5 Reasons Not to Run From REITs During Rising Interest Rates

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.

Click here to learn more about IndexIQ. 

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.
Salvatore Bruno
Building Smarter Portfolios
Twitter Email

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Prior to joining IndexIQ, ... Click for full bio

Retirement Planning Has Its Limits: How to Prepare

Retirement Planning Has Its Limits: How to Prepare

Retirement planning is one of the issues that commonly leads clients to consult financial advisers. One of its essential aspects is creating a plan to save and invest in order to provide a comfortable retirement income. Ideally, this starts many years ahead of retirement, even as early as your first paycheck.

As retirement comes closer, planning for it expands to take in a host of other considerations, such as deciding when to retire, where to live, and what kind of lifestyle you hope to have. When retirement becomes a reality, the focus shifts to carrying out the plan.

All of this planning is crucial. Yet, for both financial advisers and clients, it's good to keep in mind that planning has its limits. In the post-retirement years, it may be helpful to think in terms of preparing for old age rather than planning for it.

The older we get, the more important this distinction between planning and preparing becomes. Too many life-changing things can happen without regard to our best-laid plans. Often they occur unexpectedly, resulting in emergency situations where urgent decisions have to be made. A stroke or a fall, a diagnosis of terminal illness, a broken hip that leaves someone unable to go back to independent living—and suddenly, right now, the family needs to find an assisted living facility, arrange for live-in help, or sell a home.

What are some of the ways to prepare for these contingencies?

  • Explore housing options well ahead of time. Find out what assisted living, home care, and nursing home services and facilities are available where you live and whether they have waiting lists. Have family conversations about possibilities like relocating or sharing households.
  • Research the financial side of these options. Investigate the cost of hiring help at home, assisted living facilities, and nursing care centers. Find out what is and is not covered by Medicare and long-term care insurance. For example, people are sometimes surprised to learn that Medicare does not pay for nursing home care other than short-term medical stays.
  • Designate someone to take over decision-making, and do the paperwork. Execute documents like a living will, medical power of attorney, and contingent power of attorney. Update them as necessary, and give copies to your doctors, your financial planner, and appropriate family members.  
  • Start relatively early to downsize. Well before you're ready to let go of possessions or move into smaller housing, start considering what to do with your "stuff." Focus on the decisions rather than the distribution. There's no need to get rid of possessions prematurely, but decide what you want to do with them—and put in writing. Do this while it's still your choice, rather than something your family members do while you're in the hospital or nursing home
  • Do your best to practice flexibility and acceptance. No matter how strongly you want to live in your own home until the end of your life, for example, it may not be possible. The physical limitations of aging can limit our choices, and even the best options available may not be what we would like them to be. It is a profound gift to yourself and your family members to accept these realities with as much grace as you can muster.

Finally, please don't underestimate the importance of planning financially for retirement. Because the bottom line is that you can't plan for all the things that might happen as you age, but you can prepare to deal with them. One of the most useful tools to cope with those contingencies is having enough money.

Rick Kahler
Twitter Email

Rick Kahler, MSFP, ChFC, CFP is a fee-only financial planner, speaker, educator, author, and columnist.  Rick is a pioneer in integrating financial planning and psycholog ... Click for full bio