REIT Party-Goers May Be Jumping Ship

An article over at CNN Money is titled Is the party over for real estate investing? That's really too broad, as the article is talking about REITs, Real Estate Investment Trusts, not all real estate investing.
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An article over at CNN Money is titled Is the party over for real estate investing? That's really too broad, as the article is talking about REITs, Real Estate Investment Trusts, not all real estate investing. Let's contrast the two investment activities.

So, what's a REIT?

A Real Estate Investment Trust pools the resources of investors to invest in either property equity or in mortgages. It's like a mutual fund in many respects, with investors buying shares and the trust managers handling the investment of their money. REITs can focus on single family properties, commercial buildings, shopping centers, office space, and/or industrial property. They can also focus only on buying mortgage notes or investing in the loans made with real estate as collateral.

Who invests in REITs?

When the stock market is too volatile or investors are seeking higher returns and perceived lower risk, many buy into REITs. When bonds are paying tiny returns, many move to REITs to get a higher ROI without adding too much risk (in their opinion). REITs allow the small investor with only a few hundred dollars to own an interest in large commercial real estate in a passive role. They rely on the expertise of the trust managers to buy and sell right, just as mutual fund investors rely on fund managers to put their money to work.

So, why may the REIT party be ending?

The major reason this article sees a negative near-future for REITs has to do with interest rates. The Federal Reserve is signaling that interest rate hikes are in the future, possibly later this year. When interest rates rise, bond yields rise with them. When bond yields begin to go back up, many of those investors who want low risk will leave REITs to return to bonds. An exodus of money will lower the value of the REIT holdings.

However, that is only one factor that influences REIT returns. It's not that simple, as the article goes on to discuss. If interest rates are raised, it's because of improvements in the economy, and real estate generally benefits from those improvements. Right now, many major REITs are stagnant-to-down in returns with rumors of rate increases. The glass-half-full attitude is that rising rates signal a better economy, and real estate will benefit when jobs improve and people have money to spend.

Some of the major banks and investment firms are advising their clients to hold on and stay in their REIT positions. But, all of this is just nice information for the more active investor. The passive REIT investor may indeed move back to bonds. Active investors are not passively relying on a manager to use their money. They are also not buying a small piece of a big pie. The active real estate investor I'm talking about is buying, selling and rental investing in a primary role, and there are major differences.

The active real estate investor is their own REIT.

Locating opportunities, buying to wholesale or flip to other investors, as well as buying to rehab or as a long term rental property are all strategies these investors employ. They are "macro" investors, not buying into big pots, but taking an individual property approach to profits. A major REIT is like a large ocean tanker. It has a dedicated function and turning it or maneuvering it for market changes isn't easy or fast.

The active real estate investor is constantly adapting to their local market and making adjustments to their strategies to adapt to market changes. It's faster and, other than rental property ownership, investing in shorter time periods. The factors that can hurt a REIT's returns can also change the tactics of these investors. Rising interest rates will impact cash flow from financed rental properties.

Shorter term investors who use transaction funding will also likely pay more to fund their deals. The good news is that they can adjust more like a speedboat than a tanker, so profit margins can be protected through market research and careful deal evaluation.

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