“Because REITs generally own properties that are largely financed with debt, they can experience large swings in value from small changes in property values,” Bryan said.
Looking ahead, potential investors should keep in mind that REITs are not a good hedge against inflation and a rising rate environment will negatively impact the asset. Rising rates raise REITs’ debt financing costs. However, a flat interest rate outlook would benefit REITs in an expanding economic environment as rising rents and property prices would support the asset class. [Falling Rates Help Lift REIT ETFs]
Bryan also warns that investors shouldn’t get too trigger happy with REITs investments due to their high valuations – VNQ shows a 33.8 price-to-earnings ratio and a 2.1 price-to-book.
“High valuations and interest-rate risk are good reasons not to immediately overweight REITs,” Bryan added. “However, they can offer good diversification benefits over the long run. Rising interest rates could cause valuations to recede and offer investors an opportunity to reap these benefits more cheaply. If nothing else, REITs are worth watching.”
Vanguard REIT ETF
For more information on real estate investment trusts, visit our REITs category.
Max Chen contributed to this article.