Investing in REITs: Here's What You Need to Know

REITs slumped in 2022, with the FTSE Nareit index producing a return of negative 25%, as the Fed raised interest rates.

Real estate investment trusts hit the skids last year, with the FTSE Nareit index generating a return of negative 25%, as the Federal Reserve raised interest rates big-time.

But REITs have bounced back this year, with the index returning 10.3% in January amid hopes the Fed would soon pull back from its tightening program.

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To be sure, now that it appears the Fed will be aggressive again, the index fell during the week ended Feb. 10.

So is now a good time to jump in to the REIT market? As a REIT shareholder myself, I would say no. With rates headed higher, REITs seem to have plenty of room to fall.

Rising interest rates hurt REITs because these enterprises borrow heavily to buy properties. And they compete with other yield-generating investments for investors’ attention.

I would like to buy more REIT shares, but I’m going to wait, hoping for lower buying levels. Of course, I may be wrong. And even if I’m not, it can’t hurt to start thinking about which REITs you’ll buy when the time comes.

Here are some of the strongest real estate sectors, all of which I’ve invested in myself, including the stocks mentioned.

Apartment REITs

Elevated home prices and exploding mortgage rates have made owning a home unaffordable for many of us. That means strong demand for apartments.

The biggest multifamily-housing REIT is AvalonBay Communities  (AVB) - Get Free Report.

The company “owns and operates high-quality multifamily buildings in urban and suburban coastal markets with demographics that allow AvalonBay to maintain high occupancies and drive strong rent growth,” Morningstar analyst Kevin Brown wrote in a commentary.

“These markets exhibit traits that create strong demand for apartments, like job growth … and attractive urban centers that draw younger people.”

He puts fair value for the stock at $250, 40% above its recent price of $179. It yields 3.68%.

Industrial REITs

The explosion of e-commerce in recent years has increased the importance of warehouses and distribution centers, which make up much of industrial REIT holdings.

Warehouse/distribution-center owners went on a building binge during the pandemic, when internet commerce soared. Now that online purchases have slowed, the warehouse sector has excess supply.

But internet buying has plenty of room for growth. E-commerce made up only 14.6% of retail sales last year. That total will undoubtedly climb in coming years.

The biggest industrial REIT is Prologis  (PLD) - Get Free Report.

“The company continues to benefit from the historically low vacancy rate environment in industrial real estate,” Morningstar analyst Suryansh Sharma wrote in a commentary. “The market for industrial real estate continues to be strong.”

To be sure, “we are seeing some signs of moderation,” he said. “We believe that weaker macroeconomic conditions, slower adoption of e-commerce, and a strong supply pipeline will result in the normalization of occupancy levels and market rent growth … in upcoming years.”

Sharma puts fair value for the stock at $124, compared to its recent price of $125. It yields 2.52%

Data Center REITs

Data usage is mushrooming, with much of it taking place in the cloud. That requires boatloads of computer and telecommunications equipment, which is stored in data centers. The need for data should only increase, putting this REIT sector in good stead.

The biggest data-center REIT is Equinix  (EQIX) - Get Free Report.

“Equinix is well positioned to benefit from three trends that we expect to continue growing: creation and use of data, the need for that data to be connected, and reliance on cloud providers,” Morningstar analyst Matthew Dolgin wrote in a commentary.

“Data center providers, which can accommodate data storage, computing, and connection needs, can flourish under these circumstances, and none is positioned better than Equinix.”

To be sure, Dolgin thinks the stock is currently overvalued. He puts fair value at $580, 19% below its recent price of $717. It yields 1.9%.

Cellphone Tower REITs

Cellphone usage continues to soar, with people utilizing their mobile devices for everything from watching TV to buying airline tickets.

For mobile phones to work -- everyone hates those dropped/interrupted calls -- telecom carriers such as Verizon, AT&T and T-Mobile need to have antennas on cellphone towers. So the owners of those towers are in the catbird seat, charging the carriers rent.

The biggest owner of cellphone towers is American Tower  (AMT) - Get Free Report.

“We think American Tower's strategy to diversify its tower portfolio globally leaves it best positioned among the three U.S. tower companies, as it is primed to benefit from the continually increasing demand in mobile data worldwide,” Dolgin wrote.

“However, we don't think veering into the data-center business, which it did with its acquisition of CoreSite, will pay off, and it distracts from the tower focus we liked for American Tower.”

Dolgin puts fair value for the stock at $210, and it recently traded at about that level. It has a dividend yield of 2.97%.

The author owns shares of AvalonBay Communities, Prologis, Equinix and American Tower.