Why Do Rising Interest Rates Affect Real Estate Investment Trusts, REITs?

I like Gordon Pape’s style of writing. When I started trying to understand our finances a few years ago, I read through all of his books. When I started to take control of our investments using self-directed brokerage accounts, I subscribed to two of his newsletters, Internet Wealth Builder and the Income Investor. I learned a great deal from both. From time to time, I renew my subscriptions and I learn even more. For example, in a recent Income Investor I read an informative article on REITs that included information about why rising interest rates affect REITs.

Why I Care About REITs

I have been trying to arrange our investments so that by the time we actually retire we will have a steady stream of income. I realize this is not an approach everyone wants to follow. Some people want to maximize their actual portfolio value, often by realizing huge capital gains; they prefer to wait until they are actually retired to figure out how to use that money to generate an income.

I’d like to have a steady stream of income developed long before retirement. So as an experiment, I bought a small amount of a REIT several years ago. Without warning (to my inexperienced eyes) it took a plunge in value this spring. The distributions have not decreased and the holding still is worth more than I paid for it, but even so, I thought it was time to find out what had happened and why. (And whether I should sell now or hold on.)

Why Did Real Estate Investment Trusts Drop in Value in June?

In May and June, in the USA, the US Federal Reserve indicated that it might stop buying back bonds at its previous levels. According to Kevin Mahn in Forbes, many investors decided that meant that a rise in interest rates was imminent. That led to a hit on REIT prices.

Why Would Rising Interest Rates Matter to REITs?

According to Rob Carrick in the Globe and Mail, many high yield (income-driven) investments dropped in value when investors became hopeful that interest rates were on the way up. He says pipelines, utilities and REITs all decreased in price.

In other words, market demand for REITs might decrease if interest rates (and income rates) increase for fixed income investments. Many investors would prefer to take little or no risk provided they can get a decent rate of income from their investments. They will want to get out of REITs and even blue-chip dividend-paying stocks if they are able to get a similar rate of return with a much lower risk of loss. Decreased market demand would usually result in lower share or unit prices for REITs.

Mr. Carrick also points out that many REITS borrow money to finance new acquisitions. Higher interest rates would mean these REITs would have less profit to distribute to share holders.

Other factors cited by many reports include the possibility that if interest rates rise, people’s ability to buy houses will decrease, which will depress the economy because they won’t spend on all the things needed to maintain and use those houses, which will reduce the demand for retail and commercial properties which will impact REITs. Sounds a bit like the old “for want of a nail the kingdom was lost” nursery rhyme.

Should I Sell My Small REIT Holding Now or Not?

One thing all the financial articles online agree on is that REITs will either go down in value or go up.

Yep. No one has any idea what’s going to happen.

I read logical agreements that said “up” and others that said “down.”

Given I have a very small (actually tiny) amount of our future tied up in a REIT, and given that it is one of the REITs that is generally approved of by the pundits, I think I’ll just keep it. For one thing I don’t have any brilliant ideas of where else to invest that small amount of capital.

It’s times like these, though, that re-affirm our decision to keep a huge amount of our savings in money-losing (to inflation) GICs. Even though we are steadily losing ground on that portion of our portfolio to inflation we sleep better knowing it’s the back stop to our more volatile investments. Again, this is not the approach I recommend others take. I have no financial training and no second sight into the future. It’s just what we do.

Related Reading

  • Why REITs look ripe this summer
  • Understanding The Three Rs: REITs, The Real Estate Recovery And Rising Interest Rates
    This article pointed out that you can invest in a REIT that holds self storage locker units. Who knew?! And that there seems to be no correlation between this type of use of real estate and interest rates or the housing market. I guess if I did sell our REIT I could buy one of these ones instead.
  • Real Estate Investment Trusts are Sources of Retirement Income

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Do you use REITs as part of your income-generating portfolio? Are you going to bail out now that rates may be rising? Please share your views with a comment.

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