Raising the Roof on REITs

Inflation and interest rate hikes have not been kind to REITs and the funds that own them. However, their low valuations could indicate an opportunity for investors.

Most property indexes are down around 3% on an annualized basis for the past three years through April 19, including a 9%-10% loss for this year alone. That compares unfavorably to the 7.73% and 2.27% annualized gains of the S&P 500 and the Vanguard Balanced Index fund (VBAIX), respectively, for the same time frame. About the only thing REITs have beaten is bonds, which have turned in a 3.47% annualized loss for the three-year period.

And that performance comparison indicates something about what happened to the asset class prior to the rise of inflation and rates. The lack of bond yield for most of the past 15 years, and especially in 2021, caused the $157 billion asset class to take in a torrent of assets. In 2021, funds in the category gained $18 billion in flows, including $6 billion in the behemoth $65 billion Vanguard Real Estate ETF (VNQ). The ETF was down nearly 10% year to date on April 19.

REITs Offered High Yields When Bonds Didn’t

REITs are structured so that they pay out 90% of their net income as dividends in exchange for tax-free status at the corporate level, making them a prime equity substitute for bonds that were yielding nearly nothing.

But with the bad performance, $4 billion has left the funds in the category over the past year through March 2024, and $9 billion has left over the past two years.

Of course, certain property types are experiencing idiosyncratic problems. Post-COVID office vacancy rates are painfully high, and retail’s longer-standing struggles with competition from Amazon persist (though logistics/warehouse landlords’ benefits from online shopping somewhat offset physical mall struggles).

But the chase for yield represented by massive 2021 inflows was undeniable. The irony — now that all that money has fled over the past two years — is that the asset class looks reasonably priced on at least one key metric.