In the climate of the current bull market, stock performance gets most of the attention; but that doesn’t mean there still aren’t other investment opportunities that are poised to generate a generous return. Indeed, any well balanced portfolio is a somewhat diversified one, and there are investments other than stock, bonds, or mutual funds that can perform in a bull market.
Credit: Giovanni Calia
Specifically, REITs (or Real Estate Investment Trusts) represent a unique investment opportunity in the current economic climate. Not all REITs, however, are created equal, and whether or not a specific REIT is an investment worth making will depend on a number of factors. That being said, any REIT that is positioned to perform in this bull market (amid rising interest rates) would be an excellent candidate for inclusion in any well-balanced, diversified portfolio.
What is a REIT?
Essentially, a REIT is like the real estate version of a mutual fund. Instead of investing in stocks or bonds, however, REIT investors are investing in real estate assets like hotels, malls, apartment buildings, or office buildings.
Why to Invest in REITs
In the US, a REIT must pay at least 90 percent of its taxable income back to investors in the form of dividends, which helps avoids taxation at the company level. Consequently, REITs can offer investors generous dividend payouts, and potentially capital gains if the REIT’s properties increase in value.
Who Invests in REITs
Simply put, REITs represent a promising investment opportunity for any one who wants to buy into commercial real estate but, for whatever reason, is unable to buy into those commercial properties directly. This includes investors who:
- can’t afford to purchase an entire property,
- want the option to get in and out of commercial real estate at will (as they would if they were buying/selling stocks or bonds)
- are income-oriented and looking to diversify a portfolio that already contains more traditional investments
The point is that REITs allow investors to buy and sell commercial real estate on the open market as they would stocks or bonds. This opens the commercial real estate market up to investors that would otherwise be excluded, while affording them the tools to mitigate their risk by being able to sell their stake with a few clicks of a mouse.
Why (or Why Not) to Invest REITs in 2018
The dividend payouts and versatility of REIT investments aside, there are other, more timely factors to consider when investing in REITs in 2018. Specifically, while tax reform benefits REITs and their investors, rising interest rates can temper REIT profits as they drive up operational costs.
Tax Reform Benefits
Under the current US administration, tax reform has benefited investors in a number of ways, and some of this reform has been particularly beneficial for REITs. As US news reports:
The Tax Cuts and Jobs Act includes several provisions that are advantageous to investors in general and real estate in particular. Some of the changes included in the new tax law directly affect REITs.
[…] [These] tax changes may appeal strongly to investors looking to increase both diversification and income from REITs. [A]nd less tax means more profit for shareholders.
So recent tax reforms mean that REITs are able to post higher profits, and with a minimum of 90 percent of the REITs taxable income being paid back to investors in the form of dividends, REITs are excellent candidates for portfolio managers or income-oriented investors.
Rising Interest Rates
The US Federal Reserve has already raised interest rates twice in 2018, and another “rate hike at its next meeting in September is likely.” And generally, rising interest rates threaten the value of interest earnings, such as real estate, and that can drive down a REITs price.
However, REITs are not your typical real-estate investment. Many savvy REITs lenders take operational and financial performance into account when negotiating financing terms for REIT-owned properties, and this can mean lower interest rates for REIT borrowers. As US News explains:
Borrowing costs for REITs do not necessarily rise in lockstep with other rates because “lenders become more optimistic,” […] REITs tend to take out long-term loans, so many will benefit from the low borrowing rates they have locked in over the past few years […]
The point is that whether or not a particular REIT is a good investment during these times of rising interest rates depends on the financing terms that REIT has already locked itself into when financing its portfolio of properties. If a REIT is locked into a lower, pre-hike rate, it can be expected to benefit from tax reform measures and generate a respectable return. If it’s financing rates are susceptible to increases in the US Federal Fund Rate, however, rise in the rate can offset the benefits offered by recent tax reforms.
REIT the Writing on the Wall
The fascinating thing about REITs is how they blend the worlds of trading and real-estate investment. They allow investors to buy and sell shares in real estate holdings without the significant capital required to acquire an actual property, just as they invest in stock, bonds, or any type of mutual fund. And in bringing these two worlds together, REITs offer many of the advantages of both.
Whether or not a specific REIT is a sound investment opportunity, however, will depend on whether it’s positioned to weather interest rate hikes. If it is, then that REIT is also positioned to thrive under recent tax reforms, and makes an attractive addition to any well-balanced, diversified portfolio.