Are REIT’s a Good Investment When Interest Rates Are Low?

Low interest rates can act as a lever to enable investors to buy assets during a recession. Low interest rates can help to start a stock market or real estate market boom. So it is tempting to think that this is the time to buy a REIT, but that is wrong. The ideal time to buy assets is not when financing is chap, rather one should buy when financing is expensive because then the price will have been reduced because higher interest rates make assets less affordable.

The Fed’s low interest rates are short term and are not locked in and are specially designed to lure investors and business into taking risks and expanding their assets. But as soon as the economy recovers then the Fed will raise rates, thus hurting valuations of real estate. So an era of low rates can be a debt/deflation trap which is like a “value trap” for stock investors who misdiagnose low prices and high dividend yields as bargain when it is really a tip off that a crash is coming.

The decision to buy a REIT should be made by assuming that a REIT has no debt and then analyzing the cash flow to see what the yield is after all expenses. Of course you would need to analyze it with the interest expense as well, but for clarity an investor in real estate needs to see what is the return if the asset had no debt service. If a REIT can’t provide a yield as good as a long term maturity BB or BBB bond (using a long term average of interest rates instead of today’s low rates) then it is overpriced. It is necessary to also see if the REIT is well managed with no deferred maintenance and proper depreciation. The median PE ratio for mutual funds that invest in real estate companies was 39.7, which implies a 2.5% earnings yield.

Offering rental property for rent is simply another service that can suffer from a lack of demand. During hard times consumers and business reduce the amount of real estate that they occupy, or move to a lesser quality property, work from home, etc.

About the author

Don Martin, CFP®

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