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North American REITs have reduced their debt and refinanced loans at lower rates in recent years, making them less vulnerable to rising interest rates.putilich/iStockPhoto / Getty Images

Rising interest rates are considered bad news for interest-sensitive real estate investment trusts, so should investors stay away?

Not necessarily.

In general, experts say North American REITs have reduced their debt and refinanced loans at lower rates in recent years, making them less vulnerable to rising interest rates. And as an investment class, they may even prove to be a bit of an inflation hedge.

“There is often a knee-jerk reaction when rates move up to get out of interest-rate sensitive [investments] and REITs clearly fall into that bucket for some,” says Mike McNabb, a portfolio manager with Purpose Investments of Toronto.

He notes that in the last period of increasing rates – February, 2016, to October, 2018, when rates moved from 1 per cent to 2.6 per cent – the overall REIT market returned more than 22 per cent.

As an investment class, REITs typically do well during periods of inflation by raising rents, adds Mr. McNabb, who is co-manager of the Purpose Real Estate Income Fund (PHR-T).

“I look at them more than as an inflation play than as an interest-rate play,” he says. “In the majority of our portfolio, you are seeing rents far exceeding that of the current rate of inflation, especially re-leasing.”

Mr. McNabb says PHR is different than other Canadian REIT ETFs because it has near-equal domestic and U.S. holdings. The actively managed fund is also heavily tilted to the solidly performing apartment sector as well as retirement homes, which are likely to rebound with the end of the pandemic. He says the fund previously bought into the technology side of real estate, namely U.S. cell tower and data centre operators, and may invest in that area again as they are trading in bargain territory.

The Purpose fund is one of the smallest REIT ETFs with about $23-million in assets. It has a management expense ratio (MER) of 0.78 per cent and returned about 28 per cent over the past year (All data from Morningstar as of March 2 close).

Based on assets, the most popular REIT ETFs are the iShares S&P/TSX Capped REIT ETF (XRE-T), with about $1.3-billion in assets and an MER of 0.61 per cent; the BMO Equal Weight REITs ETF (ZRE-T), with $814-million in assets and an MER of 0.61 per cent, and the CI Canadian REIT ETF (RIT-T), with about $762-million in assets and an MER of 0.86 per cent. Each has returned between 24 per cent to 28 per cent over the past year.

The direction of interest rates is not the only factor REIT investors need to consider, says Brooke Thackray, a research analyst with Horizons ETFs (Canada) Inc. of Toronto.

“REITs will tend to do okay if rates are rising if it’s because of economic growth,” Mr. Thackray says. “If it’s not because of economic growth, but because inflation is coming and bondholders want to be compensated for that inflation, that’s when they can perform poorly.”

Investors don’t have to look too far back to find this scenario: REITs performed poorly in 2020 when governments were locking down economic activity because of the pandemic.

Mr. Thackray also points to periods of rapidly rising rates, such as the 2013 “taper tantrum,” when REITs underperformed.

His firm offers the Horizons Equal Weight Canada REIT ETF (HCRE-T) with an MER of 0.33 per cent and about $77-million in assets. It returned 27 per cent over the past year.

Other options for ETF investors include the Vanguard FTSE Canadian Capped REIT ETF (VRE-T) with a 0.38-per-cent fee and about $350-million in assets which returned 19 per cent over the past 12 months and the iShares Global Real Estate ETF (CGR-T) with a 0.71-per-cent fee and about $245-million in assets, which increased by about 16 per cent over the past year.

Given the expected U.S. growth rate of about 4 per cent this year, REITs in that country are expected to perform well, says Neena Mishra, director of ETF research with Zacks Investment Research in Chicago.

She singles out two U.S.-listed REITs: the iShares Residential and Multisector Real Estate ETF (REZ-A), which holds residential, health care and self-storage REITs; and the Nuveen Short-Term REIT ETF (NURE-A), which tends to be less sensitive to rate increases since it focuses on REITs that have shorter-term leases such as apartment buildings, hotels, self-storage and manufactured homes. REZ has about US$1.3-billion in assets, a fee of 0.48 per cent and returned about 30 per cent over the past year. NURE has US$124-million in assets, charges a fee of 0.35 per cent and is up 33 per cent over the past year.

“These are the two REITs that I think will do well in the current market environment and rising rates and rising inflation,” she says.

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