As interest rates start rising after more than a decade at historic lows, investors are asking whether the trend is going to help or hurt real estate investment trusts (REITs).
Historically, upward moves in interest rates have dimmed interest in REITs relative to stocks, because investors often see REITs as a proxy for bonds. Bonds typically fall in price as interest rates rise. But there are reasons to challenge this common perception. REITs have some bond-like features, but are different in several important ways.
REITs own office buildings, shopping centers, seniors homes, industrial properties, apartment complexes and specialty buildings such as those that house data warehouses and pharmaceutical laboratories. The REITs lease these properties to tenants. They are popular with investors seeking income because after collecting the rent and paying their expenses, REITs pay out the bulk of what’s left to shareholders in the form of dividends.
Photos courtesy of Orpea Groupe (Retirement Homes and Care Clinics)
Global REITs such as the Harvest Global REIT Leaders Income ETF (TSX: HGR) capture these features by offering high quality holdings and income diversity outside of Canada.
The Harvest Global REIT Leaders Income Fund invests in an actively managed portfolio of between and 20 and 30 developed market real estate issuers. The average market cap of the portfolio is US $26 billion. Most are outside Canada. The average dividend yield as of October 31, 2018 was 2.96%.
The Harvest selection process uses a proprietary set of quality, valuation and momentum metrics that begins at the macro level and ends with the micro selection of securities.
The process starts by examining global geographic and REIT sub-sector rankings. Various filters are then applied. They include financial stability, relative value, market capitalization and price momentum. This creates an investable universe. From there, Harvest’s portfolio managers perform further fundamental analysis, paired with third party research to produce a list of companies with strong positioning in their markets. The list is reduced to a portfolio of 20 to 30 companies which are included in the ETF. The portfolio is actively managed and monitored daily.
“We can’t control the markets but we can control the quality of the companies we buy,” says Paul MacDonald, Chief Investment Officer. As interest rates rise, REITs can be affected in a different way than interest rate sensitive stocks and bonds. REIT returns are driven by conditions in the real estate market while interest sensitive stocks like banks and insurance companies, which hold intangible financial assets, are driven by the behavior of the stock market. The face value of bonds fall as rates rise.
Slowly rising rates can be positive for REITs because the trend reflects a growing economy. In the current climate, after a long period of record lows, economic activity is picking up. That implies stronger demand for prime real estate as companies expand.
REITs with high quality holdings and prime tenants can capture that demand through higher rental income. They can also pass along higher costs through rent increases. Rising rates are usually a central banks policy to curb inflation. Leases – unlike bonds – can include inflation adjustment clauses. Inflation also help REITs retain their real value as inflation tends to increase the price of property. All these factors gives REIT holders an advantage over bonds.
A recent MarketWatch article noted that since 1960, REITs have outperformed U.S. stocks by more than a full percentage point per year. The article’s source was analysis conducted by a researcher at Erasmus University in Rotterdam, The Netherlands and economists as two Dutch banks.
The researchers looked at the performance of worldwide financial assets between 1960 and 2015 and found that REITs have beaten inflation by an average of 6.43% a year. This compared to 5.45% a year for global stocks. They noted that over an investment period of 20 years, that gap would be enough to raise your total returns by a third. The REIT advantage occurred during recessions and economic expansions and during periods of rising inflation and falling inflation, the researchers found.
To reduce volatility, the Harvest Global REIT Leaders Income ETF will selectively write covered call options on up to 33% of the option eligible securities. The ETF is reconstituted quarterly, has sub-sector diversity and an active option strategy. Unlike many other Funds, HGR has very low exposure to Canada – offering a unique diversified income source.
The Harvest Global REIT Income Fund ETF stands out for four reasons: It is global, it owns high-quality leaders in each country where it invests. The companies are leaders with a history of consistent and growing dividends.
Along with large-cap exposure, investors get:
• A source of REIT investments outside of Canada
• Attractive monthly income with the opportunity for capital appreciation
• Covered call strategy on select REITS to generate additional income
• Exposure to growth sectors: Technology, Healthcare & E-Commerce
For more information on the Harvest Global REIT Leaders Income Fund:
Harvest Global REIT Leaders Income Fund