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REITs Investment Strategies Amid Interest Rate Cut Expectations

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Moomoo Research wrote a column · May 27 22:35
In the cyclical fluctuations of financial markets, the interest rate decisions of major central banks like the Federal Reserve have always been the guiding force behind global asset allocation. Recent data shows that the U.S. unadjusted CPI year-on-year for April was 3.4%, a slight decrease from the previous month's 3.5%. Meanwhile, the core CPI monthly rate slowed to 0.3%, the lowest level since last December, marking its first significant cooling after more than three consecutive months of exceeding expectations. This data change not only reflects an easing of inflationary pressures but also reignites market discussions about the prospect of interest rate cuts.
Chart: Month-over-Month Seasonally Adjusted Core CPI in the U.S. Over the Past Year
Source: Macromicro
Source: Macromicro
In this macroeconomic context, Real Estate Investment Trusts (REITs), serving as a crucial bridge between the real estate and capital markets, are increasingly highlighting their investment value amid expectations of interest rate cuts. As REITs investment expert Ralph L. Block noted, "The prices of REITs rise with the cash flows from properties and the increase in asset values, making them ideal for investors seeking dividend income and moderate price appreciation." Therefore, with the growing anticipation of the rate cuts, exploring REIT investment strategies is of significant importance for portfolio construction.
I. What are REITs and How are They Priced?
Real Estate Investment Trusts (REITs) are a type of trust fund that pools capital from investors, which is then invested and managed by professional institutions in real estate projects. Over 90% of the post-tax net income is distributed to investors. Essentially, REITs are an institutional arrangement for investing in real estate.
Traditional real estate investments have drawbacks such as large capital requirements, lack of liquidity, difficulty in cashing out, and high transaction taxes. REITs retain the benefits of traditional real estate investments while eliminating these drawbacks:
(1)Regular Mandatory High Dividends: Most countries require REITs to distribute at least 90% of their net income to investors annually, providing a steady cash flow. Dividends are typically paid quarterly or semi-annually. However, it's important to note that distributions are still subject to the operational performance of the REITs and carry volatility risks, thus not guaranteeing returns.
(2)Lower Investment and Higher Liquidity: Compared to direct real estate investments, REITs offer higher liquidity and lower investment amounts.
(3)Lower Transaction Costs: Purchasing index REITs is akin to buying mutual fund stocks, which is cheaper compared to the high taxes and fees associated with direct real estate investments.
(4)Professional Management: REIT management teams are usually composed of real estate professionals who are more attuned to industry trends.
The pricing mechanism of REITs is a complex process influenced not only by the cash flows from the underlying assets but also by factors such as capital market supply and demand, interest rates, real estate market cycles, and investor expectations. We focus on the creation and acquisition cycle of their cash flows:
(1)Cash Flow Creation: The primary income source for REITs is the rent generated from their owned and operated real estate assets. Stable leases and high occupancy rates mean more stable cash flows. Additionally, REITs can increase cash flows by enhancing their asset portfolio value and effective management, such as through renovations, new developments, proper use of financial leverage, and cost control.
(2)Acquisition Cycle: The cash flow acquisition cycle of REITs is closely related to the characteristics of their underlying assets, ranging from a few months to several decades, depending on asset types and contract terms.
II. The Impact of Interest Rate Cuts on REITs
When market interest rate expectations decline, REITs often become more attractive to investors. This is because a lower interest rate environment makes the dividend yields of REITs more appealing compared to other fixed-income investments, thereby attracting more investors and driving up the market price of REITs.
Thus, interest rate cuts typically enhance the market performance and investment appeal of REITs. The anticipation of rate cuts or the early stage of a rate-cutting cycle often presents a favorable opportunity to invest in REITs. During this period, market optimism about the future gradually accumulates, and the prices of REITs have not yet fully reflected the positive effects of the rate cuts, providing potential room for appreciation.
III. How to Invest in REITs
When investing in REITs, related ETFs are a stable and safe investment choice. They diversify risk through a portfolio of various REITs, increase investment transparency, and simplify operations, allowing investors to achieve diversified investments with a single click. This flexibility helps investors adapt to market changes easily, whether they are novices or seasoned investors.
Here, we recommend several REIT-related ETFs in the U.S. market. Investors can choose based on their investment preferences:
1. $Vanguard Real Estate ETF(VNQ.US)$: This ETF tracks the MSCI U.S. Investable Market Real Estate 25/50 Index, which includes real estate stocks within the U.S. investment market, covering various REITs except mortgage REITs, such as office buildings, malls, hotels, and apartments. VNQ is one of the largest REIT-related ETFs in the market, offering broad exposure to the real estate industry with low fees and good liquidity.
