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.