For instance, hotels can boost room prices, or apartment buildings can push up rents more easily as tenants turn over.
And higher REIT income generally means bigger dividend payments to shareholders. REITs whose properties strike longer-term lease deals with tenants — for example, retailers at shopping malls — typically have annual increases built in that are based on the movement of the consumer price index.
However, those rent hikes also tend to have a limit to how big of a jump can occur, which means inflation could outpace those increases. Nevertheless, Rimassa said, "even if rent increases are not able to keep pace with inflation in the short term, the property values generally are still increasing. The easiest way to get exposure to many REITs at once is through a mutual fund or exchange traded fund that invests in those real estate companies.
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Retired: What Now? Another factor that may affect total returns is the ability of owners of commercial real estate to raise rents to generate higher returns. For property types where leases are shorter term like multifamily, leases renew more frequently, giving the landlord more opportunities to raise rents than properties with longer-term leases. There is no guarantee that landlords may receive the increased rates from their tenants.
However, if rates rise faster than real estate companies can increase rents, there may be some degradation in property value.
If interest rates rise due to an improving economy, however, commercial real estate landlords have the power to raise rents to keep pace with rising rates, and values can potentially strengthen because of higher rents.
On the other hand, evidence shows that increasing rates can weaken REIT performance. REITs outperformed stocks by 1. As more time passed, one year after interest rate increased, REITs outperformed stocks by 7. Here is a chart illustrating their research. In other words, interest rate increases often signal good economic news.
Although the rate rises themselves can make borrowing more expensive, they also suggest that the broader economy is healthy and growing, which generally benefits real estate investments because it means businesses are expanding, hiring, and in need of more property for their operations.
When an investor purchases a bond, the coupon rate and its maturity date are both fixed, which makes this investment sensitive to interest rate fluctuations. As rates rise, the value of a fixed-rate bond will fall, and vice versa. During periods of economic growth, REIT prices tend to rise along with interest rates.
The reason is that a growing economy increases the value of REITs because the value of their underlying real estate assets increases. In a growing economy, the demand for financing also increases, resulting in increased interest rates. Conversely, in a slowing economy, when the Fed is tightening money , the relationship turns negative. This relationship can be seen in the following chart, which details the correlation between REIT total returns and the yields on year Treasuries from For the most part, REIT returns and interest rates had a positive correlation, moving in the same direction.
This is evidenced primarily between and The periods of inverse correlation, right after , , and , all relate to Fed monetary tightening policies, reversing the actions of monetary stimulus actions that were put into place mainly after recessions. Here interest rates rose but REIT values decreased. The study compared the increased interest rates to REIT and stock performance during those periods. The information is presented in the following table.
Of these six periods of interest rate increases, REIT returns increased during four of them and outpaced the stock market during three of them. However, there are other factors and other detailed observations to consider, which may indicate positive or negative returns for REIT investments depending on the interest rate environment.
The biggest factor is that not all REITs are created equal. First and foremost, REITs operate in many types of industries. These include healthcare, hotel, residential, industrial, and many more. Each of these industries has different variables in play that react differently to the economic environment.
Another important factor is the debt profile of a REIT; how much financing they take on to grow their business. The debt profile determines a REITs ability and timeframe to pay down debt, which will be impacted by different interest rate environments.
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