Investors in real estate investment trusts (REITs) were hit hard as the Federal Reserve has aggressively raised interest rates in 2022 and 2023. REITs invest in real estate, lease it to tenants and trade on the stock market like a stock. They’re a favorite with investors because of their high dividends and strong record of growth.
The Vanguard Real Estate Index Fund ETF was pummeled in 2022, even more so than the Standard & Poor’s 500, whereas it’s typically less volatile. This underperformance may be surprising, too, since this index has often outperformed the S&P 500 over long periods.
However, REITs may be poised for a rebound in 2024 after the Fed decided to keep interest rates steady in December 2023 and indicated rate cuts are on the horizon. That’s good news, because rising rates hurt the value of REITs’ real estate.
Now might seem like a good time to buy REITs, but there are a few common mistakes investors would be wise to avoid, especially if the economy faces volatility in the future.
1. Selling at the bottom
Investing is all about buying low and selling higher. So when the market drops substantially, as it did in 2022, you want to evaluate whether you’re selling only because the REIT has gone down or because you think it’s going to fall further due to fundamentals.
A REIT stock price builds in the expectations of potentially millions of investors, who are looking at all kinds of data (vacancies, economic growth, tenant problems and many more) to determine their best guess at the value of the business. While the price can always move later, it often takes new information to shift investors’ view of the REIT.
The market is often effective at predicting the future. Good news can happen without you being aware of it, and often the good news can be attributed to investors becoming less pessimistic overall. If you had sold REITs in 2022, you would have suffered losses and missed the growth these assets have enjoyed since November 2023. Instead of selling when the price drops, savvy investors know that buying the dip can be advantageous, assuming strong fundamentals and supply-demand dynamics hold.
2. Not analyzing a REIT carefully
Whatever you’re thinking about doing with a REIT – buying, selling, or standing pat – it’s important to analyze them and the industry carefully. REITs operate in many different sectors — healthcare, lodging, apartments, retail and data centers, to name a few. The dynamics of each of these sectors is tremendously different, so you can’t take a “one size fits all” approach.
Before you make a decision on how to proceed, consider these factors as well as the more specific situation at each company. Are tenants paying their rent? Is the debt load manageable? Will the company need to raise money in the future if the economy downturns?
Of course, those are just a few of the questions that you’ll want to consider before taking any action. Let the facts guide your decisions and not the other way around.
3. Letting fear keep you from buying good REITs
If you’ve analyzed the company and the long-term future looks good, it could be a mistake not to buy more, especially if you’re receiving a significant discount to what you think the REIT will be worth in the future. So it’s important not to let fear scare you away from a good bargain.
That’s not to say that every discounted REIT is a bargain. And even good companies can become cheaper as new information emerges or investors become more pessimistic. That’s one reason why many experts recommend using dollar cost averaging to buy into stocks. Using this approach, you can spread your buying apart to average into a stock.
While REITs are known for their stable dividends, if a REIT isn’t collecting its rent, it will have a hard time paying its dividend. So investors may already be pricing in a lot of potential for a dividend cut. But if that dividend cut doesn’t happen, the stock may be primed to bounce higher.
If the REIT’s fundamentals look good and it can continue growing in the future, but it’s not priced for this scenario, then it might be a good time to pick up shares. But often you’ll have to overcome your fear. Doing a thorough analysis of a REIT can help you eliminate any doubts.
4. Only concentrating positions, not diversifying
If you’re looking to buy REITs, it can be a mistake to focus only on the ones you already own. Instead, it could be an opportunity to buy some of the high-performing stocks that simply looked too expensive before. In this way, you can take advantage of the power of diversification, actually adding more high-quality companies to your portfolio while they’re relatively cheaper.
For example, the growing digital economy has been great for some REIT sectors in the last few years – warehouses, data centers and telecom towers, especially. Other subsectors in the REIT market also look promising, including health care facilities, senior housing and manufactured homes.
By diversifying, you can reduce your portfolio risk while potentially adding some high-quality gems. It also helps balance the risk of one blowing up, given the significant debt that is common for REITs.
Bottom line
REITs offer an attractive way to invest in real estate for the long term, but investors need to tread carefully by negotiating the path between careless optimism and myopic pessimism. The market’s slide in 2022 could offer significant value to set your portfolio up for decades of great returns, including a growing stream of dividends. But you’ll want to balance this upside against the potential for loss, especially if the economy weakens again.
