While there has been a large focus on growth stocks this year, real estate investment trusts (REITs) continue to be a great way to balance your portfolio while gaining exposure to the real estate sector. Adding these income-producing investments can result in significant advantages over traditional real estate investing including increased liquidity, greater diversification, tax benefits and potentially higher returns with lower risk.
Real estate investment trusts either own or manage income-producing real estate, normally through directly investing in properties or the mortgages on those properties. The IRS mandates that REITs must pay out 90% of their taxable income to shareholders. This typically translates into much higher dividends than your average S&P 500 stock. One of the best ways to increase returns when investing in REITs is to compound the dividends received. Investors may also choose to utilize a Dividend Reinvestment Plan (DRIP), which automatically reinvests the dividends received into additional shares.
Investors have the option to buy REITs directly, or may choose to further diversify by investing in REIT ETFs or mutual funds. The iShares Cohen & Steers REIT ETF ICF boasts a Zacks ETF #1 ranking (Strong Buy) and has outperformed the broader market this year with a nearly 32% YTD return.
Zacks Investment Research
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REITs not only offer above-average yields, but also the potential for future price appreciation. With interest rates historically low for many years, investors have turned to vehicles like REITs when searching for ways to increase yield. But given the recent chatter surrounding future interest rate increases, a potential issue for REIT investors is their sensitivity to interest rates. Let’s take a look from a historical perspective to see what we can learn regarding REIT performance during periods of interest rate increases.
The table below illustrates six different historical periods beginning in the 1970s during which interest rates rose, measured by the 10-year treasury yield. During these times of increasing rates, the table compares the cumulative total returns over each period for both REITs and U.S. stocks.
Source: S&P Dow Jones Indices LLC, Bloomberg, The Federal Reserve.
The table shows that out of the six different periods, REITs generated positive returns in four of them, while outpacing the general stock market in three of the cases. This study shows that a rising interest rate environment does not translate to lower REIT prices. This is mainly due to the fact that during economic expansions, the value of the underlying real estate increases.
While REIT prices may react in the short-term to changes in the outlook for interest rates, over longer periods there is typically a positive correlation between rising rates and REIT returns. A stronger economic backdrop normally leads to higher occupancy rates, increased NOI (net operating income), and expanding property values. All of these components lead to higher dividend payments for REIT investors.
Now that we’ve established REITs can outperform even in rising rate environments, let’s take a look at three REITs with a healthy outlook that are outperforming the broader market.
Extra Space Storage (NYSE:) (EXR)
EXR is the largest self-storage management company in the United States. Headquartered in Salt Lake City, the company is a fully integrated, self-administered REIT which owns and operates self-storage properties. These properties are comprised of many units and millions of square feet of rentable storage space.
Maintaining a Zacks #2 Buy ranking, we can see below that EXR has a strong history of EPS surprises. It most recently reported earnings in October for the prior quarter of $1.85, representing an 8.2% surprise over consensus.
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