Is now the time to invest in REITs? Real Estate Investment Trusts, commonly known by their acronym REITs, have made a healthy run higher in recent years, but have begun to pull off of recent highs, due to anticipated interest rate hikes by the United States Federal Reserve. In fact, REITs have sold off approximately 10% from their early 2015 highs. This makes investing in REITs more attractive, but is it really the time to invest in REITs with interest rates expected to rise? This is a hard question to answer, but looking at past performance can yield some clues.
Is Now The Time To Invest In REITs?
Stock market participants appear to be selling REITs in anticipation of the Federal Reserve rate hikes that are expected later in 2015. The assumption is that if rates are not hiked in September 2015, they will be by December. However, even that later date is quite tentative, as the Federal Reserve is reacting to incoming economic data. If the data weakens during 2015, the rate hikes could be put off until 2016. Some even speculate that Federal Reserve interest rate hikes are unlikely before the fall 2016 election.
Why does it matter to the stock prices of REITs if the Federal Reserve raises rates sooner rather than later? Because REITs finance their operations by using a considerable amount of short to medium-term borrowing. REITs borrow heavily to maximize their real estate holdings. This works well for expanding their businesses more quickly; however, it also makes REITs quite sensitive to changes in interest rates. As interest rates rise, the cost of doing business also rises for debt-laden REITs. The rise in interest rates may not affect them right away, but once they look to roll over or expand their loans, they will be hit with higher interest costs.
Average In To Invest In REITs
Interest rates have been stuck at multi-decade lows since the financial crisis of 2008 / 2009. Sooner or later, the Federal Reserve is going to start raising rates, and it this will have implications for REIT’s stock prices.
Since the interest rate increases have not even begun yet and REITs are already selling off, is now the time to invest in REITs? It is probably not an ideal time to invest in REITs, but there are many factors that affect stock prices and investor’s perceptions of different stock sectors. Keeping this in mind, it could be a good time to initiate an investment in REITs with a small investment. If REITs fall in price as the Federal Reserve raises interest rates, an investor can average in and buy additional positions until they have purchased the total amount that they intend to invest in REITs.
Invest In REITs For Income
One reason that REITs are so attractive to invest in is because they receive special tax treatment by the Internal Revenue Service (IRS), due to laws passed by Congress. REITs deduct dividends paid to shareholders, which are technically the owners of the companies, from their bottom line earning. In order to be able to deduct dividends paid to shareholders from their federal tax bill, REITs have to distribute at least 90% of their taxable income to REIT shareholders. REIT shareholders then pay federal taxes on their REIT dividends as ordinary income.
What this all means is REITs pay high dividends and will continue to pay high dividends for the foreseeable future, as long as federal tax policy provides them special treatment for paying out most of their income as dividends. This makes REITs excellent investments for those seeking income from their stock holdings.
REITs are not high-flying stocks that can be expected to gain a lot in nominal share price in the short or even long-term. But, they are solid dividend payers that pay well above the paltry amounts that savings accounts pay. It is best to look at REITs as good vehicles for diversifying an investment portfolio into real estate and for earning income, as opposed to viewing them as long-term stock holdings. Over a long period of time, an investor just needs to continuously earn money from REIT dividends to make significant amounts of money holding REITs. The nominal price of their REIT shares are not relevant to long-term holders seeking income.
Which REITs Are Best To Invest In?
Look for REITs that have less exposure to debt or that have debt tied to longer-dated securities. Also, keep in mind that many REITs pay healthy dividends, so you can get paid while you average in and wait for them to eventually recover once the interest rate increase effects have run their course.
The following are some high-yielding REIT funds that make investing in REITs relatively easy. The funds trade on stock exchanges just like stocks, but spread out the risk of owning REITs among numerous companines. The funds pay healthy dividends that are suited for investors looking to generate income from their investments. See their current annual rates of return in parentheses.
- iShares U.S. Real Estate ETF (NYSE: IYR 3.58%) tracks the investment results of an index composed of equities in the real estate sector called the Dow Jones U.S. Real Estate Index.
- iShares Mortgage Real Estate Capped ETF (NYSE: REM, 12.88%) tracks the investment results of an index composed of real estate investment trusts that hold residential and commercial mortgages.
- UBS ETRACS Mthly Py 2xLvg Mortg REIT ETN (NYSE: MORL, 19.65%) holds mortgage REITs in the Market Vectors Global Mortgage REITs Index. MORL is designed to pay out two (2) times the dividends of the REITs that it holds. Index Fund is designed to replicate investment results that correspond generally to the price and yield of the S&P United States REIT Index.