5 Reasons Not to Run From REITs During Rising Interest Rates
If you’ve been investing in Real Estate Investment Trusts (REIT) to seek competitive yields and income in the historically long 0% interest rate environment, you’ve probably been thrilled with the returns in this sector over the past 12 months. But while real estate investment trusts handily outperformed the S&P 500 index in 2016, times are changing fast. In the wake of a growing economy, many advisors are wondering where to turn to maintain yield as rates continue to rise. The yield on 10-year Treasury securities is up from 1.37% last July to over 2.50% as of March 17th, which makes fixed-income a challenging play. And with equity prices reaching all-time highs, they present a similar challenge. And while REITs may be the last place you may turn to seek yield in a rising rate environment, if suitable, they just may be the answer you’ve been looking for. How can that be? While REITs are often seen as interest-rate sensitive, rates don’t tell the whole story. Not by a long shot.
Here are five reasons why we believe simply shifting your strategy, but not running from REITs, may provide desired yield—even in the face of yet another rate hike:
1. REITs aren’t as sensitive to interest rates as it seems.
Conventional wisdom tells us that most income producing assets are sensitive to interest rate changes; as rates rise, their prices fall and vice-versa. But REITs are much more complex. In general, interest rates rise during a strong economy. That means that while higher short-term rates may have a negative impact on the cost of real estate debt, the benefit of a stronger economy may outweigh the drawdown caused by slightly higher interest rates.
2. REITs in a strong economy.
We believe, it’s the economy—not interest rates—that dictate the profitability and yield of REITs. A stronger economy may create greater opportunity for income generation from each property contained within a REIT. Real estate is more likely to appreciate due to greater demand. Plus, higher employment rates drive higher occupancy rates. In turn, higher occupancy rates support higher rents, which result in greater profitability and an increase in payouts to investors.
3. Large cap REITs aren’t the only game in town.
When most investors think about REITs, they immediately think of large, well-known REITs that focus on retail malls, huge office buildings, and properties leased to single, large, big-name tenants (think Walmart and Costco). What they tend to overlook are small cap REITs that can offer much greater diversification. Rather than focusing on big names and high volumes, small cap REITs include properties such as medical buildings and hospitals, storage facilities, smaller office and retail spaces, hotels, mortgages, and other specialized properties. This diversification is good news for anyone seeking to reduce risk in a shifting market.
4. Small cap REITs can have less sensitivity to the market.
Compared to large cap REITs, small cap REITs historically offer competitive yields with similar levels of volatility. For example, during the “Taper Tantrum” in 2013, investors panicked and pulled their money out of the bond market. As a result, 10-year bond yields jumped over 100 bps from 1.59% to 2.96%¹. Large cap REITs had modest positive returns over this period with a price change of 7%². But small cap REITs? According to recent research³, during the same period, the return on small cap REITs was sharply positive with a price change of over 25% during this period of rising rates. This despite almost a doubling of the yield on the 10-year U.S. Government Treasury bond.
5. Small cap REITs has demonstrated greater potential to capture yield in a high interest rate environment.
According to the Bloomberg RETI Small Cap Index and Bloomberg REIT Large Cap Index, small cap REITs were up nearly 2% while large cap REITs lost -4% in the fourth quarter of 2016 amid the backdrop of rising rates in the post-Trump election environment that saw 10-year yields jump from 1.6% to 2.4%. We believe REITs can benefit in a growing economy, but while rising interest rates can dampen yields for large cap REITs, small cap REITs have demonstrated the opposite effect. Since interest rates began to rise last summer, returns on small cap REITs have risen as well⁴. With the Fed expected to continue on the path of hiking rates to support a growing US economy, small cap REITs may provide a tool to capture yield just when you need it most.
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1. Source: Bloomberg as of 3/15/17.
2. Source: Morningstar as of 3/15/17.
3. Journal of Property Investment & Finance.
4. Source: Morningstar as of 3/15/17.
IndexIQ® is the indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs. NYLIFE Distributors LLC is a distributor of the ETFs and the principal underwriter of the IQ Hedge Multi-Strategy Plus Fund. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC. Sal Bruno is a registered representative of NYLIFE Distributors LLC
Disclosure: The information and opinions herein are for general information use only. The opinions reflect those of the writers but not necessarily those of New York Life Investment Management LLC (NYLIM). NYLIM does not guarantee their accuracy or completeness, nor does New York Life Investment Management LLC assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sale of any security or as personalized investment advice.
