The Right REITs for Rising Rates
Whenever U.S. Treasury rates rise, the price of REITs falls.
It happens time and time again. In fact, when you look at a short-term picture of interest rates versus REIT prices, they’re practically a mirror image.
That’s because the 10-year U.S. Treasury rate is what’s considered a “risk-free rate.” It’s not because there is literally no risk. There’s always some risk when investing. It’s just that the risk of the U.S. government defaulting on its obligations is so minimal.
So, if investors can get a high rate of return from a basically riskless security, they’re going to put their money in it. And if investors are mainly concerned about generating income, if they can get a juicy payment from a risk-free investment, they’re going to take it.
And that’s why you’ll always see REIT prices falling as interest rates head up. Those income investors are selling REITs to buy Treasuries. And then, as prices slip, even the investors who aren’t income-seeking start to sell. And that just multiplies the decline.
Standing Too Close
But that negative correlation isn’t a long-term thing as most people believe. You've got to take a step back and look at the charts again. When you can see the bigger picture, you realize that rising rates aren't all bad for REIT stocks.
In fact, rising rates are actually a great thing for REITs. They’re a sign of a growing economy. And when there’s strong economic growth, those REITs can raise their rents without any fear of tenants not being able to pay.
So, over the course of a few years, you’ll see quality REITs grow in value right along with interest rates.
Towards the end of the bull market that led to the Great Recession, interest rates were high. And, at first, REIT stocks suffered. But then, as the economy continued to grow, the best REITs started to pull away and head up.
The blue chip residential REIT AvalonBay (NYSE: AVB) and office REIT Boston Properties (NYSE: BXP) performed incredibly well in a rising-rate environment…
Investors in AVB were up over 100%, while BXP investors were looking at gains of 165% or higher. All the while, rates were steadily rising.
But this misconception creates a compelling opportunity for those of us who know how quality REITs really perform with rising rates.
The thing about REITs — and what makes them most attractive to income investors — is that they pay spectacular dividends. You see, to be classified as a REIT, a company must pay 90% of its pre-tax earnings to investors as a dividend.
And that makes for some very juicy payments. And as the REIT grows and makes more money, it must pay a bigger dividend. The revenue growth coupled with the dividend growth sends the stock price higher. And investors get a double profit — dividends and capital appreciation.
The thing about those payments is that they seldom fall with the stock price. That means as REIT prices fall, the dividend yield grows at the same frequency…
Back in 2009, at the depth of the recession, the Vanguard REIT ETF had the highest dividend yield in the history of the fund. If you’d bought it back then, you’d still be collecting a yield of more than 8% on those shares. And that yield would only grow as the ETF increases its payout.
Right now, thanks to uninformed investors selling the sector as rates rise, the yields on REIT funds are the highest they’ve been since the recession. So, buying REITs to lock in that high yield now is a no-brainer.
But you’ve got to buy the right REITs for rising rates. Remember, only the top-notch operations will profit. So you’ve got to be picky about the REIT sectors you target and the REIT stocks in those sectors.
I’m looking into several sectors this year. And I’ve got some stocks lined up in each of them for my subscribers at The Wealth Advisory. I’ll share the sectors here, but it wouldn’t be fair to give away the stocks until my paying readers have a chance to invest.*
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Oh, Health Care Yeah!
Health care REITs have been a darling of mine for several years now — ever since the first baby boomers started hitting 65. Not because all 65-year-olds need a lot of health care, but because that marked the start of the (at that time) biggest generation in American history becoming senior citizens.
You can’t slow down aging. And as the boomers continue to add on the years, the chance that they’ll need special care at a skilled nursing facility (SNF) will keep on rising.
Over the next few years, we’re going to start having a lot more people in the 65-and-up age range. In fact, the senior population in the U.S. grew by 20% between 2009 and 2015 — from around 39.1 million people to over 47 million. And that number is projected to just keep getting larger and larger for many years to come…
It’s a recession-proof industry that’s only going to keep growing as time passes.
But as the population has been aging, the number of SNFs has been shrinking. During the same period that the 65+ population grew by 20%, the number of SNFs in the U.S. dropped by about 1%.
Now, there are several choices when it comes to health care REITs, but my personal favorite is one that’s just gone on a four-year run of payment increases and is paying new investors a fat 7% yield to buy shares.
