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Ask Millionacres: What Forces Impact REITs?

[Updated: Nov 16, 2020 ] Mar 01, 2020 by Matt Frankel, CFP
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Q: What are the three most important forces that affect REIT stock prices? -- Phil

I'm hesitant to name three forces that affect all real estate investment trusts, or REITs, in the same way, but here's my take on the major drivers of REIT prices, aside from the performance of the businesses themselves.

Interest rates are probably the number one factor that can move the entire real estate sector. Generally speaking, falling interest rates tend to be a positive catalyst for REIT prices and rising rates are a negative catalyst.

Here's why. The yields on income-focused investments tend to move in the same direction. In other words, when Treasury yields rise or fall, dividend yields tend to do the same. And, price and yield move inversely, so lower yields translate to higher prices.

That said, it's also important to point out that the "why" matters when it comes to interest rates. For example, real estate has plunged along with the rest of the market in response to coronavirus fears, even though interest rates have fallen to all-time lows. However, interest rates fell because investors are buying Treasuries and other risk-free assets out of fear that the virus could hurt businesses. And REITs are definitely not risk-free assets.

Economic growth is another factor that affects REIT prices, but its effect can vary dramatically based on the type of commercial real estate a REIT owns. Some types of REITs are highly cyclical -- for example, hotel REITs tend to be very recession-prone, as hotels rely heavily on discretionary consumer spending.

On the other hand, office and healthcare REITs tend to be far less cyclical. Both property types are typically leased to tenants on a long-term basis, and healthcare is especially recession-resistant because it's something people need no matter what the economy is doing. You'll also see recessions and economic fears affect REITs with higher debt levels more than REITs with rock-solid balance sheets.

Finally, there are industry-specific forces that can dramatically influence the prices of an entire subsector of REITs. Oversupply worries are one that tends to appear in high-growth areas of real estate -- for example, it's no secret that senior housing demand is expected to rise over the next few decades as the elderly population grows. However, in many markets we've seen senior housing construction outpace demand growth, which leads to higher vacancies and lower short-term growth potential.

E-commerce headwinds are another big example of an industry-specific force. The percentage of retail sales that occur through online channels has steadily risen for the past decade or so, and this has resulted in a wave of bankruptcies and store closures in the physical retail space. Most retail REITs have been affected by this, to one extent or another, and you can learn more about that in this article.

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