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Real estate investment trust (REIT) values are inversely sensitive to rising interest rates. With the Federal Reserve starting the most rapid rate increase trajectory in history two years ago, REIT values have fallen by about 35% over the same two years.

With interest rates likely to stay higher for longer, what are the prospects for REIT investing?

From April 2022 until July 2023, the Fed increased its Fed Funds Target rate from 0.25% to 5.25%. The rate has not changed since July of last year.

How do the recent changes (or lack of changes) in interest rates affect commercial real estate and REITs?

A central point to remember is that changes in commercial real estate happen very slowly. Mortgages go on for five to ten years. Leases are multi-year contracts. Property values are not always apparent until there is a sale.

Higher interest rates hurt REITs when they must refinance debt or mortgages. A REIT will have laddered maturities, so the adverse effects of higher rates will show up over time, meaning several years.

The remote work trend has led to fewer and fewer workers going to the office. The effects of this will happen slowly as long-term leases expire and companies look for smaller spaces to fit a smaller office workforce. Office sector REITs face some serious challenges over the next few years.

As I noted, the Fed stopped increasing interest rates in July. Those rates are much higher now than two years ago, and, as I hope I have conveyed, it will take REITs several years to adjust to the new interest rate environment.

The Fed is expected to start lowering rates later this year, but the cuts will be minor compared to the magnitude of the recent increases. The Fed Funds rate will likely be around 4% by the end of the year. That’s still much higher than the near-zero percent in effect a few years ago.

REITs will adjust. Borrowing costs will change. Lease rates will increase as leases (outside of office buildings) will increase. Property values (less office buildings) will increase. As we go through the rest of this year and next, REIT management teams will adjust their business operations to return to historic profit levels and growth profiles.

REIT share prices will lead to a recovery in business results. Stock markets are forward-looking, and the prospect of lower interest rates will renew investor interest in real estate stocks. I expect REIT values to start the next upward move in the second half of this year. It may happen sooner, but it may take a little longer.

I don’t recommend trying to time the upcoming REIT bull market. Instead, you can accumulate shares of the Hoya Capital High Dividend Yield ETF (RIET) and earn a 10% yield with monthly dividends while you wait.

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