The Vanguard Real Estate Index ETF, a broad proxy for how real estate investment trusts (REITs) are doing, is down nearly 30% from its high-water mark in 2022. That's a massive drawdown that will likely elicit worries among conservative investors. But don't panic. If you stick with high-performing, industry-leading REITs, you should come through this pullback just fine, and with your dividend checks intact.
What's gone wrong?
There are company-specific problems that have hurt specific REITs. For example, Americold Realty Trust has suffered because of supply chain problems in the food space it serves even as other industrial REITs thrived. There are also property niche problems that have hurt specific property sectors. Office REITs like SL Green have cut their dividends as the work-from-home trend has lingered as the coronavirus pandemic has waned. But from a REIT-wide perspective, one of the biggest problems has been rising interest rates.
Rising interest rates impact REITs in a number of ways. Directly, interest expenses can go up as the interest rates on variable-coupon debt increase and as fixed-rate debt rolls over. There's also an impact on the translation environment, as sellers are generally slow to lower asking prices to accommodate higher borrowing costs. Many won't until there is financial distress, effectively forcing them to sell. These are dislocations that can linger over a long period, but they aren't new or unusual, and financially strong REITs with good management teams can navigate them (for example, by pushing through higher rental rates).
The other big problem with interest rates is that REITs are income vehicles that compete for investor attention with other income options. With rates notably higher, investors have other options, including safe, government-backed CDs. The drop in REIT prices is, to some degree, increasing dividend yields to better compete. This isn't new either, though there is little that a REIT can do about what amounts to investor sentiment.
Don't give up
While REITs are lower as a group, investors shouldn't react too fearfully here. The best-run landlords haven't suddenly lost their mojo. Realty Income (NYSE: O) is still the largest net-lease REIT, with a solid financial core, and management continues to invest in the business. Prologis is still an industry-leading industrial REIT with solid financials, and management just agreed to buy 14 million square feet of warehouse space from Blackstone. You could add a lot of REITs to this "still the largest/industry-leading" list, including names like strip mall REIT Federal Realty, apartment landlord Avalonbay, and data center owner Digital Realty.
Yes, the share prices of these REITs are lower, but their dividends remain intact, and are likely to head higher over time. That's important when you compare a REIT to alternative income options like CDs or bonds, where the income you generate is basically static. That means that inflation eats away at the purchasing power of your income stream. With REITs, dividend increases can help defend your buying power. So even with the REIT pullback, there's a reason to favor REITs.
Then there's the growth angle. As noted, Prologis just agreed to buy more properties, effectively growing its business and increasing its ability to support dividend growth. Avalonbay is currently doing the same internally, with nearly $1 billion of planned development starts in 2023. Those investments will benefit the apartment landlord for years to come. When a CD matures or bond comes due, you have to hope you can find a new one at a comparable rate. And your initial capital is all you get back, there's no underlying growth.
The broad pullback in REIT shares, meanwhile, could actually have a hidden benefit for long-term investors that reinvest their dividends. By doing so, you are buying more shares at a lower price (and higher yield) with each dividend payment. So you are increasing your position and lowering your average cost. If REIT values start to recover, which seems likely at some point, you will end up with greater capital appreciation and more dividend income than you would have had if REITs hadn't declined.
For investors with spare cash, this could be the opportunity to add to existing positions at attractive prices, or to buy a REIT you have liked but that seemed too expensive. While we can't know for certain if the REIT sector will stabilize, fall more, or recover, don't let fear of the unknown stop you from picking up a bargain if Wall Street has offered one. Just make sure to stick with financially strong and well-run REITs. Now is not the right time to take on risky investment choices, but it also isn't the right time to hide your head in the sand.
Stick out the pain
Even if buying more REIT shares isn't right for you right now, don't rush to sell well-run REITs. There are unique situations in the broad sector, like offices, that have notable problems. But overall, REITs are not in a bad place. It is really just investor sentiment that has changed. And since Mr. Market is notoriously fickle, it is probably better to view the drop as an opportunity than a signal that REITs are forever tarnished.
Reuben Gregg Brewer has positions in Federal Realty Investment Trust and Realty Income. The Motley Fool has positions in and recommends Digital Realty Trust, Prologis, and Vanguard Specialized Funds-Vanguard Real Estate ETF. The Motley Fool recommends AvalonBay Communities and Realty Income. The Motley Fool has a disclosure policy.
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In the article you provided, the author discusses the recent performance of the Vanguard Real Estate Index ETF, which is a broad proxy for how REITs are doing. The ETF is down nearly 30% from its high-water mark in 2022, which may be concerning for conservative investors. However, the author suggests that sticking with high-performing, industry-leading REITs can help investors come through this pullback with their dividend checks intact.
One of the main factors contributing to the decline in REITs is rising interest rates. Rising interest rates can impact REITs in several ways. Firstly, interest expenses can increase as the interest rates on variable-coupon debt rise and as fixed-rate debt rolls over. Secondly, higher borrowing costs can lead to sellers being slow to lower asking prices, which can create dislocations in the market. However, financially strong REITs with good management teams can navigate these challenges by, for example, pushing through higher rental rates.
Another challenge for REITs in a rising interest rate environment is increased competition from other income options. When interest rates are higher, investors have more alternatives, such as safe, government-backed certificates of deposit (CDs). To compete with these options, REIT prices may drop, resulting in higher dividend yields. While this may impact share prices, it can also make REITs more attractive to investors seeking income.
Despite the recent pullback in REIT shares, there are reasons to remain optimistic. Well-run REITs with solid financials and good management teams, such as Realty Income and Prologis, continue to invest in their businesses and have the potential for dividend growth. Additionally, the decline in share prices can present an opportunity for long-term investors to add to their positions at attractive prices.
It's important to note that investing in REITs, like any investment, carries risks. Investors should carefully consider their own financial situation, risk tolerance, and investment goals before making any investment decisions. Consulting with a financial advisor or conducting further research can provide additional insights and guidance tailored to individual circ*mstances.
In summary, the recent decline in REITs, as represented by the Vanguard Real Estate Index ETF, can be attributed to factors such as rising interest rates and increased competition from other income options. However, well-run REITs with solid financials and good management teams may still present opportunities for investors. It's important to carefully evaluate individual REITs and consider one's own investment goals and risk tolerance before making any investment decisions.
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