Are REITs safer than real estate?
Publicly traded REITs offer investors a way to add real estate to an investment portfolio or retirement account and earn an attractive dividend. Publicly traded REITs are a safer play than their non-exchange counterparts, but there are still risks.
The Bottom Line
Both can also be a source of regular cash flow, though REITs are a much more passive investment than real estate. Whichever route you take, though, real estate can be a great way to grow your net worth, diversify your investments and hedge against inflation.
Here are some of the main disadvantages of investing in a REIT. Market volatility: Value can fluctuate based on economic and market conditions. Interest rate risk: Changes in interest rates can affect the value of a REIT.
Any increase in the short-term interest rate eats into the profit—so if it doubled in our example above, there'd be no profit left. And if it goes up even higher, the REIT loses money. All of that makes mortgage REITs extremely volatile, and their dividends are also extremely unpredictable.
Most of the time, REITs offer better returns with lower risk for most investors. But especially today, REITs offer far better return prospects and much lower risk because their valuations are so heavily discounted. Investing in REITs provides both a margin of safety and future upside potential.
REITs provide a much simpler way to invest in real estate and earn consistent income through dividends, but they confer less control, and their upside tends to be lower than that of rental properties.
Risks of REITs
REITs closely follow the overall real estate market and are subject to much of the same risks, including fluctuations in property value, leasing occupancy, and geographic demand. Real estate is typically very sensitive to changes in interest rates, which can affect property values and occupancy demand.
REITs historically perform well during and after recessions | Pensions & Investments.
Share prices for US real estate investment trust stocks jumped in the fourth quarter of 2023, outperforming the broader market.
The lack of government regulation makes it difficult for investors to evaluate them since little to no information is available publicly. Also, they are not required to prepare audited financial statements.
What I wish I knew before investing in REITs?
This is the biggest and most important mistake that REIT investors keep on making. They see REITs as "income vehicles" and therefore, they will select their investments based on their dividend yield. In their mind, the higher the better. But in reality, the dividend is just a capital allocation decision.
But since REITs are invested in property, there's more protection against the horror show of having shares crash to $0. By law, 75% of a REITs asset must be invested in real estate. The market value of the property owned by the REIT offers a bit of protection, as long as the value of the property doesn't go to zero.
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To qualify as a REIT, a company must have the bulk of its assets and income connected to real estate investment and must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends.
REITs allow individual investors to make money on real estate without having to own or manage physical properties. Direct real estate offers more tax breaks than REIT investments, and gives investors more control over decision making.
With government bonds, the investor is a creditor of the government. Stocks and REITs are not guaranteed and have been more volatile than bonds.
Camden Property, Prologis, and Realty Income have some of the safest dividends in the REIT industry. All three companies have top-tier financial profiles, enabling them to sustain their dividends even during tough times. They're great options for investors seeking rock-solid passive income streams.
Though REITs have typically experienced relative total return underperformance during Fed tightening cycles, they have outperformed both private real estate and equities in post-rate hike periods.
Publicly traded REITs offer investors a way to add real estate to an investment portfolio or retirement account and earn an attractive dividend. Publicly traded REITs are a safer play than their non-exchange counterparts, but there are still risks.
Traditional metrics such as earnings per share (EPS) and price-to-earnings (P/E) ratio are not reliable ways to estimate the value of a real estate investment trust (REIT). A better metric to use is funds from operations (FFO), which makes adjustments for depreciation, preferred dividends, and distributions.
Investors in real estate investment trusts (REITs) were hit hard as the Federal Reserve has aggressively raised interest rates in 2022 and 2023. REITs invest in real estate, lease it to tenants and trade on the stock market like a stock.
Why are REITs performing poorly?
A high interest rate environment and bearish investor sentiments have made it a tough year for REIT companies. In general, REITs are underperforming the real estate sector, which isn't exactly having the best year of its life either.
Symbol | Company | REIT performance (1-year total return) |
---|---|---|
AOMR | Angel Oak Mortgage Inc. | 60.92% |
SKT | Tanger Outlets | 55.01% |
MDV | Modiv Industrial Inc. | 44.80% |
SEVN | Seven Hills Realty Trust | 41.52% |
Many investors assume that as a rule, interest rates and Real Estate Investment Trusts (REITs) move in opposite directions, where rising interest rates translate to falling returns and weaker performance for REITs. This is a common misconception.
REITs. When interest rates are falling, dependable, regular income investments become harder to find. This benefits high-quality real estate investment trusts, or REITs. Strictly speaking, REITs are not fixed-income securities; their dividends are not predetermined but are based on income generated from real estate.
REITs provide natural protection against inflation. Real estate rents and values tend to increase when prices do. This supports REIT dividend growth and provides a reliable stream of income even during inflationary periods.
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