Markets & Strategies

Real Estate Investment Opportunities for 2017 and Beyond

Savvy investment strategies are paramount as demographic and consumer trends impact the real estate sector.

by Michelle Crouch - April 10, 2017

With interest rates expected to rise in 2017, many investors these days are hesitant when it comes to real estate.

However, real estate investment trusts — or REITs — have the potential to perform in a rising interest rate environment, as long as rates are increasing gradually as a result of a strong economy, says John LaForge, Head of Real Asset Strategy for Wells Fargo Investment Institute.

A REIT is a company that owns (and typically manages) income-producing property for investors. REITs historically have produced generous dividend yields, especially compared to bonds, because they must pay out at least 90% of their income as dividends. They also can at times offer a lower risk profile than stocks.

“REITs may add strong diversification to your portfolio because they have characteristics of both stocks and bonds,” LaForge explains. “Sometimes they move with the stock market and sometimes they move with the bond market.”

Real estate investments have been strong performers in recent years, but 2016 was a year of ups and downs. After spiking in the summer months, REIT performance struggled later in the year as people anticipated an increase in interest rates and then as the Federal Reserve raised rates. By early 2017, however, the sector had started to come back, LaForge says.

Demographic and consumer trends impact real estate sector

While most REITs are fairly diversified, they remain subject to changes in the real estate sector overall. As such, investors should be aware of how shifts in demographics and consumer behavior are already impacting the sector, LaForge says.

Baby Boomers, the largest segment of the population, are aging and entering retirement, driving a demand for health care facilities and senior housing. LaForge expects strong performance from REITs that are invested in those sectors, including assets such as long-term care facilities. Storage facilities have also been performing well, LaForge says, partly because Boomers are downsizing and storing some of their excess belongings.

“REITs may add strong diversification to your portfolio because they have characteristics of both stocks and bonds.”

— John LaForge, Head of Real Asset Strategy, Wells Fargo Investment Institute

While health care in general is spurring performance, hospital REITs surprisingly have not performed as well, mainly because the market tends to be good at pricing cap rates (the expected rate of return based on the income a property is expected to produce) on them, so it’s difficult to get them at a discount, LaForge says.

LaForge expects multifamily housing to stay strong for a few more years, as developers cater to Millennials. But he notes it won’t be long before that generation starts moving in greater numbers toward home ownership.

Retail risks and rewards

Another important shift is taking place in the retail market. As online shopping continues to grow, LaForge is wary of REITs that are heavily invested in traditional malls. “A lot of malls are empty today,” he says. “But it’s a tricky sector because many high-end malls are doing well. They have adapted to the move to e-commerce.”

Safer bets include office or industrial properties, which have been able to capitalize on the retail shifts. The growth of online shopping has driven many REITs to invest in the warehouses and data centers that drive e-commerce. There are even a few REITs that focus solely on data centers.

As with any investment decisions, REITs do come with risks. If the economy slows, vacancy rates climb, or property prices drop, REITs would become more volatile. “The bull market began in 2009 and we are eight years in, so we’re late in the cycle,” LaForge notes.

Another threat to REIT performance, of course, is a sudden or dramatic interest rate spike. Higher rates would raise the cost of financing for REITs, cutting into their profits and likely generating a sell-off.

Michelle Crouch writes about consumer finance, parenting, and more from her home in Charlotte, North Carolina. Her work has appeared in Reader's Digest, Parents magazine, and The New York Times.

Image by iStock

Additional Resources

Wells Fargo Advisors provides biweekly discussion around real assets, including REITS.

Risks:

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Asset allocation and diversification cannot eliminate the risk of fluctuating prices and uncertain returns.

Investments in fixed-income securities are subject to market, interest rate, credit/default, liquidity, inflation and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. All fixed income investments may be worth less than their original cost upon redemption or maturity.

There are special risks associated with an investment in real estate, including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.