In general, I’m a big fan of real estate investment trusts (REITs). I think they are relatively straightforward to understand and give my monthly income a steady boost.
Right now, though, rising interest rates have been hitting property prices and shares in real estate businesses have been falling. So is now a good time to buy REITs, or is there danger on the horizon?
Property investing
I like the idea of renting out property to generate passive income and the most obvious way of doing this is by buying a property to let out. Unfortunately, there are three main obstacles to me doing this.
The first is financing. To buy a property, I’d either need huge amounts of cash that I don’t have or a mortgage that I don’t want.
The second issue is work. If I bought a property to rent out, I’d have to find a tenant, sort out the legal work, and maintain the property, so I wouldn’t really be generating passive income.
The third is that returns on buy-to-lets where I live look pretty uninspiring. The average rental property in my area seems to have a yield of around 3.8% before taxes and fees.
None of these problems is decisive, but all of them can be avoided if I invested in a REIT instead of buying a property to rent out.
REITs own property and rent it out to tenants. They distribute their rental income to shareholders in the form of dividends.
Investing in a REIT allows me to avoid the major issues I have with buying a property to let out. I don’t have to buy a property outright, I don’t have to work on it, and the dividend yields can be attractive.
Interest rates
I own two REITs in my investment portfolio. They are Federal Realty Investment Trust and Realty Income Corporation.
Recently, shares in both have been coming down. This is the result of rising interest rates, which is putting pressure on the real estate sector more broadly.
Rising interest rates are bad for REITs for a few reasons. But the most pressing one is that it makes debt more expensive.
A consequence of paying out their earnings as dividends is that REITs often have to use debt to fund their growth. And higher interest rates mean that debt is more expensive.
This could be a particular problem for REITs that have debt that is due to mature soon. Higher interest rates could mean that they have to pay more in interest than they do at the moment.
Neither of the REITs that I own is particularly exposed to this, though. Their debt maturities are fairly well structured so that there isn’t an excessive amount of it expiring at any one time.
REIT investing
I still think that owning shares in a REIT is the best way for me to generate passive income from property. And I’m looking to add to my investments right now.
The prospect of higher interest rates is a genuine concern for property investors. But I think that the REITs that I own can continue to generate solid returns for me.