As we enter 2017, between the incoming rate hikes and improved growth expectations, it looks as if new opportunities are developing among Real Estate Investment Trusts, or REITs.
These stocks offer a simple way to invest in real estate for income as well as growth. REITs are designed to benefit from the attractive fundamentals of real estate, without saddling smaller investors with the high capital requirements and low liquidity of actual houses or other physical assets. Through various REITs, an investor can simultaneously become a landlord in an apartment complex 500 miles away, an owner of a high-end shopping center, or a self-storage entrepreneur, without the hassle of actually running these businesses.
A REIT structure allows investors to not only benefit from the long-term value appreciation of all these assets, but it also enables them to get their share of income. The high returns offered by some REITs fit perfectly with the goal of my premium newsletter, The Daily Paycheck: to provide my readers with fat monthly dividend checks.
Publicly traded REITs, as you might recall, have been moved into their own S&P 500 category as of last fall. Many market observers had anticipated that the stocks in the newly formed Real Estate S&P 500 sector — the sector that is focused on REITs — would rally strongly as the Real Estate sector was separated from financials.
Markets trade on expectations, though, and much of the bullish move had happened in anticipation of the September sector unveiling, leaving no gains to be found after the fact. In the fourth quarter of 2016, REITs, as represented by the Dow Jones Equity REIT Total Return Index (REIT), declined by about 3.2%. The good news is that the sector, even with that negative quarter, was positive for the year, up about 8.9%.
There is no question, too, that the recent decline is related to anticipated increases in interest rates. REITs are an income sector, and investors’ interest in these stocks has declined as yields on Treasury bonds have risen.
Moreover, conventional wisdom tells us that higher interest rates should hurt real estate: Borrowing costs — literally the costs of doing business for REITs — are moving higher, thus hurting profits and business outlook across the sector.
But the price decline among REITs, coupled with the perception that higher rates are a serious headwind, has created some buying opportunities.
I say “opportunities” because I think that, while interest rates are a very important factor for REITs, the sector is not that much different from the rest of the stock market: REITs, as with all stocks, ultimately trade on expectations for future profits.
Granted, these profits depend on how quickly REIT companies can raise rents to compensate for the higher interest rates. But rising property prices are also good for REITs because they translate to more assets (measured in dollars) without buying or building new properties.
A better economy, even with higher interest rates, implies a much better outlook for the sector than a declining one, when costs are low but credit is sparse. Plus, because so many REITs have deleveraged in the past few years, the sector’s strong balance sheets will make it easier to borrow.
The outlook for 2017 now calls for economic growth and higher inflation, propelled by expected tax cuts, banking deregulation and fiscal stimulus. Taken together, these factors are shaping up to help the REIT sector rather than hurt it.
And if you need an expert’s opinion, how about the word of Nobel laureate and author of the Case-Shiller index of housing prices, Robert Shiller? On Dec. 27, Shiller said in a Bloomberg TV interview that a “Trump boom” might be coming for the U.S. housing market. He didn’t go quite far enough to say that it certainly would, but he believes the opportunity is there.
Of course, just as not all business sectors are equally leveraged to the 2017 economy, neither will all REITs will benefit from it.