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Investor’s Guild
Investor’s Guild

REITs: Too soon?

REITs: Too soon?

Wednesday, June 5, 2024 by Stephanie Guild, CFASteph is a Wall Street alum and head of investment strategy for Robinhood.
Richard Newstead/Getty Images
Richard Newstead/Getty Images

REITs. This stands for real estate investment trusts—and their returns have generally stunk since early 2022. 

Let’s back up for a minute though. REITs came to be in 1960 through the Real Estate Investment Trust Act. However, they didn’t become popular until the 1990s, when more funding was needed after the real estate recession of the late 1980s. 

They're structured to make investing in real estate easier for the everyday investor and even provide some tax benefits like you may get from investing in property directly. Companies must meet several criteria to qualify as REITs, including:

  • Shareholder base: The company must have a broad base of over 100 shareholders and a limited number of controlling parties. 

  • Fully invested: 75% of their assets need to be invested in property, while the same percentage of earnings must come from rental income.

  • Pay-out rule: 90% of the income generated by the REIT must be distributed to shareholders. This also means the majority of their income is untaxed since it’s sent to investors.

REITs invest in all types of real estate from apartment buildings to data centers to healthcare properties. There are also residential REITs that focus on homes and retail REITs that focus on shopping. With over 220 publicly traded US REITs across the market cap spectrum, the S&P 500 real estate sector includes 31 real estate companies.

Like real estate, REITs are sensitive to the level and direction of interest rates. When interest rates rise, like they have since 2022 (black line in the chart), this tends to detract from real estate valuations (like the green line), and vice versa.

This phenomenon is actually true for many assets but particularly for real estate, since purchases are often made with borrowed money.

This week, we’ve gotten several data points that show growth is slowing, including a drop in the Atlanta Fed’s GDP estimate, as well as softer than expected data in the ISM Manufacturing number and job openings data (JOLTs). While we could see a major slowdown due to slowing growth and consumer behavior, the positive side of this will eventually come—lower inflation and interest rates.

In fact, the market is currently pricing in a 70% chance of a 0.48% rate cut by December, up from a 40% probability in April. 

Lower interest rates are eventually positive for real estate and stock values. So I’m starting to pay more attention to US REITs. Some stats:

  • The S&P real estate sector is down -3.85% since the start of the year and is down -1.8% per year for the last 3 years. 

  • But there has been diversity in the range of returns between different REITs, from -44% to +18% year-to-date (through June 5th). 

  • On average, dividend yields are higher for REITs. The last 12-months dividend yield for the sector was 3.6% as compared to the broader S&P 500 at 1.35%. Though note that the tax treatment is different for REIT dividends, which is considered ordinary income, while dividends from other stocks tend to be taxed at the lower qualified dividend rate.

Timing is a little more important here in relation to economic data and potential Fed actions. So I’m not fully there yet in terms of being bullish—we might still be 3-6 months out.

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