Comments from key Federal Reserve officials and improving economic data have added fuel to rate hike hopes. In September, hopes of a lift-off had fizzled out as the date for the FOMC meeting approached. However this time, factors that will help in deciding on the rate hike have growing in numbers. Moreover, market volatility is now at a level that should help the cause against the high levels seen in September.

Investors may be ‘fed up’ of Fed’s actions or inactions and the effects of both is a story that has been done to death. But we have to remind investors about funds that would be the best buys before ‘Fed ups’ the rate for the first time in a decade, even at the cost of repeating ourselves.

Fed Comments

Several Fed officials pointed toward a series of rate hikes at a moderate pace. Atlanta Fed President Dennis Lockhart stated that he was “comfortable” with a rate hike “soon.” Cleveland Fed President Loretta Mester said the central bank had not firmed up on a December rate increase. However, Mester added that: “Things are on track.”

Fed vice chairman Stanley Fischer mentioned that “some major central banks" could quit the near-zero interest rate policy “in the relatively near future.” New York Fed president William Dudley and St. Louis Fed president James Bullard also made similar comments.

According to a Dow Jones report, William Dudley said on Friday that the central bank may approach the goals needed to hike rates, but it still has time to decide on whether or not it will hike rates in December. The timing is data-dependent and Dudley expects to see indications of increasing inflation soon enough. He mentioned that the US economy is in “good shape”, helping the Fed meet the criteria for rate hike in the near future.

Separately, James Bullard reportedly said that the central bank may move back to an era of uncertain rate hikes based on meeting-by-meeting basis after the first rate hike.

FOMC Minutes

Minutes from the Federal Open Market Committee’s (FOMC) meeting in October stated that most officials anticipated that conditions to lift short-term interest rates “could well be met by the time of the next meeting” in December. The Fed is waiting for further improvements in labor market conditions and inflation to touch its target rate of 2% before hiking rates.

Fed officials with a hawkish stance also said that further delay in raising rates will show lack of confidence in the economy. Fed officials said volatility in the financial markets has subsided since September. According to them, “the U.S. financial system appeared to have weathered the turbulence in global financial markets without any sign of systemic stress.” Moreover, officials believe that there is “solid underlying momentum” in business and consumer demand, despite a slowdown in third-quarter GDP growth.

Economic Data

Last week, economic data was inclined toward the positive side. The U.S. Department of Commerce reported in its “second” estimate that the economy grew at a pace of 2.1% in the third quarter, compared to earlier projected growth rate of 1.5%. Also, third quarter’s growth rate came in higher than the consensus estimate of 2% growth.

An upward revision in business inventories emerged as the main reason behind the expansion in quarter. Business inventories were revised upward from $56.8 billion reported in “advance” estimate to $90.2 billion. However, third-quarter growth remained below second quarter’s rate of 3.9%.

The U.S. Department of Commerce reported that new orders for manufactured durable goods rose by $6.9 billion or 3% in October to $239 billion, significantly beating the consensus estimate of a 1.6% rise. Increase in demand for large, commercial airplanes was mainly behind the gain in October. It was preceded by a 0.8% decline in September.

Moreover, the Labor Department reported that jobless claims in the week ending Nov 21 declined by 12,000 from the previous week to 260,000. According to the Commerce Department, personal income rose $68.1 billion or 0.4% in October, in line with the consensus estimate. It was higher than September’s increase of 0.2%. These strong data added to rate hike possibility.

REITs: You Can Actually Buy Them Now

Interestingly, we have a contrarian view about what to do with REITs. Many would say that REITs should be offloaded and they are not very wrong given that these thrive in a low rate environment. Low rates imply low borrowing cost for the Real Estate Investment Trusts (REITs) that allow them to purchase or develop real estate. Moreover, REIT stock yields become more attractive when Treasury yields fall (REITs are often treated as bonds because of their high dividend paying nature and therefore, Treasury yields end up playing a significant role in their price movement).

Rising interest rates lead to an increase in interest costs as REITs usually look for both fixed and variable rate debt financing to pay back maturing debt, and fund their acquisitions, development and redevelopment activities. Therefore, REITs cannot practically run away from the impact of rate hikes. But the extent of such an impact would depend on the nature of their leases and funding activities.

As for the contrarian view, an improving economy will step up REIT activities and thus an increased demand for space. Since supply has been slow with tepid economic recovery in the past, this increase in demand would lead to higher rents and occupancy rates. Also, if rate hike is gradual, REITs will get enough time to adjust.

The REIT sector investors in particular should get a boost from a stronger U.S. job market, improving consumer confidence and stable housing recovery.

Adjustments with the rate environment would be comparatively easier for sectors with the advantage of pricing power like hotel, storage and apartment REITs that have shorter-term leases.

Meanwhile, a NAREIT study shows that out of the 16 periods of significant interest rate rise since 1995, listed equity REIT returns were positive in 12. This implies that REITs actually gather more steam amid rising rates.

Moreover, REITs have been proactive in the capital market in recent years. They have opportunistically used the low rate environment to make their finances more flexible, which is encouraging down the line for their operational efficiencies.

3 REIT Funds to Buy

On that note, investing in funds focused on REITs would be a prudent move. Below we present 3 funds, which have significant exposure to REITs and carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund.

Cohen & Steers Real Estate Securities A (CSEIX - MF report) seeks total return. CSEIX invests a large chunk of its assets in common stocks of companies whose operations are related to the real estate domain and REITs. CSEIX is expected to invest not more than 20% of its assets in non-U.S. companies including that from emerging economies.

CSEIX currently carries a Zacks Mutual Fund Rank #1. Over year-to-date and 1-year periods, CSEIX has gained 6.7% and 9.3%, respectively. The respective 3- and 5-year annualized returns are 15.4% and 13.6%. CSEIX has an annual expense ratio of 1.21%, which is lower than the category average of 1.29%.

T. Rowe Price Real Estate (TRREX - MF report) seeks capital appreciation over the long run with growth in current income. TREEX invests a majority of its assets in companies from the real estate domain. TRREX also allocates a notable share of its assets in real estate investment trusts (REITs), including equity REITs and mortgage REITs. The fund may also invest in non-U.S. firms.

TRREX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, TRREX has gained 4.7% and 7.1%, respectively. The respective 3- and 5-year annualized returns are 13.5% and 12.7%. TRREX has an annual expense ratio of 0.76%, which is lower than the category average of 1.29%.

Franklin Real Estate Securities A (FREEX - MF report) invests most of its assets in securities of companies that qualify under federal tax law as REITs and in companies that earn at least 50% of their revenues from residential or commercial real estate activities.

FREEX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, FREEX has gained 2.4% and 4.6%, respectively. The respective 3- and 5-year annualized returns are 12.3% and 12.4%. FREEX has an annual expense ratio of 0.99%, which is lower than the category average of 1.29%.