All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. An investment cannot be made in an index.
NBA Player Carl Landry Demonstrates the Value of Persistence in Life and Work
Written by: Jon Sabes
When you meet Carl Landry, stand-out college basketball player and nine-year NBA player, you imagine that becoming a professional basketball star was a straight forward run for the 6-foot-nine-inch power forward.
However, when you go deeper into Carl’s background, becoming a NBA professional was less than certain and little came easily to the 33-year-old from Milwaukee:
- He was cut from his high school team as a freshman and averaged less than ten points a game when he did play as a senior.
- He started his college career not at Purdue, but a junior college where it was not clear he would play.
- When he finally got to Purdue, he tore his ACL in his knee his first year and reinjured it the next year.
- While his family held a party for him the night of the NBA draft, he slept in the Philadelphia airport after missing a flight following a workout for the 76ers.
- In the NBA playoffs, Carl had a tooth knocked out, but came back in the same game to make a game-winning blocked shot as the Rockets beat the Utah Jazz 94-92.
Landry, who I interviewed on my podcast, Innovating Life with Jon Sabes (www.jonsabes.com), is a remarkable example of the value of “persistence.” In a time where technology creates the image that anything is possible at the touch of a button, persistence is an under-appreciated trait. When I spoke with Carl, I clearly saw someone for whom success has only come through a force of will that made him a NBA player, but it also made him a better player every year he played. That’s the kind of personality that has produced greatness in business as well as sports.
Carl was, in fact, drafted that night he spent in the airport. The Seattle Supersonics chose him as the 31st overall pick and then traded him to the Houston Rockets where he rode the bench for much of the first half of the season. When All-Star teammate Yao Ming was injured, he stepped in and played a key role in the Rockets astonishing 22-game winning streak (the third longest streak in NBA history). And, that season, after sitting on the bench for 33 of the first 36 games, he was named to the All-Rookie second team.
Carl was the first in his family to go to college. “I told myself that this was my ticket out, so I did everything I possibly could to be the best person in school and also on the court,” he said.
His family life in Milwaukee showed him what he didn’t want to do. “Just being honest with you, seeing some my cousins, peers, they went to work for jobs paying six, seven dollars an hour or they didn’t go to work at all and then living off welfare. I didn’t want that.”
When he was first injured, he had to contemplate the end of a career before it even got started. “When you have an ACL tear, it’s over…no more basketball,” he told me. “I said, God, give me health again and I’ll do everything I can to leave it all out on the line and be a successful individual.”
On my podcast, Carl pointed out another interesting lesson he learned in the NBA: Not doing things just to fit in.
“Fitting in was easy,” he said. “Doing everything that everybody else does was easy. If I stood out in some type of way, I’m going to have different results. I’m going to have stand-out results.”
That’s called the “Law of Contrast” and it produces that exact effect of changing the outcomes that everyone else is experiencing. Carl is smart, he recognized that differences make a difference, and doing whatever it takes is what is required to make real, meaningful differences.
Every off-season for the last 11 years, he has run a camp for kids in Milwaukee where he tells youth his story of hard work and persistence. “I always tell the kids to apply themselves and always be persistent,” he said. “If you dream, apply yourself and be persistent. With hard work, man, the sky’s the limit.”
When Carl says the sky’s the limit he means it. He is smart to recognize that it’s important to dream big, because if we don’t – we may be selling ourselves short. “You have to dream bigger than your mind could ever imagine,” he said. “I wanted a nice house. I wanted a nice car. I said, and I got all of that. So, what do I do, do I stop now? Maybe I didn’t dream big enough.” That’s a big statement coming from a kid who grew up to be the first in his family to graduate college and go on to be not only a top NBA basketball start, but a good businessman, father and someone who gives back to the community.
I’m convinced that in whatever he takes on as a basketball player or in his post-hoops career, Carl Landry is not going to stop getting better at whatever he does, and in the process of doing so, make the world a better place.
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