Hotel, Motel, Holiday Inn
Hospitality REITs are another sector on my radar for 2018 and a rising rate environment. The economy’s doing better. People have more money to spend. They’ll travel more. They’ll book more hotel rooms.
And these companies have the right idea about owning a hotel. They own the buildings and property, but they rent them out to hotel management companies to run.
You know that Hilton you just stayed in? Or the Marriott across the street? Well, there’s a good chance that one or even both are owned by one of these companies.
And this industry is incredibly cheap right now — read that as it’s got super-high yields, too. There are two reasons for that.
First off, lodging is cyclical. The economy has to be doing well for lodging stocks to do well. And they’re a lagging indicator of a booming economy. That means they’re not going to go up until the economy already has.
But the economy is improving right now, so we can expect to see this lagging indicator start to improve, too. And we can get in at historically low price levels and lock in historically high yields.
The second reason hotel stocks are down now is Airbnb (and the entire sharing economy). Investors are worried that companies like Airbnb that allow homeowners to rent out rooms or their entire place to visitors will destroy the hotel sector as we know it.
But state governments have caught on to Airbnb and are adding hotel and hospitality taxes to your purchase. In fact, I went to book a house for a week trip to Vermont this winter and was looking at over $600 in hotel taxes on Airbnb.
Those taxes are going to make Airbnb much less competitive as more localities tack them on.
And there’s actually a way to avoid Airbnb entirely in your hotel investment. That’s by looking for hotels that are near airports, business districts, convention centers, and other places where travelers are more likely to just want a room with fresh towels instead of a house with someone else’s stuff in it.
My favorite hospitality REIT has just that. Its hotels are all concentrated in urban gateway markets. They’re primarily located in the central business districts and dense metropolitan centers of cities like New York, Boston, D.C., Philadelphia, Miami, LA, and San Diego.
They get business travelers who don’t want to be too far from where the meetings are. They also get international business and leisure travelers who aren’t so keen on renting a house from a perfect stranger. And those are the most desirable travelers in the lodging sector. They’re not going to trash your room. They’re going to pay you before they leave. And they’re likely to come back for repeat visits.
Oh, and did I mention that it pays new investors a 6% yield for coming on board? And that it's on a four-year run of hiking its dividend payout, too?
All the Pretty Houses
I’m also looking into both industrial and residential REITS. I haven’t narrowed those two sectors down to a single stock yet, but I’m getting close. The right companies stand to do very well in the coming years.
Ecommerce is growing and knocking off traditional retailers one by one. They’re closing stores. They’re laying off staff. Some are on the verge of declaring bankruptcy. Eventually brick-and-mortar stores may even become a thing of the past.
But there’s one thing those traditional retailers and ecommerce ones have in common: They both need warehouses — lots of them. They also need ways to move products between those warehouses and get them to customers.
And that’s creating a massive opportunity in the warehouse and logistics sectors. The right company is going to grow by leaps and bounds right along with the ecommerce industry.
Then there are the other houses, the kind you live in. I see residential real estate growing in the coming decades. Just not necessarily in the traditional way you’d expect.
As all those baby boomers hit retirement age, they’re starting to think about moving from the big house where they raised their family to something smaller now that it’s just them. The trend is called “downsizing.” And a whole industry is springing up around it.
But in the REIT world, residential apartments are looking tempting to me. When you’re ready to move into a smaller place, an apartment or condo is likely to do just the trick.
There’s no lawn to take care of. There’s no maintenance at all. If something breaks, you call the management company. And you’re in a close community with all sorts of amenities that you just wouldn’t have in a house.
So I’m convinced that the right residential REIT will treat investors very well as the years progress.
And with prices so deflated and yields so high, now is the time to invest.
To learn more about how successful we’ve been with REIT investments at The Wealth Advisory and to learn more about one of our absolute best income-generating investments, click here.
To your wealth,
After graduating Cum Laude in finance and economics, Jason analyzed complex projects and budgets for the U.S. Army. Then, at Morgan Stanley, he led the assistants' team for the North American repo sales desk, responsible for hundreds of multibillion-dollar trades every day. Jason is the assistant editor for The Wealth Advisory income stock newsletter. He also contributes regularly to Wealth Daily. To learn more about Jason, click here.
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As the Wall Street Journal reported:
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