It's been a challenging market for businesses that are sensitive to interest rates, especially those around real estate. Since March 2022, the Federal Reserve has aggressively raised interest rates by 525 basis points from near-zero levels during the pandemic.
Real estate investment trusts (REITs) have had an especially tough time. These businesses use debt to leverage their investments and can be a solid source of dividend income during times of stable interest rates.
Since the start of 2022, AGNC Investment (AGNC 0.97%), SL Green Realty (SLG -0.53%), and Stag Industrial (STAG -0.17%) are three high-yielding dividend stocks that have fallen anywhere between 20% and 45%. These companies continue to face headwinds, but if I had to buy just one of them today, the choice is clear.
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Rising interest rates have wreaked havoc on real estate companies
Real estate values have taken a hit in the past couple of years, primarily due to rising interest rates. That's because property values have an inverse relationship to interest rates. REITs are particularly sensitive to rising rates because they use leverage to finance investments. As rates rise, so do REITs' borrowing costs, which can pressure their profits and, eventually, dividend payments.
The rising interest rates have made it difficult for real estate companies to find financing and make deals. For example, commercial real estate properties, like offices and retail stores, have experienced a drastic slowdown in property sales and debt financing, according to CBRE Group, the world's largest commercial real estate company.
AGNC's residential real estate business has struggled for years now
Many companies in and around real estate have taken a shellacking in the past couple of years. AGNC is a mortgage REIT that can be particularly sensitive to rising rates. It doesn't buy properties like traditional REITs. Instead, it invests in residential mortgage-backed securities, which are pools of mortgages that are packaged and sold to investors.
When interest rates rise, the value of those securities falls. Also, the higher borrowing costs make it harder for AGNC to profit on the interest rate spread -- the difference between the cash flows coming in and its debt costs.
The company's book value per share is one metric that provides some good insight into AGNC's health. At the end of 2021, before the interest rate increases, its book value per share was $15.75. In its recent third-quarter earnings, its book value per share was roughly half that amount, at $8.08. This represents a 14% decline from the second quarter due to the rise of longer-term interest rates in the quarter.
AGNC has struggled for years, and high rates make the stock unappealing for investors looking for reliable dividend income. Until there is a clear indication that interest rates have peaked and credit expands again, I'd avoid this REIT.
Office properties are highly vulnerable
In addition to higher interest rates, office properties suffer from long-term trends that have accelerated in recent years. During the pandemic, office employees began working from home, and many businesses continued this or moved to hybrid work arrangements, significantly reducing the need for office space.
According to the commercial real estate specialist Jones Lang LaSalle, vacancy rates at offices across the U.S. and Canada were 21% in the third quarter, the highest level on record. Before the pandemic, vacancy rates in North America were around 13%. Recent news about WeWork's bankruptcy filing is another factor that makes office landlords nervous about losing one of their largest tenants.
According to CBRE Group, office properties could take twice as long to recover their lost value compared to the decline during the Great Recession. Given the pressures on the sector, I'd avoid office real estate stocks, too, like SL Green Realty, until vacancies subside and credit becomes more widely available.
If I had to buy one REIT today, this would be it
Stag Industrial focuses on leasing industrial properties, like warehouses and distribution centers, across the U.S. The company has benefited from the shifting landscape as consumers shop online more. Since going public in 2011, it has become one of the largest owners and operators in the U.S. industrial real estate market.
Stag Industrial should continue to benefit from e-commerce trends that increase the demand for warehousing and distribution. Allied Market Research expects the market for warehousing and distribution logistics to grow 7.7% annually through 2031.
Of its nearly $2.5 billion in debt outstanding, $53 million matures by 2024, and $375 million comes due in 2025, putting Stag Industrial on solid footing to ride out higher interest rates.
