6

I have investments in a bunch of REITs like AGNC, NLY. With recent confirmation from FED on a hike in interest rates, I am seeing bond prices undergoing a correction. As far as I know REITs are very sensitive to hike in interest rates.

My question is:

  1. Why are REIT prices not undergoing a correction?
  2. Is it time to invest more in REITs for a steady income stream?
3

There are five main drivers to real estate returns: Income (cash flow from rental payments); Depreciation (as an expense that can be used to reduce taxes); Equity (the gradual paydown of the mortgage the increases underlying equity in the property); Appreciation (any increase in the overall value of the property); Leverage (the impact of debt financing on the deal, increasing the effective "cash-on-cash" return). (Asset Rover has a detailed walk-through of the components, and a useful comparison to stocks)

So interest rates are certainly a component (as they increase the expenses), but they are just one factor. Depending on a particular market's conditions, appreciation or rent increases could offset or (exceed) any increase in the interest expense.

My own experience is mostly with non-listed REITs (including Reg A+ investments like the ones from Fundrise) and commercial syndicates, and for right now in both cases there's plenty of capital chasing yield to go around (and in fact competition among new funding sources like Reg D and Reg A+ platforms seems to be driving down borrowing rates as platforms compete both for borrowers and for investors).

Personally I pay more attention to where each local market (and the broader national market) is along the ~18-year real estate cycle (spoiler: the last trough was 2008...). Dividend Capital puts out a quarterly report that's super useful.

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5

I don't like REITs because they are more closely correlated to the movement of the stock market. They don't really do the job of diversifying a portfolio because of that correlation.

When the stock market dropped in 2008, REITs were hammered as well because the housing bubble burst. Bonds went up, and if you rebalanced (sold the bonds to buy more stock) then you came out much further ahead when the stock market recovered.

The point of adding bonds for diversification is that they move in the opposite direction of equities; blunting the major drops (and providing buying opportunities). REITs don't fit that bill.

REITs are not undergoing a correction like bonds because the price of real estate is a function of housing supply and buyer demand. Rising interest rates only make it a little harder for buyers to buy, so the effect of rising interest rates on real estate prices is muted. The other effects on real estate prices (more wealth in the economy for buyers) pushes in the opposite direction of the rising interest rates.

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  • Kind of disagree that interest rates do not affect REIT. In 2013 REIT prices underwent major correction when FED had just mentioned about interest rates rising. I think the demand for housing did not go down during that time – vsingh Mar 16 '17 at 18:04
  • @vsing could that correction reflect a preexisting bubble in the REIT market? If so, an interest rate discussion might have spooked investors that were over-exposed. – NL - Apologize to Monica Mar 16 '17 at 18:11

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