REITs and rate uncertainty: investment opportunity or future collapse?

REITs are increasingly attracting the attention of investors due to the significant depreciation suffered in recent years due to rising interest rates.
With the new expectations related to rates, recently somewhat dampened, many are wondering whether the right time has come for a rebound in the price of the various REITs listed on international stock exchanges.
The answer to this question is not immediate and investment in these assets, while attractive, requires careful consideration, especially in this particular historical period.
Indeed, although an imminent lowering of rates is expected, this does not automatically imply a return to favorable financial conditions in the short term for companies, and in the specific case of REITs, this could have a high cost.
What are REITs and how is their business structured? REITs, an acronym for Real Estate Investment Trusts, are companies that own, manage or finance profitable real estate.
They offer investors the opportunity to participate in the real estate market without the burden of purchasing, managing or financing properties directly.
To retain REIT status, they must distribute at least 90% of their taxable income to shareholders, making them attractive to those seeking regular income.
Furthermore, being listed on the stock exchange, REITs offer greater liquidity than direct investment in real estate.
They allow you to diversify investments across various types of properties and geographical areas, but they also expose you to the high risks of the real estate sector.
read also What are real estate REITs and how to invest How do interest rates impact the business of a REITs? REITs present risks related to real estate market fluctuations and changes in interest rates, and their performance is influenced by company management.
A key factor is the relationship between REITs and money market performance, due to their reliance on debt to finance real estate purchases and developments.
Rising interest rates raise the cost of debt, reducing REITs' profit margins, while lower rates can lower the cost of debt, improving profitability.
Additionally, interest rates affect property values: higher rates can decrease demand and lower property prices.
REITs often use leverage to maximize profits, which can make them vulnerable to sudden and prolonged increases in interest rates, increasing the cost of servicing debt.
If rates remain high, REITs may face cash flow pressure.
In extreme situations, a highly indebted REIT with insufficient revenue to cover debt costs may face financial distress or bankruptcy.
What's happening to highly leveraged stocks? The risk of commercial failure, accentuated by the current financial structure, is growing, especially in the United States, where bankruptcy filings increased by 72% in 2023.
The cause is simple: the 2020 pandemic has increased the need for financing for companies, which took advantage of almost zero rates.
However, rising financing costs combined with rapidly rising interest rates in recent years have weighed heavily on the balance sheets of over-leveraged companies, often leading them to collapse.
REITs, not all, are considered highly leveraged companies due to the nature of the real estate market.
The bankruptcy of WeWork, for example, a company that rents and sells co-working spaces, in November 2023, alarmed many investors, despite its business model differing from that typical of REITs.
So what to expect from REITS? It must be considered that, in order to address certain difficulties, the financial structure of REITs has progressively become oriented towards the market.
REITs, in which it is possible to invest through the stock market, collect a large part of their financial needs from the stock market, in order to reduce financial leverage.
This leads to a reduction in short-term exposure, but at the same time an increase in long-term exposure.
However, they remain strongly anchored in performance and the size of dividends, which could become less competitive in the market in periods of high bond yields.
Since most listed REITs are investment grade, they are assumed to have access to favorable financial terms, shifting the focus to the long term.
This is why the idea, previously hypothesized by Powell, of "high rates for longer" was worrying, considering that the average duration of the debt of REITs is 6.5 years, and that the debt is mainly at a fixed rate.
The FOMC minutes did not provide specific guidance on the future path of interest rates, and Fed officials show a high degree of uncertainty about the US economic outlook.
Despite this, the market and many experts expect three rate cuts in 2024, starting in March, but this will mainly depend on the country's economic performance.
As a result, stock markets have recently reduced interest rate bets.
This uncertainty makes investment decisions in real estate trusts more complex.
Looking at the ETF market globally, Ishares Developed Markets Property Yield has shown positive performance in recent sessions.
Although it is still about 30% away from the highs of 2022 and closed 2023 at a loss, in December it recorded an 18% growth from the lows of the month, supported by the new monetary policy assumptions of the US central bank.