Is Real Estate A Safe House?
June 1, 2022 | George Yacik | Financial Advisor
With inflation running at its hottest pace since the 1980s, the Federal Reserve raising interest rates over the next two years, and growing worries about a looming recession, how will real estate be expected to perform in this new environment?
Actually, this state of affairs may make some real estate investments—whether they are made through direct purchases of individual properties or real estate investment trusts (REITs)—a smart move going forward.
Real estate was the best performing sector in the S&P 500, after energy, in 2021, rebounding from a relatively weak 2020, when it was the worst, albeit with a 4.9% return. From the beginning of this year through May 9, the real estate sector lost 17.7%, while the S&P 500 lost 16.3%.
What should financial advisors advise their clients to do?
As it happens, financial advisors are pretty bullish on the sector. According to a recent survey conducted for the National Association of Real Estate Investment Trusts (Nareit), 83% of them recommended REITs to their clients, and suggested an allocation of 4% to 12% to the sector in client portfolios.
Indeed, REITs tend to perform pretty well during periods of rising rates, according to John Worth, Nareit’s executive vice president for research and investor outreach. “When we look at 12-month periods since the early 1990s where the 10-year Treasury was rising, you see positive REIT returns 85% of the time,” he says. “In general, for long-term investors, there’s no reason to deviate from holding REITs in your portfolio during a period of rising interest rates.” In addition to scoring positive returns, REITs act as a diversifier to both stocks and bonds while also providing income and capital appreciation.
The main reason interest rates are rising, Worth notes, is the positive expectations for economic growth, and this benefits real estate investment trusts. “More economic growth means rising rents and higher occupancy rates, which flows through to positive REIT earnings,” he says. In 2021, REIT earnings increased 25% above 2020 earnings to their highest on record.
REIT balance sheets are also “resilient to rising rates and really well prepared for an increase in interest rates,” he says. The average term on REIT debt is eight years. The interest expense as a percentage of operating income is near its historic low. And REITs’ use of leverage has declined dramatically. It is also now near an all-time low.
