How REITs Perform In Different Economic Cycles

Investment tips

Published: December 4, 2023

Aerial view of commercial and residential buildings

Real Estate Investment Trusts (REITs) are a popular investment vehicle that offer individuals the opportunity to invest in large-scale, income-producing real estate. A key feature of REITs is their ability to provide investors with a regular income stream, as well as the potential for capital appreciation. However, like all investments, the performance of REITs is influenced by the prevailing economic conditions. Understanding how REITs perform through different economic cycles is crucial for investors looking to diversify their portfolios and manage risk effectively.

During periods of economic expansion, REITs can benefit from increased consumer spending and business activity, which typically lead to higher demand for real estate spaces such as retail centers, office buildings, and industrial properties. Conversely, in times of economic downturn, REITs may face challenges as businesses contract and consumer spending declines, potentially leading to higher vacancy rates and reduced rental incomes. Keep reading to learn more about how REITs compare to other long-term investment options.

With the recent downturn in the U.S. real estate market and rising interest rates on mortgages, many investors are beginning to shift away from REITs and towards alternative long-term options. Keep reading to learn more about how REITs perform in different economic cycles and what your alternatives are.

Understanding REITs And Their Place In The Investment Market

In the vast and diverse world of investments, Real Estate Investment Trusts (REITs) hold a unique position. As a distinctive way to invest in real estate, they offer investors the opportunity to participate in the ownership of income-generating properties without the need to buy or manage the property themselves.

What Are Real Estate Investment Trusts?

REITs allow individuals to invest in portfolios of large, income-producing properties. They can include a wide range of property types, including office buildings, shopping centers, hotels, and even data centers. When you invest in a REIT, you’re essentially purchasing an interest in a large real estate portfolio, making you a partial owner of numerous properties without having to manage the properties directly.

REITs are required to distribute at least 90% of their taxable income to shareholders each year through dividends, making them particularly attractive to income-oriented investors. This feature often results in higher dividend yields compared to other types of stocks.

REITs counterbalance more volatile investments as they can provide a degree of stability during economic downturns since real estate often holds its value better than other assets. Additionally, because REITs can be bought and sold like stocks on major exchanges, they provide the liquidity that direct real estate investments typically lack.

Types Of REITs

Real estate investment trusts come in different forms, offering unique opportunities and risks. Understanding the different REIT types can help you choose the most suitable options for your portfolio. The main categories of REITs include:

  • Equity REITs: This is the most common type of REIT. Equity REITs own and manage income-producing real estate properties. They generate their income primarily by leasing space to tenants in properties ranging from office buildings and shopping centers to apartments and hotels.
  • Mortgage REITs (mREITs): Unlike equity REITs, mREITs invest in mortgages or mortgage-backed securities. They earn income from the interest on these investments. mREITs can focus on either residential or commercial mortgages.
  • Hybrid REITs: Hybrid REITs combine the strategies of equity and mortgage REITs. They own income-producing real estate and invest in mortgage-backed securities to diversify their income sources.
  • Public Non-Traded REITs: These are registered with the SEC but do not trade on national stock exchanges. While they can offer higher dividends, they’re less liquid than their publicly traded counterparts and can come with higher fees and less transparency.
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REITs Performance During Different Economic Cycles

Real estate investment trusts (REITs) can perform differently over different economic cycles. They can be affected by various factors, such as interest rates, economic growth, property demand, and rental income.

Expansion Phase

During an economic boom, this period is typically characterized by low interest rates, which can significantly lower REIT borrowing costs. Lower borrowing costs can make it more affordable for REITs to acquire new properties or develop existing ones, which can lead to higher profits.

Economic growth typically leads to increased economic activity and consumer spending, which can spur demand for both commercial and residential real estate. For commercial REITs, increased business activity could mean more companies looking for office space or retail locations. For residential REITs, increased consumer spending power may lead to higher demand for rental units.

Peak Phase

The peak phase is usually accompanied by robust economic activity and high consumer spending. Companies may be looking to expand, leading to increased demand for commercial real estate, such as office and retail space. Similarly, consumers, bolstered by job security and higher incomes, may be more willing to spend money on housing, boosting demand for rental housing.

