REITs Investment Strategies Amid Interest Rate Cut Expectations

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

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.

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.

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.

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:

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.

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.

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%.

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.

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%.

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.