As interest rates rise, so does the cost of financing property. Since REITs are in the business of property ownership, you may be wondering what’s going to happen now that interest rates are poised to rise. Here are a few things you need to understand about REITs and interest rates.
Rising Interest Rates
REITs are sensitive to changes in interest rates. That’s because REITs have a higher dividend yield than other real estate products. In fact, REITs and interest rates are 47% negatively correlated. This means that as interest rates rise, yields go down. Since rates are definitely rising, some investors are reconsidering REITs in their portfolio.
After historically low interest rates for several years, the Federal Reserve has begun raising rates. In fact, rates have risen six times in the last 18 months and could rise another three to four time before the year is out. Many statisticians suggest that 2019 will see the same trend.
However, there is more to REITs than interest rates. Let’s look at the REIT sector, the Treasury rate, and your own portfolio.
Every REIT is different. Some focus on single-family housing. Others focus on industrial spaces. Some on commercial property. If you would like to keep REITs in your portfolio, you should consider REIT sectors that do better with rising interest rates.
First, you should focus on equity REITs. These are funds that give you shares in actual properties rather than mortgages. Then you need to think about sectors. Some to consider include:
- Residential and Office – Higher interest rates go hand-in-hand with economic growth and higher demand. Both can increase the REIT yield as long as the higher interest rates actually indicate a good economic forecast. This is especially true if occupancy and rents are rising, too.
- Industrial – eCommerce is booming despite higher interest rates, leading to high-yield industrial REITs
- Data Center – Cloud computing is a growing field that is not hampered by rising rates. This sector is projected to continue to have substantial growth.
10-Year Treasury Rate
Although there is a correlation between Federal Reserve rates and REITs, the 10-year Treasury rate matters even more. REITs typically remain a good investment as long as 10-year treasury rates don’t jump up swiftly.
That’s because Treasury rates correlate with economic growth and inflation. As the economy grows and inflation rises, treasury rates fall. As Treasury rates fall, interest rates increase for the very same reason.
Of course, eventually, treasury rates will rise with interest rates. The decision you’ll need to make is whether the REIT can outperform the rate hikes. Some people holding REITs in their portfolio choose to diversify into other real estate assets as interest rates rise.
Your Financial Portfolio
Finally, your own financial portfolio will help you determine if you want to keep your REITs. All decisions about rising rates should be seen along with your overall financial plan.
If you are currently seeking to reduce risk, such as those nearing retirement, then divesting of REITs may be right for you. REITs swing more than other investments. This means that if you rely on these investments for income, you may not be able to count on a specific amount each month.
However, for those not as risk-adverse, REITs often provide great yields. For those using REITs for income, having a yield investment makes sense. That’s because most of the market’s growth comes from dividends and yields as opposed to higher stock prices.
REITs may still be a good investment even with rising interest rates. If the economy keeps growing, then REIT yields will also continue to grow. However, watch the numbers closely to be sure that economic forecasts continue to be solid.
If you’d like more information about getting started with REITs or other real estate investment techniques. Give me a call. I’d love to help you understand REI and the economic power it brings to those that invest.