However, the peak period is often a harbinger of an impending economic downturn. When the economy reaches its maximum growth and begins to contract, the expectation of lower real estate demand in the future can lead to lower valuations for REITs. Investors anticipating a possible contraction in the economy may become cautious and pull back from real estate investments.

While the peak period may offer some benefits in the form of higher rental income, it also poses potential risks. It’s a time of heightened vigilance when investors need to be prepared for the possibility of an economic downturn and its impact on real estate demand and REIT performance.

Recession Phase

During a recession, businesses and consumers often tighten their belts. To cut costs, companies downsize or close operations, resulting in lower demand for commercial real estate, such as office space and retail locations. For commercial REITs, this can translate into lower occupancy rates, lower rental income, and potentially lower property values.

Similarly, consumers may also shrink spending during a recession, often due to job losses or fear of job loss. This restraint can affect the residential real estate market by reducing demand for rental housing. Residential REITs may experience higher vacancy rates and may need to lower rents to attract tenants, both of which could impact revenue.

But even in the face of a recession, it’s not all gloom and doom for REITs. Those well-diversified across property types, geographic locations, and tenant sectors can often weather the storm better than others. A diversified portfolio can help REITs escape sector-specific or regional downturns.

Recovery Phase

One of the key characteristics of a recovery period is the potential for lower property values that often follow a recession. When property prices fall, REITs can acquire new properties at a lower cost. These acquisitions can expand their portfolios and set the stage for significant capital appreciation when the economy and real estate market recover. For investors, this can translate into potential long-term gains and higher dividends.

The recovery period also often hikes up economic activity and consumer confidence. As businesses recover, demand for commercial real estate, such as office space and retail stores, may increase. Similarly, demand for rental housing may increase as consumer purchasing power improves, which may lead to higher occupancy rates for REIT-owned properties.

Higher occupancy rates and the ability to increase rents as the market improves can increase rental income for REITs. This increase in rental income can have a positive impact on the performance of REITs, resulting in higher revenues and potentially higher dividends for investors.

Why REITs Typically Perform Well

Real estate investment trusts have become a popular investment option due to their consistent performance. This success story is no accident but the result of a unique blend of factors that make REITs a compelling asset. Some of the main reasons that investors are attracted to REITs include:

  • REITs typically own properties in various sectors and locations, providing investors with a diversified portfolio. This diversification helps mitigate risk and can contribute to more stable returns. It also allows investors to gain exposure to different real estate markets, which can increase opportunities for capital appreciation.
  • REITs are managed by qualified professionals with extensive knowledge and experience in the real estate market. Their expertise in acquiring, disposing, and managing real estate can help maximize returns.
  • They’re traded on major exchanges, making them accessible to a larger number of investors. This public trading also provides liquidity, a characteristic that is typically not present in direct real estate investments.
  • Long-term growth in the real estate market usually leads to an increase in property values. This can lead to capital appreciation for the properties owned by REITs, increasing the total return to investors.
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How REITs Compare To Other Investments

REITs offer a unique blend of features from different investment types, combining liquidity, income generation, potential for capital appreciation, and exposure to the real estate market. However, as with all investments, it’s important to consider your individual financial goals, risk tolerance, and investment horizon when deciding if REITs are a good fit for your portfolio.

REITs vs. S&P 500

REITs are required to distribute at least 90% of their taxable income to shareholders, resulting in high dividend yields. These attractive dividends can significantly increase total returns, especially at low interest rates. Additionally, with the growth of the real estate market in recent decades, REITs have benefited from capital appreciation as the value of their properties has increased, further increasing total returns.

On the other hand, the performance of the S&P 500, an index of the 500 largest publicly traded U.S. companies, is driven by a wide range of sectors and is often considered a barometer for the U.S. economy. It’s also important to note that while REITs can outperform in certain market situations, they can also underperform the S&P 500. Despite this possibility, the chart below shows how REITs have significantly outperformed the S&P 500 over the past 20 years.

Year REITs Performance S&P 500 Performance
2000 +25.3% -9.1%
2005 +12.2% +4.9%
2010 +27.9% +15.1%
2015 +2.8% +1.4%
2020 +20.9% +18.4%

REITs vs. Private Real Estate

A survey conducted by CEM in 2022 showed that REITs performed better than unlisted real estate. On the other hand, private real estate is known for its lower volatility and more stable values, which offer some change from the typical fluctuations of the stock market.

