Real estate investments will likely rise as rates fall: A look at 5 REIT categories

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A common, critical question looms over various investment markets: When will the Federal Reserve Board (the Fed) start cutting the federal funds rate?

Anticipated cuts in that rate will trigger declines in prevailing rates, lowering the cost of loans for pretty much everyone. Corporations will likely benefit because they’ll pay lower interest rates on their bonds. As corporations would be in better financial shape as a result,Fed rate decreases tend to push up stock values.

Lower interest rates benefit various stock sectors, but few as much as real estate — specifically, landlord companies known as real estate investment trusts (REITs).

REITs lease out all kinds of property, including office buildings, warehouses, apartments, nursing homes, senior housing, data centers and cell towers. Investors buy shares on major exchanges and collect relatively high dividends.

This is a highly convenient way to invest in real estate because investors don’t have to buy, sell or manage property—no late-night calls from tenants screaming that they have no heat or stress from tenants not paying their rents on time. Instead, investors just buy shares.

As REIT price movements have lower correlation to those of other assets — their prices don't necessarily move in the same direction — these investments can diversify portfolios, reducing risk. However, most individual investors should probably only seek a tincture of this diversification, with portfolio allocations of perhaps no more than 15%.

REITs’ relatively high dividends are enabled by a special tax status that requires them to pay out 90% of their taxable income to shareholders as dividends.

But, as income plus growth (rising stock prices) is better than income alone, the REIT market is currently focused on the boost their stock prices will likely get from Fed rate decreases. Lower interest rates mean lower costs in financing the purchase and renovation of property.

Rates are currently elevated, after a series of steep, historically rapid increases in 2022-2023 to counter historically high inflation. Higher rates suppress business activity, slowing economic growth to tamp down rising prices.

Now that inflation has declined substantially and is well on its way toward the Fed’s 2% target, the idea is to lower rates so as not to overdo the dampening, potentially leading to a recession. The question is when to start cutting so as not to fan any lingering embers of inflation.

Amid elevated rates over the past couple years, REITs have been pretty beaten up, with prices hitting bottom earlier this year. While some types of REITs have since grown, others continue to languish.

No one knows when rate cuts will begin, but many now expect them to start in September. When Fed Chairman did nothing July 31 to throw water on the notion of a first cut in September, the always-forward-looking market, including REITs, got a boost

Depending on the REIT category involved, this may be a good time for investors to hold on to their shares, in anticipation of upward impetus from rate cuts.

But new investors, attracted by current dividends and expectations of growth next year, after likely incremental rate decreases, may find these motivations enough to buy REITs.

Regardless, it’s not too soon for current and potential REIT investors to get a handle on the status of various categories.

Tom Kaiser, CFA, CPA, and Edward “JR” Humphreys II, CFA, CAIA, are portfolio managers and Dave S. Gilreath, CFP, is a partner and chief investment officer with Sheaff Brock Investment Advisors and Innovative Portfolios®. As of June 30, the firms managed assets totaling about $1.4 billion.

Investments mentioned in this article may be held by those firms, Innovative Portfolios’ ETFs and affiliates, or related persons. There may be a conflict of interest in that the parties may have a vested interest in these investments and the statements made about them.