By: Dividend Sensei
You wouldn’t think it to look at the market’s performance of the last few days, because it’s basically been flat. BUT that doesn’t mean that certain stocks aren’t getting taken out back to the woodshed. Real Estate Investment Trusts, or REITs underwent a bloodbath today, which is just a continuation of a correction that’s been going on in the industry for the last three months.
For example, The Vanguard US REIT ETF (VNQ) was down 2.6% today, 3.7% for the week, 8.7% for the month, and 12.5% in the last 3 months. In fact REITs are down 15% since their July high.
But even that painful performance hides the true pain that many high-quality REITs have gone through.
For example, CorSite Realty Trust, one of my favorite fast growing data center REITs was down almost 7% today, and is down 35% from its July high.
Or take Realty Income, the ultimate name in Sleep Well At Night or SWAN blue chips. Down 3.6% today, 25% since July.
Not a single sector in the industry was spared the carnage of the last few months. Data centers, medical, retail, apartments, hotels, timber, infrastructure, all crushed under the heel of the market’s seeming hatred of this once hot high-yield industry.
So what’s the deal? Simple, the market is pricing in the likelihood that the Federal Reserve will raise interest rates in December, which now stands at 78.5% according to futures markets.
Why do interest rates matter so much to REITs? For two reasons.
First, higher interest rates mean higher borrowing costs, and lower profits, which means potentially slower dividend growth. At least that is what the market is thinking. In reality, the best REITs have long histories of growing steadily in much higher interest rate environments, such as when rates were almost 6% in 2007.
Another reason is the concern that, as rates rise, the yield on Treasuries will too. And since many investors piled into REITs as an alternative to low bond yields, the increased yield on bonds might suck some of the newer money out of REITs.
BUT here’s the thing. Yes REITs were overvalued in January, they’ve been on an epic run for years. In other words, this correction is a natural and healthy pullback that will allow long-term dividend investors to earn higher total returns over time.
Does that mean that all REITs are now cheap? No, some are still trading at frothy levels, such as the faster growing data center ones. BUT yields on many quality REITs are now getting back to historical norms and that makes for a great time to open a position or start adding to one.
That doesn’t mean the rout won’t continue, BUT given the realities that rates are likely to rise only by 25 basis points and then not rise again for the first half of 2017, the current correction can’t go much lower before the entire sector becomes oversold.
In other words, this is a good time to buy, BUT it isn’t necessarily the bottom. The sector may still fall perhaps 5% by the time the Fed raises rates in December, and then may fall another 5% beyond that. But I can tell you this. Another 5% drop would make REITs cheap, and a 10% drop from here (25% from their high) would be a bear market that would make most REITs a screaming buy.
So as long as you have a five year investing horizon, NOW is the time to get started on researching REITs, making a buy list, and opening some starting positions (if you don’t own REITs already). Don’t wait to see where the bottom is because that won’t be apparent until the recovery is already well underway. Plus there can be numerous fake outs, so don’t try to time the market.
Just buy the highest quality REITs, add on dips, reinvest the dividends, and wait to get rich, and drowned in dividends;)
I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.