When interest rates rise, investors fear that income-producing investments such as bonds and real estate investment trusts (REITs) will fall because of the inverse relationship between rates and prices.
Interest rates have jumped over the past two years from record lows, causing price disruptions. So why haven’t REITs fallen?
Here’s a chart that may open your eyes to a longer-term view:
The chart shows that the weighted price of the S&P Composite 1500 real estate sector is higher now than it was two years ago, while the yield on 10-year U.S. Treasury notes TMUBMUSD10Y, -0.45% rose to 2.87% on Aug. 21 from 1.63% two years earlier. There have been two major declines in REIT prices over the past two years, but prices recovered as the economy continued to grow.
So a REIT investor who ignored conventional wisdom and didn’t sell, received his or her dividend income (the primary purpose of most REIT investments) the entire time, while the value of the investments ultimately recovered (and then some) from two significant declines.
All things being equal, if interest rates increase, the market value of a bond will decline because a newly issued bond (of similar quality) will pay more. The old bond’s market price falls so that its yield will attract a buyer. But for REITs, the story is different. Interest rates normally increase during a period of economic expansion. So while there is downward pressure on a REIT’s share price, the REIT’s rental income may be increasing and the value of the properties it holds may go up as well.
So for an investor who really needs the income, patience is required during periods of rising rates. The income will continue to flow, as long as the REITs he or she selects have sufficient cash flow to cover or raise their dividend payouts.
Analysts at Pimco have argued that REITs are competitive long-term investments, factoring in total returns, volatility and tax advantages. But for these long-term periods, as a group, the REITs have underperformed the S&P Composite 1500 Index (made up of the large-cap S&P 500 SPX, +0.62% the S&P 400 Mid-Cap Index MID, +0.40% and the S&P 600 Small-Cap Index SML, +0.35% ):
|Total returns through Aug. 21|
|3 years||5 years||10 years||15 years|
|S&P 1500 Composite Real Estate Sector||28%||69%||130%||288%|
|S&P 1500 Composite Index||55%||93%||181%||301%|
The REITs have trailed the S&P 1500 Composite significantly for all these periods except for 15 years. But the very long-term data supports Pimco’s argument.
If you wish to diversify your portfolio with real estate, here are two examples of ETFs that track the performance of the SPDR Dow Jones REIT ETF RWR, +0.57% :
• The Schwab U.S. REIT ETF SCHH, +0.66% has a 30-day yield of 3.51%, according to Morningstar and annual expenses of 0.07% of assets. The ETF’s five-year total return through Aug. 21 was 61%, according to FactSet.
• The SPDR Dow Jones REIT ETF RWR, +0.57% has a 30-day yield of 3.50% and annual expenses of 0.25%. Its five-year total return through Aug. 21 was 59%.
The yields on the two ETFs mentioned above are not particularly attractive. Among the 106 REITs included in the S&P 1500, there are 29 with market values of at least $1 billion and dividend yields above 4.5%:
|REIT||Ticker||Primary investment activity||Dividend Yield||FFO yield based on past four quarters||‘Headroom’ based on past four quarters||Total return – 3 years|
|Washington Prime Group Inc.||WPG, +1.03%||Shopping centers||12.63%||23.99%||11.36%||-15%|
|Uniti Group Inc||UNIT, -0.63%||Communications infrastructure||11.56%||12.09%||0.53%||41%|
|Government Properties Income Trust||GOV, +0.47%||Properties leased to government agencies||10.12%||12.65%||2.53%||40%|
