With interest rates set to rise, income investors are understandably concerned about the potentially negative effect of higher borrowing costs on their rate-sensitive assets, but real estate investment trusts and related exchange traded funds may be seen as an alternative income opportunity for yield-minded investors.
“As we continue to operate in a rising rate environment, investors are considering how to capitalize on these dynamics and generate meaningful returns. One way to do so is by utilizing REIT ETFs, which unlike other real assets provide long term fixed cash flow and the shorter duration end of the market provides lower volatility and lower sensitivity to rising rates,” Martin Kremenstein, Head of NuShares, Nuveen’s ETF business, said in a note.
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Nuveen also has its own REITs-related ETF offering, the NuShares Short-Term REIT ETF (BATS: NURE), which which is comprised of real estate investment trusts that invest in residential or commercial real estate with a shorter-than-average lease duration than REITs investing in other sectors.
NURE provides “access to REITs with short-term lease agreements which may be less volatile and sensitive to interest-rate changes than longer-term REIT,” according to Nuveen.
These types of shorter-term REITs may be a good way for income-minded investors access yield generation in a rising rate environment as short-term contracts allow businesses to more quickly reprice and adapt to changing market environments. Due to the REITs structure that allows the majority of revenue to be distributed as income to shareholders, businesses’ prudent reactions could translate to higher returns for investors. NURE shows a 3.54% 12-month yield.
Conventional wisdom makes us think that most income assets are sensitive to rate changes because higher rates usually mean their prices fall and vice-versa. REITs, though, are much more complex. Interest rates typically rise during a strong economy,and while higher short-term rates may have a negative impact on real estate debt, the benefits of a stronger economy may also outweigh the downside from slightly higher rates.
Moreover, a stronger economy could also support profitability and yield of REITs. An improving economy could provide greater opportunity for income generation from each property within REITs as properties are more likely to appreciate due to greater demand. Furthermore, rising employment drives higher occupancy rates, which translates to greater rents and greater profitability or higher payouts for investors.
Investors interested in gaining broad exposure to the dividend-paying REITs can look at ETF options like the Vanguard REIT ETF (NYSEArca: VNQ), iShares Dow Jones US Real Estate Index Fund (NYSEArca: IYR) and Schwab US REIT ETF (NYSEArca: SCHH), among others. Additionally, for those interested in the potential growth of small-cap REITs, investors can look to the targeted IndexIQ US Real Estate Small Cap ETF (NYSEArca: ROOF).
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