can increase when interest rates rise quickly. Stocks have plummeted recently as increased interest rates have pushed investors to move their money to more stable investment options.
This dip has caused many REIT investors to wonder if they have their investments in the right industry. An unprecedented period of low-interest rates makes it difficult to understand how these changes may impact different industries.
However, we can make some reliable estimates by comparing historical REIT returns to the 10-year treasury yield.
REITs and Interest Rates
The federal reserve has historically increased interest rates during inflationary periods to prevent runaway inflation.
Inflationary periods usually occur during times of economic growth, so it can be difficult to disentangle which effects on commercial real estate are the result of growth, and which are the effects of the interest rates themselves.
Interest rates can affect REITs in different ways. Depending on their portfolio, REITs may have different relationships with interest rates, which means that the effects are slightly different.
Residential REITs and interest rates
Higher interest rates mean higher mortgage costs. High mortgage rates can drive consumers away from home ownership, increasing the demand for rentals.
This increase in demand leads to profits for REITs invested in residential real estate. The Fed setting higher mortgage rates also means that REITs offering financing to properties can (and will) charge higher rates to borrowers, thereby increasing their returns.
Retail REITs and interest rates
REITs are often able to charge higher rates for retail spaces during times of high interest, which leads to increased profit.
On the other hand, the retail industry as a whole is negatively affected by increased interest rates due to increased overhead costs.
Because retail can suffer during times of high interest rates, it offsets some of the increased returns that REITs may have otherwise expected.
For example, if interest rates are high, retail stores are less likely to expand and rent new spaces, or increase manufacturing.
Regardless of inflation and interest rates, food demand will remain stable. When money is tight, consumers will not cut food from their budgets (barring dining at restaurants).
Because food is a necessary and essential commodity, agriculture continues to grow even when interest rates rise.
Historical precedent suggests that even if the agricultural sector suffered, it would gain support from the federal government.
Historical REIT Returns
Like all aspects of the economy, REITs and interest rates are linked in various ways. Understanding every connection between interest rates and REITs requires data and insights that even expert analysts don’t have.
While it is impossible to predict the market perfectly, we can gather some insights from past interest rate spikes to estimate how REITs will be affected by increased interest rates.
When interest rates spiked in the past, REITs had higher returns in four out of six reviewed instances. REITs have outperformed the S&P over the last 30 years, regardless of interest rates and economic downturns.
This outperformance is likely because, even raising capital costs more, REITs can charge higher rates for rentals and loans.
These increased rental rates will probably impact REITs more significantly than the cost of capital, thus causing an overall increase in returns.
Do REITs do well when interest rates rise?
It is possible, however, that if interest rates stay high for a long time, REITs will struggle with long-term growth after a short period of rapid success.
This long-term risk is because the cost of capital will increase, and purchasing new investments may become difficult causing REIT companies to stagnate.
How to Invest in REITs in High Interest Rate Environment
Investing in a REIT during a period of high interest rates is the same as investing during any other time, except for the process of choosing a REIT investment.
If interest rates are high, you should look more closely the portfolio of a REIT before you invest. Overall, when interest rates increase, the REIT sectors that you should consider for a positive total return are:
- Residential real estate REITs
- Diversified portfolio REITs
- Agricultural REITs
After deciding in which kind of REIT you want to invest, you should look for a company that meets your portfolio goals. If the REIT you selected is private, you will need to meet with a broker.
If you want to invest in a traded REIT, you can purchase REIT stocks like any other common stock through the major stock exchanges and a brokerage.
Choose a brokerage where you want to open an account, and then follow their guidelines on investing.
Should I Invest in REITs When Interest Rates Rise?
Yes, you should invest in REITs when interest rates rise. Historically, REIT performance has been better than the stock market in rising interest rate environments.
Though there is some risk for investors if interest rates stay high in the long term, due diligence and diversification can protect you from most losses.
REITs can also provide you with a good source of cash flow from dividend income when it may be difficult to justify a loan, and you are not likely to go under in the event of a financial crisis.