Consequently, when rates and yields rise, REITs are sold off on expectations of higher costs for financing real estate acquisitions, and their dividends become less attractive against less risky Treasuries.
“Income hunters have reason to worry. REITs are basically a collection of loans and mortgages, and higher rates mean higher expenses on debt payments and more expensive acquisitions. Investors have been especially fixated about slowing growth in the retail sector, notes Evercore’s Steve Sakwa. “Our response continues to be that the perception of slowing fundamentals is worse than reality,” he says,” reports Crystal Kim for Barron’s.
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.
Enthusiasm for REITs also waned after real estate became the 11th S&P 500 sector last year, separating from financial services. Now, some market observers believe the sector is under-owned and could offer rebound potential this year for income investors.
Higher interest rates are seen as punitive to REITs’ cash flow, which can hinder the company’s ability to boost dividends, the primary allure of the asset for many investors.
For more information on real estate investment trusts, visit our REITs category.