Tag Archives: REITs

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

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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
    http://www.forbes.com/sites/advisor/2013/08/15/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.

Real Estate Investment Trusts are Sources of Retirement Income

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When interest rates on fixed income securities like GICs and T-bills dropped, many people living off their investment income had to look for other ways to generate money. Income trusts became a popular new investment. Then came Jim Flaherty’s “Hallowe’en Horror” and the elimination of many income trusts because of changes to Canadian tax laws. Real Estate investment Trusts, REITs, were one of the few types on income trusts that were exempt from the most damaging of the tax changes. So REITs became very popular investments for people, especially retired persons, seeking income.

What Are REITs?

A real estate income trust is a type of company that invests either directly in property by buying and owning it, or indirectly by buying and owning mortgages, or both. Different REITs tend to prefer to invest in different types of properties. For example, some REITs hold mostly apartment buildings; others shopping malls; others industrial parks.

An investor can buy a share in a publicly traded REIT on the stock exchange. Like other shares, the price for a unit can go up or down dramatically.

The investor usually receives distributions from the REIT either monthly, quarterly or annually.

The distributions are NOT dividends. They are usually income and/or a return of capital. They can be very messy to keep track of taxes properly for in an unregistered investment account, like a regular cash brokerage account. Keeping them in a registered investment account reduces the need for some types of paperwork. (For example keeping them in a RRSP, RRIF or TFSA.)

The idea of an investment trust is to reduce taxes. In a common situation, a company makes money, pays taxes on it, and distributes some of the after tax growth to its investors as dividends. An income trust turns this around. Instead, it makes money, distributes it to the investors and has them pay the taxes on it. If those investors pay lower tax rates than the corporate tax rates, there is less tax being paid and, at least in theory, the investors can get a higher return.

Why Do Investors Like REITs?

Investors like high income investments. REITs appear to give them a high yield, often 5% or better on a pre-tax basis.

Investors also like the idea of investing in real estate but being able to sell it off quickly and easily at any time. If they buy an apartment building with several friends, it would be difficult to sell their position immediately. But if they buy units in a REIT that holds apartment buildings, they can sell their position with a few quick keystrokes on their brokerage website. (Whether they can sell it for a profit is another story.)

Many investors have convinced themselves that the value of real estate can only go up so to them REITs seem like very safe investments. As safe as, say, houses. (I don’t count myself among those investors.)

Many REITs are also legally obligated to keep paying out a high percentage of their profits. They can’t suddenly suspend payments like a dividend paying stock can, simply at the discretion or whim of management. That appeals to some types of investors as well.

REITS Are Vulnerable

So far it seems like REITs are a great investment and it sounds like we should all sink huge amounts of our savings into them. Unfortunately, no investment is invulnerable and no investment is simple. REITS are susceptible to increases in interest rates. In Part Two, I’ll explore Why Do Rising Interest Rates Affect Real Estate Investment Trusts, REITs? And try to answer the selfish question: should I sell my small REIT holding now or not?

Related Reading

Join In
Do you have some REITs in your portfolio? Did the dip in prices this spring send any shockwaves through you? Please share your experiences and insights with a comment.