Why REITs are not popular with investors?
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.
Interest Rate Risk
The value of a REIT is based on the real estate market, so if interest rates increase and the demand for properties goes down as a result, it could lead to lower property values, negatively impacting the value of your investment.
REITs do not grow too much in value. This is because they are mostly structured as pass-through entities. About 90% of the rental income that the REITs earn from these properties is paid out to the investors as a dividend. A mere 10% is retained and that too, for emergency purposes and administrative expenses.
Risks of investing in REITs include higher dividend taxes, sensitivity to interest rates, and exposure to specific property trends.
Warren Buffet prefers to invest in REITs instead of real property because they are a great source of passive income, are reward-oriented, and are more liquid than property ownership.
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.
REITs allow investors to pool their money and purchase real estate properties. By law, a REIT must pay at least 90% of its income to its shareholders, providing investors with a passive income option that can be helpful during recessions.
Still, in a general sense, they are income securities and do trade like income securities. You can usually count on high-yielding REITs moving up when rates are moving down.
REIT Market Outlook and Forecast
The REIT market is projected to see 2.6% year-over-year growth in 2023. The REIT market is forecast to grow at a CAGR of 2.8% from 2022 to 2027. The market size is estimated to increase by $333.01 billion from 2022 to 2027.
Stocks have delivered higher returns in recent years, with the S&P 500 beating REITs over the previous one-, five- and 10-year periods. However, the overall data shows that REITs have outperformed stocks over the long term.
Can a REIT lose money?
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.
If the REIT fails this ownership test for more than 30 days (31 days if the year has 366 days) in a taxable year of 12 months, it can lose REIT status and cannot elect to be treated as a REIT for five years (IRCазза856(a)-(b)). The test is pro-rated for taxable years shorter than 12 months.
This is known as the geographic market test. Section 856 (d)(2) (C) excludes impermissible tenant service income (ITSI) from the definition of rent from real property, making it “bad income” for the 75% and 95% REIT gross income tests.
Buffet and REITs
However, Berkshire sold its holdings of STORE Capital in 2022 after the company announced it was being acquired by two outside investment funds. Since then, filings have shown that Berkshire Hathaway has not owned shares of any other REIT.
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.
Why Doesn't Berkshire Hathaway Pay its Shareholders a Dividend? Company founder and CEO Warren Buffett believes profits can generate better shareholder value spent in other ways. He frequently shares these views during Berkshire's annual meetings.
At that rate of return, a monthly investment of $300 in REITs would grow into $1 million in about 30 years. If you invested more money into REITs or those producing a higher average annual return, you could become a millionaire even faster.
The Cheapest Option: REITs—$1,000 to $25,000 or more
These are securities and are traded on major exchanges like stocks. They invest in real estate directly, either through property purchases or through mortgage investments.
Bottom line. Investors eyeing REITs may find a potential recovery ahead. With rate cuts on the horizon, many publicly traded REITs have rebounded, and the industry as a whole seems well-poised for a recovery in the coming year.
REIT Stock Performance and the Interest Rate Environment
Over longer periods, there has generally been a positive association between periods of rising rates and REIT returns. This is because rising rates generally reflect improvement in the underlying fundamentals.
Are REITs a good investment in 2024?
Feb. 5, 2024, at 2:45 p.m. Real estate investment trusts, or REITs, have the potential for some sizeable dividends with their large real estate portfolios. Real estate investments can be an excellent way to earn returns, generate cash flow, hedge against inflation and diversify an investment portfolio.
Historically, REITs are one of the better-performing sectors during inflationary periods. We can see this in the following image. You'll notice REITs are in the upper right area, showing they are outperformers during periods of high inflation. In contrast, check where mortgage REITs are in the bottom left.
According to consensus forecasts from FactSet, the number will dip in 2023, drop further in 2024 and return to growth in 2025 and beyond before hitting $633mn for the 2027 calendar year.
After lagging equities the past two years, REITs offer an attractive investment opportunity in 2024. The headwind of higher bond yields and central bank rate hikes is likely to abate and may turn into a tailwind if our view about an impending economic slowdown and decelerating inflation trends is correct.
After looking at correlation patterns and historical data, it appears that returns from REITs vary during different interest rate periods, but for the most part have shown a positive correlation during increasing interest rates.
