Not all real estate is created equal and investors need to position themselves accordingly as different property sectors have different risk and return characteristics. This is especially critical as we enter a period of rising interest in the months ahead. When there were rising treasury yields from 1992 – 2017, REITs posted positive total returns in 87% of the time meanwhile outperforming the S&P 500 in more than half of that time according to Nareit. (Past performance is not an indicator of future results.)
Different property types have distinct characteristics, for example:
- Lease duration (Hotels are as short as one night, while Class-A office space is 5-10 years)
- Barriers to supply (city, state, and federal entitlements)
- Specific economic drivers (e-Commerce, retail apocalypse, consumer vs. corporate spending)
Investors and advisors allocating money to real estate can no longer pretend that all real estate is created equal as the bull market matures and interest rates trend higher.
Questions for investors
Two of the biggest questions for investors for the remainder of this year will be:
- What happens to interest rates?
- How will changes in the interest rate environment affect businesses and financial markets, including rate-sensitive sectors such as real estate?
How to think about real estate
When thinking about real estate, investors should keep in mind:
Real estate is a key asset class. Commercial real estate —such as stocks, bonds and cash — is a fundamental part of a diversified portfolio that covers the entire U.S. investment market.
- Real estate has a distinct economic cycle relative to the cycle for most other stocks and bonds.
- Real estate has provided solid long-term investment returns, including growing income from rents plus capital appreciation over time.
- Real estate offers inflation protection due in part to the fact many leases are tied to inflation and that real asset values have tended to increase in response to rising replacement costs. (It’s important to note that during inflationary times there may be rising maintenance and labor costs that effect the real estate management companies and their tenants. This may impact property values, occupancies and overall real estate performance.)
How to think about REITs
Publicly traded real estate equity securities are like other stocks in many ways. Different sectors tend to perform differently as the business models vary significantly. Take high flying technology stocks versus capital intensive utilities for example. They offer distinct advantages though of liquidity, diversification and institutional management. REITs are no different.
REITs provide these benefits:
- Strong total-return potential
- High current income potential
- Transparency and corporate governance
- Geographic and sector diversification
- Value creation by company managements
Benchmark believes REIT shareholders will benefit from tax reform, specifically from the new 20 percent deduction in pass through dividend income, and 260 basis point reduction in the top marginal individual tax rate. This could result in a significant increase in after-tax income on REIT dividends for some shareholders, although dividends are not guaranteed.
Benchmark’s ETF REIT solutions help investors capitalize on the trends in retail towards online shopping via real estate investing in key aspects of the process.
- Pacer Benchmark Data & Infrastructure Real Estate Sector ETF – ticker SRVR, invests in REITs and C-corps related to data centers, cellphone towers and communications infrastructure. Data center REITs and cell tower REITs are the backbone of technology real estate and power the internet of things from self-driving cars to online video, social networking and mobile data traffic driving intense demand. Furthermore, SRVR real estate serves as the foundation of online commerce, cloud computing, and artificial intelligence.
- Pacer Benchmark Industrial Real Estate Sector ETF – ticker INDS, invests in industrial REITs related to e-commerce distribution, logistics, and fulfilment networks. These companies deal with order processing and fulfillment in this retail model.
- Pacer Benchmark Retail Real Estate Sector ETF – ticker RTL, invests in commercial real estate REITS. These companies are involved with the portion of retail that is still local and with local order pickup for online shopping that is becoming more of a trend. They tend to be high quality properties located in communities with higher incomes and solid economic fundamentals.
In a rising interest rate environment, rising rents matter more than ever. These three property management sectors are positioned to potentially thrive in the upcoming rising interest rate environment on top of the rent escalators every year. “Technology real estate (SRVR), e-Commerce real estate (INDS), and retail real estate (RTL) are all seeing long-term growth trends that are leading to higher occupancy rates, stronger rent growth, and increased earnings which, in-turn, leads to higher dividend payments and rising property values. Anytime a person uses their phone to buy an item online, they are using the real estate backbone from the cell phone towers to the datacenters to the warehouse, or even, to the storefront,” said Kevin Kelly, CEO of Benchmark Investments.
Real estate as an asset class is something to be considered as part of a diversified portfolio. With the coming rising interest rate environment and the prospect of increased inflation, real estate investors should choose carefully.
To learn more about Benchmark’s solutions, visit investbenchmark.com.
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