|Global Net Lease Inc||GNL, -0.42%||Diverse commercial properties||9.89%||8.92%||-0.98%||13%|
|Senior Housing Properties Trust||SNH, -0.16%||Senior housing and health care properties||8.19%||8.35%||0.16%||50%|
|Omega Healthcare Investors Inc.||OHI, +0.18%||Health-care properties||8.03%||5.95%||-2.08%||15%|
|Sabra Health Care REIT Inc.||SBRA, -0.39%||Health-care properties||7.74%||10.96%||3.22%||15%|
|Lexington Realty Trust||LXP, +0.33%||Commercial properties||7.71%||10.97%||3.26%||35%|
|GEO Group Inc||GEO, +0.00%||Prisons||7.45%||7.37%||-0.08%||54%|
|Hospitality Properties Trust||HPT, +0.00%||Hotels||7.29%||12.00%||4.71%||35%|
|Kite Realty Group Trust||KRG, +0.46%||Shopping centers||7.27%||11.51%||4.24%||-19%|
|CoreCivic Inc.||CXW, +0.04%||Prisons||6.74%||8.42%||1.68%||7%|
|Medical Properties Trust Inc.||MPW, +0.40%||Health-care properties||6.67%||9.47%||2.80%||47%|
|Kimco Realty Corp.||KIM, +0.53%||Shopping centers||6.57%||9.09%||2.52%||-19%|
|Iron Mountain Inc.||IRM, -0.50%||Document and data storage facilities||6.47%||5.67%||-0.80%||50%|
|Ramco-Gershenson Properties Trust||RPT, +0.80%||Shopping centers||6.35%||9.31%||2.96%||0%|
|EPR Properties||EPR, +0.07%||Entertainment, recreation, education||6.18%||7.25%||1.07%||53%|
|Tanger Factory Outlet Centers Inc.||SKT, -0.33%||Outlet shopping centers||5.67%||8.72%||3.04%||-13%|
|HCP Inc.||HCP, +0.04%||Senior housing and health care properties||5.50%||7.13%||1.63%||-12%|
|Ventas Inc.||VTR, -0.83%||Senior housing and health care properties||5.34%||7.05%||1.71%||16%|
|Summit Hotel Properties Inc.||INN, -0.44%||Hotels||5.26%||8.69%||3.43%||28%|
|Welltower Inc.||WELL, +0.05%||Senior housing and health care properties||5.24%||6.15%||0.90%||14%|
|Easterly Government Properties Inc.||DEA, +0.65%||Properties leased to U.S. Government agencies||5.18%||6.28%||1.10%||47%|
|Macerich Co.||MAC, +0.21%||Shopping centers||5.06%||6.21%||1.15%||-11%|
|Weingarten Realty Investors||WRI, +0.23%||Shopping centers||5.04%||7.53%||2.49%||7%|
|LTC Properties Inc.||LTC, +0.29%||Senior housing and health care properties||4.97%||6.61%||1.64%||20%|
|Chesapeake Lodging Trust||CHSP, +0.06%||Hotels||4.88%||5.79%||0.91%||29%|
|Lamar Advertising Co. Class A||LAMR, +1.43%||Billboards||4.83%||6.36%||1.52%||58%|
|Realty Income Corp.||O, +0.26%||Diverse commercial properties||4.51%||5.05%||0.55%||40%|
An attractive dividend yield doesn’t tell you very much. You need to have confidence that a REIT will continue to be able to cover or raise its dividend payout over the long term. This means you need to do your own research to understand the strategy of any REIT you consider for investment.
We have included each company’s real-estate specialty, as well as 12-month FFO yields. Funds from operations (FFO) is a non-GAAP figure used in the REIT industry to gauge dividend-paying ability. It adds depreciation and amortization back to earnings, while subtracting any gains from the sale of real estate. Dividing FFO per share by the current share price gives us the 12-month FFO yield.
If a company’s FFO yield is well above its dividend yield, it appears to have “headroom” to pay higher dividends. But 12 months of FFO data cannot be your only indication of dividend-paying ability. There may have been an extraordinary event that drove it up or down over the past year. This underlines the importance of gaining a level of comfort before committing to a long-term investment,.
As you can see from the three-year total return figures, some of these REITs, especially those that own shopping centers and malls, have been hit very hard over the past several years. A very high yield certainly indicates a lack of confidence among investors that the dividend will be maintained.
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