Question

6. When you think of investing in real estate, what economic factors do you think are responsible for returns in the REIT market? Do you think REITs belong in your portfolio and why?

Answer 1

1)

REITS invest in residential property, offices, warehouses, shopping centers, medical facilities, and hotels. The key demand drivers for revenue generation for these investments are population growth, the rise in economic activities, improvement in the job market, mortgage rates, and commercial and industrial growth, among others. Fluctuations in any of these key drivers will have a direct impact on the demand generation of residential, office, warehouse, and shopping center properties. It will affect REIT earnings.

Economic growth

Economic growth is the major factor that determines REITs’ growth. An uptick in economic fundamentals positively affects all of the REITs like Simon Property Group (SPG) and Ventas (VTR) by increasing business growth.

Job market

The strength of the job market fuels the demand for the housing, office, and hotel industry. Strong job growth can drive higher occupancy rates and lead to a rise in the unit rental revenue. In contrast, high unemployment and slow job growth can result in falling occupancy rates and lower revenue per unit.

Demographics

The rate of population growth in the company’s operating regions is another key determinant of the company’s success. Rising population results in greater demand for apartments, hotels, and warehouses units. In addition, a decision by Millennials to rent or own a house has a lot of implications on REITs’ earnings.

Occupancy rates and rents

Higher occupancy rates and rising rents are the most immediate sources of revenue growth for REITs like Equity Residential (EQR). Higher occupancy rates lead to higher income for REITs and vice versa. As the economy expands, the demand for space increases. This leads to a rise in rents.

Mortgage rates

If mortgage rates are lower, buying a home becomes more attractive than renting. It’s more affordable to buy a house. In such a scenario, the demand for rental properties diminishes. In contrast, if the mortgage rates are higher, renting an apartment becomes more appealing. This leads to a rise in occupancy rates and higher rental revenue.

Interest rates

Rising interest rates can hurt REITs in many ways. When interest rates rise, investors demand a higher dividend yield on REITs. This drives down their stock prices. Another negative effect of rising interest rates on REITs is that they have to incur a higher interest cost to finance building purchases. This puts the margins under pressure.

Investors looking for diversification in the REIT sector can get exposure to REIT ETFs like the Vanguard REIT ETF (VNQ), the iShares U.S. Real Estate ETF (IYR), and the iShares Cohen & Steers REIT ETF (ICF).

2)

In general, a good rule of thumb is that REITs should not make up more than 25% of a well-diversified dividend stock portfolio, depending on your individual goals (such as what portfolio yield and long-term dividend growth rate you're targeting, and how much volatility you can stomach).

And as always, the primary focus of conservative REIT investors should be on maximizing safe income, rather than taking on excessive risk by reaching for yield in stocks with potentially unsustainable dividends. Our Dividend Safety Scores can help investors sidestep stocks with the riskiest payouts.

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From Mona....