Real estate has historically been a great investment during times of high inflation. And in certain ways, it’s also a good investment to be holding during times of high-interest rates. Just a month or so ago, the US saw inflation at over 7%. And during the Federal Reserve meeting in January, Jerome Powell made it very clear that interest rates would be rising in the near term. So, what are you waiting for?
Ok, before you go off buying, let me dig a little deeper into why real estate and REITs are good during times of inflation and high-interest rates. For the most part, REITs will perform well during periods of high inflation because while goods and services are increasing in price, so will real estate because the price to build new homes will have risen due to inflation.
Think about what we just saw over the last two years with residential real estate in the US. Lumber, metal, plastic, concrete prices all increased due to the pandemic supply chain issues. Thus, the cost to build a brand-new home also went higher. If the price to buy brand new goes higher, then the price of pre-owned homes can also go higher simply because of the laws of supply and demand. And if the price of building a new home or buying a pre-owned homes goes higher, rent prices can also go higher.
This is where most REITs make the bulk of their money from rent prices. However, some will and do sell some of their real estate holdings when they see fit, and profits for investors can be had during those sales. But most REIT investors are looking for strong cash-generating properties. And if you owned real estate prior to the recent run-up in prices, you are likely sitting pretty nice now that both prices and rent payments have risen substantially in the past few years.
As for interest rates and REIT’s performance or just real estate performance in general, again, the main thinking is that if interest rates go higher, the ‘cost’ to buy real estate also rises, even if the actual purchase price is flat or even falls slightly. The difference between a 3% interest rate and a 4% interest rate could be hundreds of dollars a month for the average American homeowner with a 30-year mortgage, let alone a large commercial property owner who has a loan in the tens of millions. The alternative to buying is renting; thus, if the cost of buying, whether it be due to rising prices or rising rates, goes higher, those who own property can charge a little more since that’s the only other alternative.
Let’s take a look at a few options you have if you like the idea of owning a REIT right now, and then we will discuss a few reasons why you would want to sell these REITs in a few years.
The first is the Schwab U.S. REIT ETF (SCHH). This REIT tracks a market-cap-weighted index of US real estate investment trusts, which excludes mortgage REITs and hybrid REITs. Essentially the ETF owns US-based equity REITs that primarily own and operate income-producing real estate. The ETF does not invest in any real estate finance in any way and does not own mortgages. The fund keeps its largest holding from being more than 10% of the fund, and the aggregate weight of all the companies weighing more than 4.5% may not exceed 22.5%. That all means one or a few companies can’t blow the ETF up. This is a great catch-all REIT ETF.
Another option is something like the iShares Global REIT ETF (REET). This is very similar to the SCHH ETF, but it is focused on the global market, not just US-based companies. Solid fund with 342 holdings, a 3.5% yield, and an expense ratio of just 0.14%. If you are looking for a good, quality catch-all REIT ETF, this is another one that is hard to ignore.
Finally, we have another REIT ETF that is a little different in terms of the other two; it is the Global X SuperDividend REIT ETF (SRET). This ETF tracks an equal-weighted index of global REITs and then picks the 30 highest-yielding ones that also have low volatility companies. The fund pays out the dividend monthly, and it is currently at a 6.75% yield. However, the fund does charge a 0.58% expense ratio.
So why would you want to sell, and what should you be looking for in the future as an indicator that you should be selling?
Well, first and foremost, the reason to buy REITs is because the economy is healthy and growing. So, a great reason to sell a REIT is because you think the economy is weakening or growth is slowing. This could be seen if real estate prices start dropping below a certain percentage. If interest rates fall. If we begin to experience deflation at a healthy rate without assistance from monetary policies. Jobless numbers increase and high unemployment. Wage deflation would be another great indicator. Most of these signs will all come slowly and one by one, so it shouldn’t be too difficult to miss what is happening.
However, you really do need to keep a close eye on what is going on because if you own a REIT and we fall into a recessionary situation, you could be in for some pain. With that being said, it may not even take a recession to occur, just the thought that it is coming in order for investors to pull back on REITs; for example, all three of the REIT ETFs I mentioned above are down over the past 3 months. This could be due to a number of factors; most likely, it is because of the expectation that the market is going lower, not a fundamental problem with the REIT industry at this time. But something to think about before you pull the trigger on a new investment.
Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.