Daily Gains Letter

Time for Income-Starved Investors to Reconsider REITs?

By for Daily Gains Letter |

Time for Income-Starved Investors to Reconsider REITsAfter a serious pullback in May, is it time for income-starved investors to reconsider real estate investment trusts (REITs)? Or will America’s favorite sugar daddy, Federal Reserve Chairman Ben Bernanke, tease investors with ongoing threats of tapering?

The North American REIT bull market was stopped dead in its tracks on May 22, after Bernanke hinted the central bank might begin tapering its massive $85.0-billion-per-month government bond-buying program.

By being the major purchaser of U.S. government bonds, the Federal Reserve has been able to keep interest rates artificially low. Tapering its bond-buying program would mean, in theory, that interest rates head higher. In an effort to protect their retirement portfolio, investors are selling stocks they see as being vulnerable to rising interest rates.

REITs are at the top of the list. That’s because REITs are in the business of purchasing property and higher interest rates on the heels of financing translates into lower profitability.

While artificially low interest rates are a godsend to REITs, they’re a nightmare for average Americans looking to generate retirement income on their long-term bonds.

Interestingly, since May and the ensuing market volatility, the Federal Reserve has said that inevitable tapering would not necessarily result in higher interest rates. That’s more good news for REITs—and more bad news for income-dependent investors.

Unfortunately, many REITs have failed to fully recover from the Federal Reserve’s May 22 comments. Those depressed prices have opened up a door of opportunity for savvy investors. That’s because, when prices for REITs (and dividend stocks) fall, yields rise. The volatility means investors can pick up quality REITs at depressed prices with higher returns.

REIT volatility could diminish in the short term, as fears of looming higher interest rates fade. After all, the chances of the Federal Reserve hiking interest rates in a climate of high unemployment and weak overall economic growth are virtually nil.

For investors looking to generate income and capital appreciation, REITs are more attractive now than they were in the spring—not just because they’re cheaper, but because their yields are, by extension, higher.

After climbing more than 17% between January and May 22, the SPDR Dow Jones REIT (NYSEArca/RWR) has lost 15% of its value and more than erased all of the year-to-date gains.

Between January and May 22, iShares Cohen & Steers Realty Majors (NYSEArca/ICF) climbed more than 16%; since then, however, it has lost 15% of its value and is trading at levels not seen since December 2012.

While some investors may be staying away from REITs, the current entry-level prices, yields, and outlook make them an attractive option.

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