REITs Investment Strategies Amid Interest Rate Cut Expectations
VNQ is renowned for providing stable dividend returns. As of May 27, 2024, VNQ offers a dividend yield of 4.22% and has an asset size of $32.556 billion. Its major holdings include several REIT-related companies such as Prologis, Public Storage, and Simon Property Group. Additionally, VNQ has an expense ratio of approximately 0.08%, making its transaction costs lower compared to its peers.
REITs Investment Strategies Amid Interest Rate Cut Expectations
2. $Schwab Strategic Tr Us Reit Etf(SCHH.US)$: This ETF tracks the Dow Jones U.S. Select REIT Index, which includes publicly traded REITs in the U.S. real estate market. It represents the U.S. commercial real estate market and provides investors with returns related to direct real estate investments in the United States. SCHH offers investment in U.S. REITs at a relatively low expense ratio, making it suitable for cost-conscious investors.
REITs Investment Strategies Amid Interest Rate Cut Expectations
As of May 27, 2024, SCHH offers a dividend yield of 3.41% and has an asset size of $6.385 billion. Its major holdings include several REIT-related companies such as Prologis and Welltower. Additionally, SCHH has an expense ratio of approximately 0.07%, providing a significant cost advantage within the industry.
REITs Investment Strategies Amid Interest Rate Cut Expectations
3. $Real Estate Select Sector Spdr Fund (The)(XLRE.US)$: This ETF tracks the Real Estate Select Sector Index, which includes companies in the S&P 500 that are involved in the real estate business. This index is a subset of the S&P 500, focusing on the real estate sector, and includes companies involved in real estate development and direct real estate operations, primarily REIT-related trusts. XLRE is part of the Select Sector SPDR series, offering lower risk.
REITs Investment Strategies Amid Interest Rate Cut Expectations
As of May 27, 2024, XLRE offers a dividend yield of 3.57% and has an asset size of $5.959 billion. Its major holdings include several REIT-related companies such as Prologis and Simon Property Group. Additionally, XLRE has an expense ratio of approximately 0.4%.
REITs Investment Strategies Amid Interest Rate Cut Expectations
4. $iShares US Real Estate ETF(IYR.US)$: This ETF tracks the Dow Jones U.S. Real Estate Index, which reflects the overall performance of the U.S. real estate industry. It includes companies from residential, commercial, and industrial real estate sectors, as well as various REIT-related trusts. IYR provides broad investment exposure to the U.S. real estate market, encompassing residential, commercial, and industrial REITs.
REITs Investment Strategies Amid Interest Rate Cut Expectations
As of May 27, 2024, IYR offers a dividend yield of 2.82% and has an asset size of $3.01 billion. Its major holdings include several REIT-related companies such as Prologis, American Tower, and Simon Property Group. Additionally, IYR has an expense ratio of approximately 0.42%, which is relatively higher.
REITs Investment Strategies Amid Interest Rate Cut Expectations
5. $Spdr Dj Wilshire Reit Etf(RWR.US)$: This ETF tracks the same index as SCHH, the Dow Jones U.S. Select REIT Index, which represents publicly traded REITs in the United States. Unlike SCHH, RWR has a smaller asset size and relatively lower liquidity. However, RWR was launched earlier than SCHH and has higher market recognition. Additionally, there are some differences in their holdings distribution.
REITs Investment Strategies Amid Interest Rate Cut Expectations
As of May 27, 2024, RWR offers a dividend yield of 3.90% and has an asset size of $1.424 billion. Its expense ratio is 0.25%.
REITs Investment Strategies Amid Interest Rate Cut Expectations
Risk Warning
Amid expectations of interest rate cuts, REITs present attractive investment opportunities. However, while seizing this opportunity, investors should deeply understand and be wary of the accompanying risks. For instance:
-REITs do not guarantee investment returns. Market conditions, real estate policies, and economic cycles can all affect property occupancy rates and rents, thereby impacting the fund's income. Consequently, the principal investment may suffer significant losses.
-If the majority of a REIT's returns come from a limited number of assets and properties, the price may fluctuate sharply due to changes in individual rents.
-REITs may use their capital to distribute dividends or may engage in actions such as issuing additional shares. This places high demands on the capabilities and integrity of the actual controllers. Therefore, investors should review the fund's historical performance announcements and financial reports to understand the composition of dividends and the history of financing activities to avoid managers with questionable integrity.
Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only. Read more
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