Real estate investment trusts (REITs) are making a comeback from their post-pandemic downturn—and with the sector still lagging the stock market, we’ve got a chance to buy at attractive discounts.
And we’re well set up to add some 7%+ dividend yields—that have started to grow lately—as we do, not in REITs directly, but in REIT-focused closed-end funds (CEFs).
REITs’ Lag Has Been Dramatic, But the Winds Are Shifting
While the S&P 500 has enjoyed a 14.0% annualized return over the last five years, as of this writing, REITs, as measured by the performance of the benchmark SPDR Dow Jones REIT ETF (RWR), have returned a paltry 2.6% annualized over the same period.
That’s unusual, as REITs—landlords who own properties ranging from apartments to data centers and warehouses—usually outperform the S&P 500, as you can see by RWR’s long-term return (from the date of RWR’s IPO) below.
REITs Typically Beat Stocks—Until Lately
What makes this trend even weirder is that it is happening even when there’s not been a shift in the trendlines between REIT prices and house prices. I know these may sound like separate things, so let me explain.
REITs Soar, Home Prices Fall
In the mid-2000s the housing bubble plateaued, as we can see in the US House Price Index (in blue above), but investor fervor for real estate more generally did not, causing investors to bid up RWR (in orange) far above the trendline we saw for houses.
Today, the trend is the exact opposite, with investors bidding less for REITs (again in orange) than the trend in house prices would suggest is most natural.
Higher House Prices, Lower REIT Prices
Housing prices have gained 7.2% per year on average over the last decade, yet RWR has gained just 3.7% over the same time period.
The reason? A 7.2% annualized gain is just too much for houses—if we go back 33 years, since records of this metric were first kept, housing rises an average 4.5% per year, so we’re due for a pullback. Still-high 30-year mortgage rates add further pressure here.
In other words, all the bad news is currently priced into REITs, which as we just saw, are lagging home prices.
This real estate pessimism means REITs are currently at a lower price point than they were both in 2007, during the bubble, and in 2015 to 2019, after the real estate market had recovered and mortgage rates continued to climb.
Real Estate’s Current Sale
This is important because interest rates are going to move lower, either in 2025 or later. And even if they do fall more slowly than people first thought, REITs will still be able to collect rents from their current portfolios as they wait for rates to decline, and still see their properties’ value increase, even if we see no rate cuts in 2025. The Fed, however, has made it clear that it does plan to cut rates.
When rates do fall, mortgages will get cheaper, driving more real estate demand.
But there’s another hidden benefit for REITs specifically, and that’s leverage.
When the Fed lowers interest rates, it lowers the cost of borrowing across the market, and that means REITs can borrow for less (and of course, they can already borrow for much less than your typical homebuyer). This expands their profit margins and results in more dividend cash handed over to investors.
So REITs can take advantage of lower rates to expand their book of owned properties.
Will REITs do that? Not only will they, but the data suggests they’ve already begun.
Before interest rates first started rising, REITs performed well, thanks to the weird economic factors of the pandemic, which meant that leverage was at a multi-decade low in 2021, when interest rates started to climb.
While REITs have started to borrow again (see right side of chart above), bringing current leverage ratios to mid-2010s levels, there’s still plenty of room for them to borrow and expand.
When they do, this will increase their net asset values (NAVs) and the total amount of income they receive, driving up payouts to shareholders in the form of higher dividends.
We’re already seeing this.
Higher Payouts for REIT Holders
Source: CEF Insider
After an unsurprising dip in income following the pandemic, REITs have been able to grow payouts so that they’re now 7.5% higher than pre-pandemic levels. Yet REITs cost less to buy now than they did back then.
With interest rates headed lower (again, even if slowly) and potential declines in housing prices priced in, REITs are compelling, but there’s another part of the story. Some REIT sectors (infrastructure, data centers and cell towers most notably) are seeing strong growth now, regardless of interest-rate trends.
Others, like office REITs, are recovering from the return-to-office trend that is still dominating work life, so much so that companies like Starbucks, Amazon and JPMorgan are requiring workers to return to the office.
Thus, even if housing prices fall in the future, it seems likely that other real estate sectors will see prices rise. And even if housing prices do fall, REITs’ ability to borrow at lower rates will let them pick up residential properties and start renting them out, collecting more income. This suggests REITs’ dividend hikes have just gotten started.
Think CEFs, Not ETFs, When Buying REITs
RWR’s 3.8% yield is really too small for us to take seriously, so I’d suggest playing this trend through a CEF like the Cohen & Steers Quality Income Realty Fund (RQI). The fund’s 8% yield has been consistent—RQI has maintained its dividend for the last nine years—and its total returns (in purple below) put those of RWR (in orange) to shame.
RQI Crushes the REIT Index
Despite its outperformance, high yield, and consistent dividend, RQI trades at a small discount to NAV—and that discount is likely to turn into a premium if market demand for both high yields and real estate continues apace.
Furthermore, with 13% of its portfolio in telecommunications, 11.2% in healthcare and 9.4% in data centers, the fund has positioned itself for those kinds of real estate seeing the most demand, while its single-family-home portfolio, at 3.5%, is much lighter, meaning it’s ready to profit from a downturn in home prices if they do happen to take a dip in the short term.
Huge 9.8% Dividends From … AI?!
REITs are far from the only investments we can tap through high-yielding CEFs. Few people realize it, but these funds also let us tap into AI’s continued growth and get a fat dividend yield in return.
Individual stocks? They just don’t cut it: AI poster boys like NVIDIA (NVDA), Microsoft and the like yield next to nothing.
That’s NOT the case with the 4 “AI-Powered” CEFs I’m pounding the table on now. They yield a fat 9.8% on average today and they’re ALL cheap—so much so that they essentially let us buy the AI stocks in their portfolios at prices that haven’t been available to “regular” investors for months.
Now is the time to buy these 4 impressive funds and start reaping big profits (and dividends) as AI continues to embed itself in our day-to-day lives.