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Hey, did you hear? Interest rates are going up.
You know what that means: We should sell our real estate investment trusts (REITs).
Well, that's what Wall Street would like you to believe during periods of rising interest rates.
After all, REITs borrow a lot of money, so their borrowing costs will go up, their cash flows will shrink, and they might have to cut their dividends. Higher rates mean more competition from fixed-income investments. That urges investors to sell their REITs, then take that cash to go buy bonds, thus dragging REIT prices lower.
I mean, the Federal Reserve began raising rates in June 2004, going from 1.25% to 5.25% by summer 2006. That's a massive increase in just two years and had to have been horrible for REITs.
There's just one small problem with this thinking, though…
In fact, if you look at the most recent period of rising interest rates, REITs performed exceptionally well.
And it looks like we're entering yet another period of rising interest rates in which we can outsmart Wall Street at their own game, collecting profits from undervalued REITs every step of the way…
Wall Street Lies, but the Numbers Never Do
It's strange how everyone accepts Wall Street's REIT myth when all they have to do to debunk it is look at the numbers.
During that 2004–2006 period, in which rates increased fourfold, REITs saw a total return of 80%. They outperformed the fixed-income alternatives Wall Street told us were a better idea, and they even doubled the stock market's return over those two years.
Not so shockingly, the accepted wisdom and gospel of Wall Street were simply wrong. Those who listened to the Big Bad Banks' advice missed an opportunity to nearly double their money in less than three years.
To understand how REITs actually perform well during rising rate environments, we have to first understand why the Fed hikes rates in the first place.
In essence, the central bank does it to cool off a heated economy and keep inflation in check. Rates only rise when the economy is firing on all cylinders.
A healthy economy means people travel for business, parents take their children to the beach, and hotels are fully booked. Rents and occupancy rates across every real estate class rise. The net asset values of the properties increase, and because REITs are structurally obligated to pay out 90% of their taxable income, dividends will grow as cash flows improve.
Think about how common-sense that is: The same conditions that cause rate hikes also cause the real estate business to boom.
I guess common sense is just not that common on Wall Street.
The truth is that REITs are in fantastic shape right now. Cash flows are increasing, property values are stable, debt has been reduced, and the industry has the lowest leverage in 20 years.
After the broad sell-off last year, many REITs trade at a discount to what the properties would be worth in a private sale, and that's attracting buyers. We saw several merger and acquisitions deals in the REIT sector in 2018, and I am sure we will see more this year.
Urgent: Feds use obscure loophole to threaten retirees. If you have a 401(k), IRA, or any type of retirement account, this could cause you to miss out on $68,870 or more. Learn more…
But there's another compelling factor in play right now that's going to drive real estate prices and REIT values higher…
About the Author
Tim Melvin is an unlikely investment expert by any measure. Raised in the "projects" of Baltimore by a single mother, he never attended college and started out as a door-to-door vacuum salesman. But he knew the real money was in the stock market, so he set sights on investing - and by sheer force of determination, he eventually became a financial advisor to millionaires. Today, after 30 years of managing money for some of the wealthiest people in the world, he draws on his experience to help investors find "unreasonably good" bargain stocks, multiply profits, and build their nest eggs. Tim tirelessly works to find overlooked "hidden gems" in the stock market, drawing on the research of legendary investors like Benjamin Graham, Walter Schloss, and Marty Whitman. He has written and lectured extensively on the markets, with work appearing on Benzinga, Real Money, Daily Speculations, and more. He has published several books in the "Little Book of" Investment Series and a "Junior Chamber Course" geared towards young adults that teaches Graham's principles and techniques to a new generation of investors. Today, he serves as the Special Situations Strategist at Money Morning and the editor of "Max Wealth" and Heatseekers.