REITs Under Pressure, but Deals Lie Ahead

If you have real estate investment trusts (REITs) in your portfolio, you might be panicking a little bit.

The sector has been hit hard over the past week and you are probably seeing a little too much red in your portfolio. But I’m here to assure you it’s not time to panic.

REITs are a “must have” in an income-focused portfolio. These investments were created in 1960 to give the individual investor the opportunity to invest in commercial real estate. By law, they must pass through 90% of their taxable income to shareholders as dividends to avoid paying corporate taxes.

Us dividend investors love them because we get exposure to real estate with an above average yield. And we can skip the headaches of being a landlord.

We’ve talked about REITs many times before and how you can find them in various types of real estate. Some of the common types are retail, residential, healthcare, office, and industrial REITs. These equity REITs all generally hold real estate with triple net leases. There are also mortgage REITs (mREITs) that hold portfolios of mortgages.

At any point in time, I’ll have two or three different types of REITs in my portfolio. I’m still bullish on several sectors of real estate right now, but the overall situation is about to get nuanced.

A Rate Hike Would Shake Up This Sector

Last week, Kevin Warsh took the reins at the Fed and led his first FOMC meeting. He introduced a handful of changes and created task forces in five areas to identify improvements.

But most importantly, the meeting confirmed what analysts had already been pricing in—a rate hike.

If we rewind back to March, the Fed’s dot plot—each member projects where short-term interest rates will be at the end of the year—implied at least one more rate cut. To be precise, half of the policymakers projected higher rates by the end of 2026. This is important information for REIT investors.

REITs are heavy borrowers by design. They finance their properties and earn a profit from the spread between the finance costs and the rent income.  When rates rise, refinancing debt and funding new acquisitions gets more expensive.

If a REIT can’t pass higher finance costs on to its tenants as higher rents, its FFO (funds from operations) gets squeezed.

When rates are rising in response to a strong economy, REITs with good occupancy and pricing power can offset the headwinds. This only works for certain REITs, and many businesses can’t afford higher rent right now.

REITs also face rising competition from other income options. The 2-year Treasury yield popped to 4.2% last week. As the yields on risk-free investments rise, money will flow out of dividend stocks and into them. Growing pressure from alternatives will result in REITs underperforming the market through the end of the year.

You Just Might Find Hidden Opportunity

I’m not selling my favorite REITs. Instead, I’m adding to my long-term positions.

It’s no secret that one of my favorite REITs is VICI Properties (VICI). The company specializes in experiential properties, including casinos, bowling alleys, hotels, and golf courses. It owns a large chunk of the Vegas strip and recently added Club Med to its impressive roster of tenants.

Last week, shares hit a new 52-week low, boosting its current yield to 6.8%. My target yield was 5.5%, and I was happy with my entry price yield of 5.7%. VICI has 100% occupancy and has raised its dividend for eight consecutive years. On top of that, it’s AFFO (adjusted funds from operations) comfortably covers its dividend.

REITs should be on your radar in a big way through the end of the year. I think there will be other opportunities ahead to own shares of high-quality REITs at a great price locking in a great yield.

For more income, now and in the future,

Kelly Green