The real estate investment trust (REIT) sector has suffered for almost two years in a bear market that started at the end of 2021. REIT share prices should soon bottom, and it’s a great time to invest in the sector.
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REIT values dropped with the rest of the stock market during the 2022 broad-based bear market that bottomed in October 2022. REITs have not joined in the somewhat bumpy bull market that started a year ago.
The problem for REITs has been the Federal Reserve’s continued interest rate increase.
REITs must pay out 90% of their income as dividends, which means investors view these stocks as income investments. Income investment prices tend to move in the opposite direction of interest rates. As rates rise, investors want higher yields, which pushes down prices.
REITs own commercial properties, and—as real estate investors do—these companies use debt to pay for a large portion of the investment properties purchased and owned. Rising interest will increase the cost of debt as commercial mortgage loans or bonds mature and must be refinanced. Higher interest expenses can squeeze net income and the cash flow to pay dividends.
In addition to the interest rate challenges, REITs have been hit by the challenge of empty office buildings as employees resist the idea of returning to in-office work. Owners of city center office buildings face serious challenges.
In investors’ minds, office sector challenges have tarred the entire REIT sector. The reality is that there are a couple dozen different types of commercial properties, and most REITs focus on just one.
With the Fed close to finishing with increasing interest rates and expecting they will be able to start reducing rates next year, we should be close to the bottom of the decline in the REIT sector.
Here are a couple of investment ideas in the REIT sector. One is an ETF, and the other is a well-run but beaten-down individual stock.
The Hoya Capital High Dividend Yield ETF (RIET) employs a balanced approach to diversify the portfolio across small, medium, and large REITs. Here is the targeted portfolio breakdown:
RIET pays stable monthly dividends and currently yields over 10%.
Kilroy Realty Corp (KRC) is an office sector REIT. Kilroy develops, owns, and operates a portfolio of Class A office properties on the West Coast and in Austin, TX. Owners of lower-quality properties will feel the office sector problems. Class A buildings should stay fully leased.
Kilroy Realty has a long track record of above-average performance. With the share price down by more than 50% since April 2022 and a current yield of over 7%, the return potential from here for KRC is outstanding.
An old saying is that the stock market doesn’t ring a bell at the bottom of a downturn to announce the next bull market. REITs are poised for a bull market that could go on for several years.
— Tim Plaehn
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Source: Investors Alley