The performance difference between the two is often associated with the speed of price discovery and transactions. REITs, because of their public nature, typically allow for faster price discovery and quicker transactions, which may appeal to investors seeking flexibility and agility in their investments. The private real estate sector is characterized by slower price discovery and slower transactions, which may be less attractive to certain investors seeking liquidity and quick returns.

Historically, investments in established, unlisted REITs have generated positive returns, making them a viable investment option for many. However, private equity real estate is often lauded for its potential to generate steady returns even amidst the volatility of the broader market. This steadiness can make private real estate a valuable component of a diversified investment portfolio.

REITs vs. Gold & Silver

REITs allow investors to participate in real estate markets without having to acquire direct property ownership. They are known for providing a steady income stream through dividends, often resulting in high-yield returns during strong real estate markets. However, despite the regular income checks, REITs are also subject to real estate market conditions and are affected by factors like interest rates, economic growth, and property supply and demand dynamics.

Gold and other precious metals, on the other hand, are often considered “safe haven” investments and are typically used as a store of value in times of economic uncertainty or high inflation. They can provide a hedge against market volatility and tend to perform well when traditional asset classes like stocks, bonds, and real estate are underperforming.

Over the long term, gold and silver can provide a portfolio with a non-correlated asset class that potentially increases in value as demand for these precious metals rises, especially in times of geopolitical tension or when investors are seeking stability. Furthermore, unlike REITs, which are tied to the performance of the real estate market, gold and silver are globally recognized commodities that can be liquidated in any market around the world, providing a level of liquidity and flexibility that can be particularly advantageous for long-term investors.

Key Factors You Need To Consider Before Investing In REITs

While REITs can be a valuable addition to a diversified portfolio, it’s important to research and consider these factors before investing thoroughly. As always, make sure to reach out to a financial advisor to ensure that any investment is consistent with your financial goals and risk tolerance.

Market Conditions

Market conditions can affect property values, rental income, and occupancy rates, which can affect returns. Therefore, it’s important to know the current market conditions before investing in REITs.

Key factors to consider include interest rates, economic growth, and supply and demand dynamics in the real estate market. Low interest rates often lower the cost of borrowing for REITs, which can increase profitability. At the same time, high interest rates can increase borrowing costs and potentially lower property values.

Understanding Risks

Similar to conventional real estate, REITs are susceptible to fluctuations in property values and changes in property taxes, which can significantly affect total returns. Although REITs trade on major exchanges like other securities, they don’t always offer the same level of liquidity as stocks or bonds. This difference could make it difficult to sell REIT shares in certain market conditions.

Another key risk is the potential impact of declining property values on your investment. Economic downturns or corrections in the real estate market can lead to declining property values, negatively impacting the value of REITs and the income they generate.

Dividends vs. Capital Appreciation

While high dividends can provide a steady stream of income, capital appreciation — the increase in the value of REIT properties over time — can contribute significantly to total returns. A REIT that offers high dividends but little or no capital appreciation may provide less total return than a REIT that offers a balance of the two. For example, a REIT may offer an attractive dividend yield, but if the underlying properties don’t appreciate or decline in value, the total return could be less than expected.

When evaluating a REIT for investment, it’s important to look at the current yield and consider the potential for future growth. You’ll want to examine the quality and location of the properties in the REIT’s portfolio and pay close attention to management’s strategy for increasing property values. Factors such as these can have a significant impact on the potential for capital appreciation.

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Diversify Your Retirement Portfolio With Precious Metals Today

While real estate investment trusts can be an attractive option during real estate market booms, when real estate starts to take a downturn, it’s always a good idea to reconsider your options and even rebalance or diversify your portfolio.

Whether you’re interested in purchasing physical precious metals to store at home or investing directly in a gold and silver IRA, Noble Gold Investments has a variety of precious metals and investment options that are suitable for just about any investor.

Don’t let market volatility catch you off guard. Take the first step toward securing your financial future and give us a call at (877) 646-5347 to speak with one of our team members, or click here to open an account today.

Investment tips
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