Are REITs a Buy?

The following post was written by Ben Carlson at A Wealth of Common Sense.

REITs Commercial office buildingAs interest rates have spiked higher since early May, many income producing investments have been hit hard.  Higher interest rates act as competition for yield hungry investors. This is one of the main reasons why high yielding investments have sold off since the rise in rates began a few months ago.

The 10 year treasury yield has increased by almost 1.3% since the lows of May.  In that time, high yielding investments such as high-yield dividend stocks, preferred stocks, junk bonds and REITs (Real Estate Investment Trusts) have all experienced a large sell-off.

REITs are an interesting asset class, in part because of their high yield, but also because the aggregate real estate market is so large.  According to Rick Ferri, the commercial real estate market is nearly the same size as the stock market.  REITs give you the opportunity to invest in a diversified mix of residential, retail, office and industrial real estate.  Because of the way they are structured for tax purposes, REITs pay out the majority of their earnings to investors in the form of dividends.

REIT Performance

The iShares S&P/TSX REIT ETF (ticker XRE) is down from almost 18% since May while the yield is up about 19% from a low of 4.3% to the current 5.2%.  The two largest holdings for XRE, RioCan and H&R REIT, make up nearly 35% of the entire ETF.

RioCan Real Estate (ticker REI.UN) has seen its share price drop almost -18% since May as the dividend yield has jumped to nearly 5% from a low of about 4%.  That means the dividend yield is up almost 23% in that time.  H&R REIT (ticker HR.UN) has lost almost 17% while the dividend yield has risen over 37% from 4.3% to 5.9%.  So the rise in dividend rates for REITs has been similar to the rise in bond interest rates.

The dividend yields for these two REITs look very appetizing, but they can continue to go higher based on the historical averages.  According to Capital IQ, the 5 year average yield for RioCan is 6.6%.  For H&R the 5 year average yield is 6.3%.  Both stocks are fast approaching those averages, but to get back there would mean more pain in share price in the meantime.

Value Investing

Looking for value in beaten down markets requires a balancing act of sorts.  You don’t want to get caught catching a falling knife, but at some point things are bound to turn around as prices continue to decrease and yields rise.

However, at a certain point, value will win out.  Your tolerance for risk until that value gets recognized should determine whether or not you can stomach further losses in REITs.  Averaging into these names in case of further share price weakness could be a way to reduce risk.  And you can get paid to wait through the higher yields as well.

Don’t Try to Forecast Rates

There’s no way to guess the direction of interest rates, so it’s difficult to make a decision on REITs based solely on where you think rates will be in the future.  There are simply far too many variables to consider, such as economic growth, inflation, loan demand, investor appetite for risk and the decisions of the various central banks around the world.

REITs are also heavily tied to economic growth since appetite for rents can be cyclical and correlated to the state of the economy.  And one of the reasons that interest rates rise is because economic growth is improving.  That means higher rates can also act as a positive for REITs as things improve.

What do you think?  Is it time to load up on REITs or will there be more pain to come?

15 Responses to “Are REITs a Buy?”

  1. Rob aka Mr BTSX

    Sep 16. 2013

    Funny you would mention this, as Garth Turner (aka Greater Fool) has been talking about this for while. Matter of fact it was comments on his blog that alerted me to a big sale coming (stuff like melt down on REITS panic panic) so I started checking my stocks and found RIO CAN to be down about 10%.

    Anyways I took advantage to add to my holdings of FAP (Aberdeen Asia Pacific) down to $6 from 7.50. I also added some REITS as well. In this case I went with smaller lessor known REITS, Dundee, True North Apartments etc. In buying this I don’t expect increases in payouts but with yields running 8-10% I don’t really mind.

    Reply to this comment
    • Ben

      Sep 16. 2013

      Good point. They don’t have to really go anywhere for a while price or dividend wise as long as the payout stays consistent.

      The only way I can see the payouts getting hit would be if rates rose high enough to affect the rates that they pay on their debt. But it would take much higher rates for that to happen.

      Reply to this comment
      • Rob aka Mr BTSX

        Sep 17. 2013

        Exactly, also what I did was spread my money over 4 REITS (technically 3 REITS and 1 closed end MF) and I’m buying for the long term. Funny thing is RIO CAN (shares I inherited from my Dad) are down about 15% but it really doesn’t bother me, as I’m still getting my dividends. That’s one of the big advantages to dividend stocks.

        Reply to this comment
  2. My Own Advisor

    Sep 16. 2013

    Own REI.UN, HR.UN and just recently made a small purchase in CWT.UN. If I had more money, I’d buy more CWT.UN since the others are already DRIPping at cheaper prices now.

    XRE is also a “buy” I think.

    Just need to find some cash….maybe if I rub some pennies together? :)

    Good post Ben.

    Mark

    Reply to this comment
    • Ben

      Sep 16. 2013

      Thanks. I’ve heard that if you want to double your money you can fold your cash in half and put it back in your pocket.

      Reply to this comment
  3. The Dividend Ninja

    Sep 16. 2013

    Great post Ben!

    I’m interested in REI.UN and HR.UN, which is essentially one-third of XRE as you mentioned. I like the diversity of assets between these two REITs. I’m hoping by the time I would like to buy they will still be discounted. ;)

    Cheers

    Reply to this comment
  4. gibor

    Sep 17. 2013

    MOA, imho XRE is a good investment if you have small amout (2-3K) allocated to REIT. If you have more $$, I think better to buy individual stock (like REI, HR, CUF, AX….), it will have about 50% of XRE holdings. Yield will be higher, and for XRE you will be paying annually $60 that equal 6-8 trades depends on brokerage. Another possibility is ZRE who have equal weight and you have more exposure to smaller REITs.

    Reply to this comment
  5. Rob aka Mr BTSX

    Sep 19. 2013

    Good timing!

    See second image

    http://www.greaterfool.ca/2013/09/18/rock-bottom/

    Rob

    Reply to this comment
  6. Martin

    Sep 26. 2013

    Since REITs were horribly beaten up these days by all sorts of panic around FED tapering I think in a long run of next 20 years they are a buy. Mostly those which are not too involved in MBS such as Realty Income. And even those in MBS are OK to buy IMHO. They were able to survive before the crisis, during the crisis and after the crisis, so I believe they will be OK.

    Reply to this comment
    • Dividend Ninja

      Sep 27. 2013

      Martin, I agree. ;)

      I’m not familair with the term MBS, but entering into REITs after they have been recently pummelled is looking attractive to me. I just hope by the time I have capital to invest they will not have run up in price already.

      Cheers

      Reply to this comment
      • pluckie

        Oct 01. 2013

        MBS = mortgage backed securities? Which I entirely agree. I just look at the yields and can’t think of a better investment right now.

        I built my own basket of larger REITs recently including REI, HR, D, CWT, AX, CUF. Most of the selling is done I think and even if prices stayed flat, I’m happy to pull in 7-7.5% which was the effective yield at the prices I bought.

        Reply to this comment
  7. Moe

    Oct 17. 2013

    I hold zre as 10% of my portfolio and altho still working at 68 I will be retiring with a modest income. I’m wondering if reits are a good investment for a retirement portfolio

    Reply to this comment

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