There’s an epic rally coming in real estate.
And now’s the time to get on board…
The real estate sector is mostly made up of REITs (real estate investment trusts) that collect rent from the properties they own.
REITs are required to return most of their earnings to shareholders through dividends. So they are traditionally seen as income investments.
But with interest rates zooming up over the past year, the dividends that real estate stocks pay looked less and less attractive.
Plus, the headlines have been filled with stories of empty office buildings and predictions of the coming collapse of the real estate market.
The doom and gloom has led to the real estate sector losing 16% while the S&P 500 has returned 5% over the past year.
But the negativity is overdone.
And REITs are trading at discounted valuations not seen in years.
That means there’s an attractive margin of safety that will lead to strong price gains when the market realizes its mistake.
When you add that to the outsized income that REITs produce, there’s a good chance real estate will produce market-beating returns in the months to come.
Today I want to show you why it’s a good time to be investing in real estate and give you multiple ways to profit from it.
The Problems Facing Real Estate Right Now
It’s easy to look at a stock that has dropped in price and assume there’s something terribly wrong with the company.
And in some cases, that’s an accurate assessment. But it’s not the case for many REITs right now.
True, offices are down in the dumps for good reason. And I have written about that before.
But REITs that own other types of properties are perfectly healthy.
Digital Realty is a REIT that owns data centers. It has customers knocking on its door asking for computing power for artificial intelligence.
Prologis, the largest REIT in existence, owns industrial properties like warehouses. Its CEO told investors he’d like to see his occupancy rate drop.
Many of his tenants have leases that are 30-50% below market rental rates, and he wants to increase prices. Because of high demand for Prologis’s properties, if his current tenants left, he could charge much higher prices to new tenants.
And my favorite REIT – Realty Income – reported a 99% occupancy rate for three quarters in a row.
There’s clearly plenty of demand for the right kind of quality real estate.
Meanwhile, new real estate is in short supply.
Cohen & Steers is an investment management company that focuses on real estate. According to its analysis, real estate supply grew by 1.3% in 2021 and 1.7% in 2022. That’s well below the long-term average of 2.6% growth since 1996.
Inflation over the past few years has also increased the cost of building new real estate. That increases the value of older buildings and allows them to charge more rent.
REITs have taken advantage of years of low interest rates to reduce the cost of their debt and increase the amount of time they have to pay it back.
Before the Financial Crisis in 2008, REITs paid an average of 5.8% interest and their debt was due in 5.3 years.
Today, REITs pay an average of 3.9% interest and their debt is due in 6.8 years.
Even though REITs are firing on all cylinders, they’re priced for recession simply because interest rates have been going up.
So when will REITs turn around?
Buy Now to Profit from the Rally
Cohen & Steers analyzed every cycle of interest rate hikes since 1990.
It found that REITs returned an average of 15.8% in the six months after the Fed stopped raising rates. That’s nearly double the 8.4% return for the S&P 500 during those same periods.
And we may already be there.
The CME FedWatch Tool estimates the probability of rate hikes based on the price futures.
Right now, the numbers are showing a less than 40% chance of one more hike in November or December. And the market is betting the Fed will start cutting rates early next year.
It all adds up to the perfect combination for REITs to shine.
One quick way to get REIT exposure in your portfolio is through the Vanguard Real Estate Index Fund ETF (VNQ).
It’s the largest, most well-known REIT exchange-traded fund (ETF). But remember, with an ETF, you’ll be buying bad real estate – like offices – along with the good properties.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research