Real estate investment trusts (REITs) and sector-related exchange traded funds (ETFs) are a good source of attractive payouts in a low-yield environment.
REITs are securities that trade like a stock and invest in real estate directly through property ownership or mortgages. Consequently, revenue are mainly generated through rents or interest on mortgage loans. To qualify for special tax considerations, the asset also distributes the majority of income, about 90% of taxable profits, to investors as dividends.
“Incremental demand from a slowly improving economy has accrued to existing landlords in the form of higher occupancies, higher rental rates, and solid same-store net operating income growth,” according to Morningstar analyst Robert Goldsborough.
Additionally, REITs provide diversification benefits as the asset shows a lower correlation to stocks and bonds. However, the asset category has recently experienced heightened volatility due to interest rate risks. Some investors fear REITs will act negatively in rising interest rate environment. The high dividends in REITs are attractive in a low-rate environment but are less enticing once safer Treasuries show higher rates.[related_stories]
“Interest rates undoubtedly will rise at some point, and higher interest rates remain the REIT sector’s greatest potential headwind,” Goldsborough added. “As rates rise, REITs’ interest payments go up, which means REITs have less cash flow available for dividends for equity investors. As a result, higher rates mean greater interest expense.”