REITs on the Rebound! Forget Stocks and Bonds

The Fed is going to raise rates next month – killing the real estate investment trust (REIT) sector.

Or so popular wisdom would have you believe. The problem is, it isn’t true. Or at the very least, it isn’t supported by history. Worse, it completely ignores two important reasons why REITs are more likely to remain strong rather than flop.

For one, it’s hard to see the Fed raising rates by more than 0.25% to 0.50% unless we see the pace of economic growth suddenly step it up a notch. The dollar is already so strong that it’s stifling export growth, and the Fed isn’t looking to make a bad situation worse. Raising rates by any significant degree would do just that. So it’s doubtful that investors will sell their income-bearing REITs for Treasury bonds that still dish out next to nothing.

But not only will this likely be a relatively mild tightening cycle compared to past rate hikes, in some cases REITs actually fair just fine – even quite well – during these periods.

The chart below tracks the price performance of the NAREIT All Equity REIT Index going back to the early 1980s (in blue). It compares the index to the Federal Reserve’s targeted Fed funds rate (in orange). Periods of extended tightening are highlighted in the blue columns.

REIT Price Performance - Periods of Fed Tightening

We’ve had five periods of extended tightening since 1981. In three of them, REIT prices did indeed suffer. But in the other two – or a full 40% of the total – REIT prices did very well. In fact, the last tightening cycle in the mid-2000s coincided with one of the greatest bull markets for REITs in history.

As for today, most of the hurt in the REIT sector that comes with a rate hike has already been priced in. That’s because this is the most telegraphed Fed tightening in history. Yellen has been preparing us for this day for months. Investors who wanted to sell, for the most part already have.

So as a result, income-focused investments like REITs have had a terrible year. After topping out at $89.27 per share in late January, the Vanguard REIT ETF (NYSEARCA: VNQ) fell to as low as $74.67 by late June. That’s a decline of 16%, based almost exclusively on Fed fears.

But since then, REITs have been making a comeback, up about 6%. For the reasons I’ve explained, I expect that modest momentum to continue, with or without a Fed hike. With bond yields still very low, and the stock market looking wobbly, REITs are one of the few attractive options for investors looking for growth and income.

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Charles Sizemore

Editor, Dent 401k Advisor